Four types of variances analysis
Variances can be broadly classified into four main categories with corresponding sub-categories. Let’s break down each one and see how they can help businesses identify potential weak spots in their budgets.
1. Material efficiency variance
Calculating material variance helps you see how efficiently you are using your materials. Material cost variance, for example, is the difference between the standard cost of direct materials and the actual cost of direct materials that you use in your business.
On the other hand, material quantity variance measures the difference between the standard quantity of materials expected to complete a project and the actual amount you used.
Finally, there’s material price variance, which is the actual unit cost of an item minus its standard cost. Say you manufacture clothes, and you paid $9 per unit of fabric. If the standard cost was $10, you have a favorable efficiency variance because you paid less than the standard.
2. Labor variance
If your business is labor-intensive, it’s crucial to understand how your employees’ productivity compares to your labor costs. Calculating the direct labor efficiency variance determines whether your employees are spending time the way you anticipated. Say it takes four hours to sew a dress: If you budgeted five hours, that yields a favorable variance.
Another way to evaluate labor variance is by analyzing your labor costs. The labor rate variance is determined by calculating how much you spent on labor hours and seeing how that number compares to your original budget. For example, if a contractor who makes a dress for you charges $20 per hour, but you budgeted $22 per hour, you would have a favorable variance.
3. Overhead variance
Overhead variance refers to the difference between actual overhead and applied overhead.
In some cases, this can be a variable overhead variance that occurs when there is a discrepancy between your actual variable overhead and the standard variable overhead. Furthermore, the variable overhead efficiency variance is the difference between the real time it takes to manufacture a unit and the time budgeted for it.
On the other hand, a fixed overhead variance occurs when there is a difference between the standard fixed overhead for actual output and the actual fixed overhead.
4. Sales variance
If your business exceeds its sales goals or comes up short, this is called a sales variance. If you know how to calculate a volume variance, you can understand whether you have reached your expected sales levels.
For example, if you anticipated selling 100 bicycles this year but only sold 92, your sales volume variance is the cost of the eight bicycles you didn’t sell. This is an unfavorable variance because you didn’t sell quite as many bikes as you budgeted for.
Keep in mind; you only need to analyze the variances that apply to your business. For example, a service-based business like a law firm may only need to examine its labor efficiency variance. On the other hand, a construction company would want to keep close tabs on its material quantity variance.