Variance Analysis: Explained

What is it, how to calculate it, formula, why it's important

Let's talk about variance analysis. Sounds complicated, right? Well, it can be, but don't worry; I'm here to break it down for you in a way that even I can understand - and I'm the CFO!

First off, what is variance analysis? Essentially, it's a way for companies to compare their actual financial results to their budgeted or expected results, in order to identify any significant differences or variances.

Why is this important? Well, for one, it helps us understand if we're meeting our financial goals or if we need to make some adjustments. Maybe we're spending too much in one area or not enough in another. By analyzing these variances, we can make informed decisions about where to allocate our resources.

So, let's dive into the nitty-gritty. There are two main types of variances: favorable and unfavorable. A favorable variance is when our actual results are better than expected - for example, maybe we spent less than we budgeted for on a project or made more sales than we anticipated. On the other hand, an unfavorable variance is when our actual results are worse than expected - maybe we spent more than we budgeted or didn't sell as much as we thought we would.

It's important to note that just because a variance is unfavorable doesn't mean it's necessarily a bad thing. Sometimes there are factors outside of our control that impact our results. For example, maybe there was a global pandemic that affected our sales, or maybe the price of raw materials skyrocketed unexpectedly. In these cases, an unfavorable variance is understandable and not necessarily cause for alarm.

Okay, so we know what variances are and how to classify them. But how do we actually analyze them? One common method is to break down the variances into their component parts. For example, let's say we have an unfavorable variance in our sales revenue for the month. We can break that down into smaller variances, such as a decrease in quantity sold, a decrease in price per unit, or a decrease in the number of customers. By doing this, we can pinpoint the specific issue and work on correcting it.

Another thing to keep in mind when analyzing variances is the concept of materiality. In simple terms, this means that we should focus on the variances that are the most significant and ignore the ones that are too small to make a meaningful impact. For example, if we have a $10,000 unfavorable variance in a million-dollar budget, that's probably not a big deal. However, if we have the same variance in a $50,000 budget, that's a much bigger issue.

One final tip: when analyzing variances, it's important to look beyond the numbers and try to understand the underlying causes. Maybe there's a cultural issue in the company that's causing employees to be less productive, or maybe a key supplier is experiencing problems that are affecting our production. By understanding the root cause of a variance, we can develop a more effective solution.

So, there you have it - variance analysis in a nutshell. It's a vital tool for any company that wants to understand its financial performance and make informed decisions. If you're a business owner or manager, I highly recommend incorporating variance analysis into your financial planning and analysis process. Trust me, your CFO will thank you!

Financial modeling made easy

Looking to build a financial model for your startup? Build investor-ready models without Excel or experience in Finance.

By clicking “Accept”, you agree to the storing of cookies on your device to enhance site navigation, analyze site usage, and assist in our marketing efforts. View our Privacy Policy for more information.