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Variance Analysis: A Key component of Performance

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Financial Statements published for any company are the most widely referred to and used by the public. But for any company a vast majority of the accounts keeping and reporting are done by the management of the company.  These are reports which are created based on past and future events which help the company managers to plan their budgets, know the expenses, the costs and the profits and finally to analyse performance.

Reports are then internally created, tracked, discussed and examined to tabulate the performance of the company. One such important analysis is the variance analysis report. The definition of variance is to compare the standard cost with the actual cost incurred over a period of time for a particular activity. Variance analysis has two aspects: firstly, measuring the difference between the planned and actual cost, and secondly, determining the cause of variance between the planned and actual cost.

Reasons for variance

Many factors lead to causes in variance of the planned cost. Some of them are

  1. changed market conditions where the raw materials’ prices have been hiked due to its shortage or transportation issues
  2. or, the budgeting standards followed were very idealistic
  3. or, variations in service delivery standards
  4. or no past data available for estimating accurate costs.

Variance Analysis

Types of Variance analysis

There are various types of Variance analysis reports done by every company within various business units. They can be categorised broadly into three types:

  1. Material variances: This can be caused due to the difference between the planned and the actual costs incurred in the materials used. It can also be caused when there is difference between the amount of the planned versus the actual quantities of material used.
  2. Labour variances: This is due to the difference between the estimated cost of labour for production versus the actual labour amount paid for the planned production.
  3. Overhead variances: It can be of two types, fixed and variable overhead expenses. Overheads can be in areas of material, labour and other expenses. Overhead variances are calculated when there is difference between the overhead costs budgeted and actual costs

Significance of variance analysis

Variance analysis is a very important part of the organisation’s business planning and budgeting, finally leading to the profitability of the company. It encapsulates critical data for all future planning.

Benchmarks are set in advance against which, the performance and profitability of the company is judged. Hence a lot of time is invested by experienced personnel for maximising the benefits of this approach through calculated proactive thinking. These processes apply to the numerical part of the variance analysis.

In actually determining the cause for the variance , business units and teams get to learn why the deviations took place and where they have to plug the gaps so that similar losses do not occur in  future. Thus, this qualitative analysis helps in “post facto” determination of causes for loss and helps in fine-tuning the processes for future.

Lastly this process also lays down accountability of the various business groups in a company. It helps in the performance measurement of a particular group versus their budget and objectives and also the performance of its planning leaders.

Hence we understand that the variance analysis report is a key information database for any organisation to measure, track and improve their profitability and performance. Therefore  processes and practices should be put in place to utilise these reports to maximise the financial performance of a company.