What is Variance Analysis?
Variance analysis is the process of calculating and analyzing any differences in budgeted and actual performances. It is a tool that companies use to monitor and control their costs. However, it only takes a reactive approach to controlling, which means that it cannot prevent problems. Despite that, variance analysis plays a significant role for most companies.
There are several types of variance analysis that companies can use. For example, companies can use sales or cost variances to examine specific areas of interest. Similarly, companies may further divide variances into those caused by prices and those caused by usage or efficiency. Some companies may also use variance analysis to investigate product mixes, yields, or for planning variances.
The variance analysis process starts with establishing standards or preparing forecasts. Once companies do so, they must monitor their actual performance closely and identify any inefficiencies. Sometimes, the process may not be as straightforward, though. Therefore, companies will have to wait until the end of their accounting periods to obtain actual performance results.
Once companies have both their forecasts and actual results, they can compare both of them. This process comprises one of the parts of variance analysis, which is the calculation of a variance. Once companies identify any differences in their performances, they must investigate those variations. It is the second part of the process, which is investigating those differences.
What is the Importance of Variance Analysis?
Variance analysis plays a significant role in management and cost accounting. These are both areas in accounting that relate to controlling, monitoring and decision-making. Companies primarily use variance analysis to monitor actual costs and control them when needed. However, there is much more to that process apart from the basics.
Variance analysis can be of significant importance to companies for the following reasons.
Acts as a monitoring and control tool
Technically, variance analysis isn’t a monitoring tool. Instead, forecasts and budgets provide a basis for analyzing costs. However, companies cannot actually monitor their costs if they don’t compare them with actual results. It is where variance analysis is helpful. Companies can use variance analysis to calculate any differences between budgets and actual results.
Through this process, companies can actively identify any efficiencies and eliminate them on time. This way, companies can control any deviations from the set plans for performance. Similarly, companies can also accumulate all the information and perform variance analysis at the end of each period. Based on this process, they can make changes that can help avoid any inefficiencies in the future.
Focuses on favourable and adverse variances
Unlike some other tools, variance analysis focuses on both favorable and adverse variances. Although favorable variances are beneficial for companies, they still need to the reason behind it. Sometimes, these variances may come from miscalculations or improper budgeting, which companies should investigate. If that is not the case, companies still need to understand how these variances generated so they can build on the favorable performance.
Adverse variances, on the other hand, are harmful to the company. By analyzing these, companies can identify problem areas within their processes. By doing so, they can eliminate any problems which can be beneficial in the future. Some companies may only focus on adverse variances, though. However, variance analysis provides a tool to identify both favorable and adverse variances.
Considers significant variances
Variance analysis is a great tool to catch and rectify significant variances. Companies can suffer variances in actual performance due to several reasons. Sometimes, these reasons may be random or seasonal. However, variance analysis allows companies to adjust for these variances and allows a better performance analysis.
Similarly, variance analysis allows companies to consider material variances only. During the process, companies can set a threshold for the difference that they want to investigate. If any variance does not meet this threshold, companies can ignore that. This way, the process is much straightforward.
Detects inefficiencies in planning or operations
Variance analysis takes a budget and compares actual performances with it. However, it doesn’t focus on operational inefficiencies only. It also allows companies to examine their budgets for any unrealistic expectations. This way, companies can identify any problems with their forecasts and rectify them for the future.
Most of the time, however, variance analysis catches operational inefficiencies. It is one of the reasons why companies use it. Operational anomalies are common in every business environment. By identifying these, companies can uncover any problematic areas within their process and correct any errors.
Provides a basis for accountability
As mentioned, companies may focus on variance analysis toward specific areas. This way, variance analysis can allow companies to hold their managers accountable for their performance. Furthermore, companies can differentiate between controllable and uncontrollable variance. Through this process, they can further identify the departments or managers responsible for variances.
Some companies may also use variance analysis as a part of their performance appraisal. Similarly, companies may also reward managers for favorable variances. This way, variance analysis can provide an accountability tool for companies. Likewise, if the expectations are reasonable, companies can use variance analysis as a motivation tool.
Conclusion
Variation analysis is a process that companies use to identify any differences between budgeted and actual performances. This process can be of significant importance for companies. Given above are some of the reasons why variance analysis is critical for companies and businesses.
