Variance analysis is a valuable tool in managerial accounting where the deviations of actual performance are compared to budgeted or projected performance. This methodology allows business analysts to uncover the answers to critical questions pertaining to a project.
Metrics That Can Be Analyzed With Variance Analysis
Since variance analysis evaluates the difference between planned and actual figures, it can be applied to anything within a business. Things such as time, resources, or any other major project factor can be analyzed. With that said, there is a wide variety of well-known and commonly used variance analyses. The following is a very small sample of the possible variance analyses a small business can complete:
*Sales volume variance – measures the change in profit as a result of budgeted and actual sales.*Sales mix variance – measures the change in profit attributed to the variation in the proportion of different products sold.*Direct material price variance – analyzes the difference between the actual cost of direct material and the standard cost of quantity purchased.*Direct labour rate variance – analyzes differences between actual cost and the standard cost of labour utilized.*Fixed overhead volume capacity and efficiency variance – measures the difference between budgeted and actual fixed production overhead.
Example Variance Analysis
As a very simple example of variance analysis, assume a manager is reviewing two business projects that were just completed. He or she wants to determine the variance between the budgeted and actual number of employees needed for each of the projects. Project A was budgeted to need 10 employees but only actually required seven. Project B was budgeted to need eight employees but actually required 12. The variances for each project are:
Project A variance = ((budgeted – actual) / actual) = ((10 – 7) / 10) = 30%Project B variance = ((budgeted – actual) / actual) = ((8 – 12) / 8) = -50%
With the first project, the variance is positive. This indicates less resources were needed than planned. In most cases, this is a good result, but there may be cases where it is not. With the second project, the variance is negative. In almost all cases, a negative variance is worrisome. This is clear sign that more resources were needed than the budget required. In both cases, the results should be analyzed further.
Functions and Importance
Variance analysis is a tool that can help businesses plan, create standards, and employ benchmarks. Further, it acts as a control mechanism and highlights operational deviations. Analyses should always be done at the completion of a project and on a regular basis so management can correct course regularly. Lastly, due to accurate inputs required, this type of analysis facilitates responsible and accurate accounting procedures.
Common Causes of Variance
Common causes of variance include inappropriate procedures, poor working conditions, bad equipment, measurement error, accidents, poor equipment maintenance, computer malfunctions, and even traffic, weather, or natural disasters.