Analysing The Variance Report

Click here to view a video that explains what is Variance Analysis.

There will always be discrepancies between your budget and actual performance results. To make constructive adjustments for the future, provide for a framework with which to understand and analyse all such discrepancies.

It is important to understand why there are discrepancies, no matter how small, between your budget and actual performance. What might seem an insignificant discrepancy to you and your department could be crucial to the whole organisation, especially if other departments are also not meeting their budgets. By assessing why discrepancies have occurred, you will be able to ensure that the chances of them happening again are reduced and that future discrepancies are more efficiently anticipated.

Comparing actual performance with a budget is the traditional tool used by senior management to measure managerial and business performance. A good business management system asks questions such as “Do I have the correct plans in place?” and “How is each part of the business contributing?” A budget managed properly and taken seriously becomes a more forward-looking document that can assist senior management to identify trends, predict year-end results and avoid any unpleasant financial surprises.

The report has a heading showing the month of the year of the variance report.

You will see from the example that the actual results are compared to the budget and expressed as a variance. The results from the current year are then compared to the previous year and the variance is shown as a percentage.

It is important to continually monitor the discrepancies and understand how they have arisen. Variances are generally categorized as either budget errors or unexpected variances. Constant monitoring helps to promote a greater overall understanding of cost behaviour, which will help you produce a more accurate budget next time around. However, to do this well you must establish suitable monitoring procedures. Experience shows that to be truly effective, your procedure must be regular, easy to administer and sufficiently detailed.

Let’s look at how this is done:

Identify significant variances so that you can make sure that your budget is adhered to as closely as possible. To select which variances to look at further, consider the likelihood of the variance being controllable, the probable cost of investigating the variance and the chance that it might arise again in the future.

Once you have identified the variances there may be a lot that you can do about them. A controllable cost is one that can be influenced by the budget holder. If a cost is controllable then senior management will expect you to exercise your influence and adjust your expenditure where appropriate. Consider the situation where the cost price of raw material has increased significantly during the budget period. Although you cannot change the price of the raw material, perhaps you could use a cheaper alternative.

If skilled labour shortages drive up rates, consider using other grades or even lowering the skills needed for the job to avoid this constraint. Using alternatives is not the only type of control you can exercise. You could, for example, consider reducing your discretionary costs by choosing not to spend money on advertising, staff parties and bonuses.