So we’ve seen some simple examples, in sample financial statements, of how things can go differently than planned. The real management here isn’t just the calculations, but rather the management of the differences.
You have to look beyond the numbers, talk to the people, bring these things up in the meetings so the plan stays alive as planning, and becomes management. It isn’t always obvious.
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 and actual numbers. Good management looks at what that difference means to the business.
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. Talk to the People
This presentation of variances shows how important good analysis is. In theory, the positive variances are good news because they mean spending was less than budgeted. The negative variance means spending was more than the budget.
Continuing with our example, the $5,000 positive variance in advertising in January means $5,000 less than planned was spent, and the $7,000 positive variance in literature (meaning collaterals, such as brochures, sales pamphlets and folders) 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.
Evaluating these variances takes thought. Positive variances aren’t always good news. For example:
- The postive variance of $5,000 in advertising means that money wasn’t spent, but it also means that advertising wasn’t placed. Systems sales were way below expectations for this same period — could the advertising missed in January be a possible cause?
- For literature, the positive $7,000 in February 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.
Among the larger single variances for an expense item in a month shown in the illustration was the positive $7,000 variance for the new literature expenses in February. Is this good news or bad news? Every variance should stimulate questions.
- Why did one project cost more or less than planned?
- Were objectives met?
- Does a positive variance reflect a cost saving or a failure to implement?
- Does a negative variance reflect 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.
Variance analysis on sales can be very complex. There can be significant differences between projected and actual sales because of different unit volumes, or because of different average prices. In the sales variance example in this chapter, the units variance shows that the sales of systems were disappointing. In the expenses variance, however, we can 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 thus not good for the company. Sales and Marketing expenses were also above plan in March, causing another negative variance.
The sales forecast variance table, shown earlier, which compares units variance and sales variance, yields no surprises. The lower-than-expected unit sales also had lower-than-expected sales values. Compare that with 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.
The quality of a business plan is measured not by the quality of its ideas, analysis, or presentation, but only by the implementation it causes. It is true, of course, that some business plans are developed only as selling documents to generate financial resources. For these plans, their worth is measured by their effectiveness in selling a business opportunity to a prospective investor. For plans created to help run a business, their worth is measured by how much they help run a business — in other words, their implementation.
Variance analysis is vital to good management. You have to track and follow up on budgets, mainly through variance analysis, or the budgets will be 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.