Many businesses, especially the small, entrepreneurial kind, ignore or forget the other half of the budgeting. Budgets are too often proposed, discussed, accepted, and forgotten. Variance analysis looks after-the-fact at what caused a difference between plan vs. actual. Good management looks at what that difference means to the business. Business Plan Pro Premier provides the plan vs. actual data that owners and managers need to do that critical variance analysis.
Variance analysis ranges from simple and straightforward to sophisticated and complex. Some cost-accounting systems separate variances into many types and categories. Sometimes a single result can be broken down into many different variances, both positive and negative.
The most sophisticated systems separate unit and price factors on materials, hours worked, cost-per-hour on direct labor, and fixed and variable overhead variances. Though difficult, this kind of analysis can be invaluable in a complex business.
Look for specifics
This presentation of variances shows how important good analysis is. In theory, the positive variances are good news because they mean spending less than budgeted. The negative variance means spending more than the budget.
In this example, the $5,000 positive variance in advertising in January means $5,000 less than planned was spent, and the $7,000 positive variance for literature in February means $7,000 less than planned was spent. The negative variance for advertising in February and March, and the negative variance for literature in March, show that more was spent than was planned for those items.
Illustration 1: Profit and Loss Variance
Evaluating these variances takes thought. Positive variances aren’t always good news. For example, the positive variance of $5,000 in advertising means that money wasn’t spent, but it also means that advertising wasn’t placed. Systems sales are way below expectations for this same period–could the advertising missed in January be a possible cause?
Among the larger single variances for an expense item in a month shown on the illustration was the positive $7,000 variance for the new literature expenses in February. Is this good news or bad news? It may be evidence of a missed deadline for literature that wasn’t actually completed until March. If so, at least it appears that the costs on completion were $6,401, a bit less than the $7,000 planned.
Every variance should stimulate questions. Why did one project cost more or less? Were objectives met? Is a positive variance a cost saving or a failure to implement? Is a negative variance a change in plans, a management failure, or an unrealistic budget?
A variance table can provide management with significant information. Without this data, some of these important questions might go unasked.
More on variance
Variance analysis on sales can be very complex. There can be very significant differences between higher or lower sales because of different unit volumes, or because of different average prices. Illustration 2 shows the Sales Forecast table (including costs) in variance mode, for the example company.
Illustration 2: Sales Forecast Variance
The units variance shows that the sales of systems were disappointing. In the expenses outlined in Illustration 1, we see that advertising and mailing costs were below plan. Could there be a correlation between the saved expenses in mailing, and the lower-than-planned sales? Yes, of course there could.
The mailing cost was much less than planned, but as a result the planned sales never came. The positive expense variance is not good for the company.
In systems, the comparison between units variance and sales variance yields no surprises. The lower-than-expected unit sales also had lower-than-expected sales values. Compare that to service, in which lower units yielded higher sales (indicating much higher prices than planned). Is this an indication of a new profit opportunity, or a new trend? This clearly depends on the specifics of your business.
It is often hard to tell what caused differences in costs. If spending schedules aren’t met, variance might be caused simply by lower unit volume. Management probably wants to know the results per unit, and the actual price, and the detailed feedback on the marketing programs.
Variance analysis is vital to good management. You have to track follow up on budgets, mainly through variance analysis, or the budgets are useless.
Although variance analysis can be very complex, the main guide is common sense. In general, going under budget is a positive variance, and over budget is a negative variance. But the real test of management should be whether or not the result was good for business.