How is variance analysis used to evaluate performance?

Are you uncertain about the true financial performance of your business? Are you missing out on valuable insights that could take your business to the next level? 

The uncertainty and lack of visibility into your financial performance can be overwhelming, but there is a solution called variance analysis.

In this article, we will dive into how variance analysis is used to analyze performance.

What is variance analysis in accounting?

Variance analysis is a way for businesses to understand how well they are doing financially. 

It compares what a business actually made or spent (the actual results) with what it planned to make or spend (the budgeted or expected results). 

By looking at the differences between these two sets of numbers, businesses can figure out where they did better or worse than planned and take steps to improve. 

This process is often used to look at things like how much a business made in sales or how much it spent on things like materials and labor.

Variance analysis is an important tool for businesses to evaluate their performance, identify areas for improvement, and make better decisions in the future.

How can variance analysis help plan a budget

Variance analysis helps businesses compare their actual financial results to their budgeted or expected results. 

By identifying the differences between these two data sets, businesses can better understand how they’re performing and adjust their future budget plans. 

Here are a few ways that variance analysis can help plan a budget:

Identifying trends: 

By looking at past results and comparing them to the budget, businesses can spot trends in their financial performance. 

Actual performance is then used to predict how they’ll perform in the future. This will allow them to calculate a more accurate figure when determining price and quantity. 

Identifying areas of over or under-performance: 

By comparing the company results to budgeted results, businesses can see where they’re doing better or worse than expected. 

This can help them identify which areas of their business need more resources or attention and make adjustments to their budgets.

Identifying cost inefficiencies: 

The use of variance analysis can also help businesses identify areas where they’re spending more money than they need to. 

Businesses can spot overspending and make changes to improve cost control by comparing actual costs to budgeted costs.

Improving forecasting accuracy: 

By analyzing the differences between actual and budgeted results, businesses can better understand how different factors affect the company’s actual performance. 

This can help them make more accurate predictions about their future performance and plan their budget accordingly.

Prioritizing resources: 

By identifying areas of over or under-performance, variance analysis can help businesses decide where to allocate resources effectively. 

This can help them make the most of their budget and ensure they’re getting the best return on their investment.

In simple terms, variance analysis helps a business to understand how it’s performing compared to what it planned for, and make adjustments to its budget plans accordingly. 

It’s a tool that helps businesses to be more efficient, proactive, and adaptable in their budget planning.

Different types of Variance analysis

There are different types of variance analysis that businesses can use; some of the most common include: 

Variance in Purchase and selling price: 

Purchase price variance: 

This looks at the difference between the actual price paid for materials used in production and the standard costs of those materials; it’s then multiplied by the number of units used.

Selling price variance: 

This looks at the difference between the actual selling price and the standard selling price, multiplied by the number of units sold.

Variable vs. Fixed Overhead Variances

Variable overhead spending variance: 

This is the difference between the actual cost of variable overhead and standard costs of variable overhead multiplied by the number of units produced.

Fixed overhead spending variance: 

This looks at the difference between the actual cost of fixed overhead and the standard cost of fixed overhead for the reporting period.

Variable overhead efficiency variance: 

This looks at the difference between the budgeted units of activity on which the variable overhead is charged and the actual units of activity multiplied by the standard variable overhead cost per unit.

Material Yield and Labor Hours Variances

Material yield variance:

This is the difference between the actual amount of direct materials used and the standard quantity of materials supposed to be used, multiplied by the standard price per unit.

Labor rate variance: 

This type of variance looks at the difference between the actual cost of direct labor used in production and the standard cost of labor; it’s then multiplied by the number of units used.

Labor efficiency variance:

This looks at the difference between the actual amount of labor used and the standard amount of labor consumed, multiplied by the standard labor rate per hour.

Importance

These variances are important in analyzing the performance of a business and identifying the areas that need improvements. 

By understanding and calculating these variances, businesses can make informed decisions and take necessary actions to improve their financial performance.

Variance analysis on financial statements

Analyzing variance on financial statements is a way to compare a business’s actual financial performance to what it had planned for. 

Here’s a general overview of how to analyze variance on financial statements:

Gather financial statements: 

Collect the actual financial statements, such as the income statement and balance sheet and compare them to the planned or budgeted financial statements.

Identify variances: 

Look for any differences between the actual and planned results. These differences can be in the form of over or under-performance in revenue, expenses, or other financial metrics.

Determine the cause of the variances:

Once you have identified the variances, try to understand the reasons for the differences. 

For example, if there is a variance in revenue, determine if it was caused by changes in sales volume, pricing, or product mix. 

If there is a variance in expenses, determine whether it was caused by changes in cost of goods sold, overhead costs, or other expenses.

Analyze the impact of variances: 

Evaluate the impact of the variances on the overall financial performance of the business. 

For example, a positive variance in revenue may have a positive impact on the bottom line, while a negative variance in revenue may have a negative impact.

Take corrective action: 

Based on the analysis, management can take corrective action to address variances. 

For example, suppose there is a variance in expenses. In that case, management may decide to cut costs, negotiate better prices with suppliers, or take other measures to reduce expenses.

Continuously monitor: 

It’s important to constantly monitor the variances to ensure that corrective actions are effective and if necessary, more action can be taken.

Conclusion

Variance analysis is used to analyze performance by comparing actual results with budgeted or expected results. 

By analyzing the differences between these two sets of data, businesses can identify trends, areas of over or under-performance, cost inefficiencies, and make adjustments to their future budget plans accordingly. 

The use of variance analysis can also help improve forecasting accuracy and prioritize resources.

For assistance, feel free to reach out.