Using Variance Analysis to Inform Business Decisions

Understanding the Concept

Variance analysis is a quantitative examination of the differences between planned financial outcomes and the actual results achieved.
It is a method used in financial planning and forecasting to understand a business’s performance and make informed decisions.
Variance analysis aims to identify and explain the reasons for the difference (the ‘variance’) between actual and projected figures.

Components of Variance Analysis

The process involves the comparison of actual results against budgeted or planned figures across different areas of the business - sales, expenditure, profits, etc.
Variance can be categorised as favourable (positive) or unfavourable (negative). A favourable variance implies better-than-expected results, while an unfavourable variance indicates the opposite.
For example, spending less than budgeted on materials results in a favourable variance, while earning less revenue than projected would result in an unfavourable variance.

Using Variance Analysis for Making Business Decisions

Variance analysis can help to highlight areas of concern or any potential opportunities within a business, enabling managers to take appropriate actions.
For example, if there’s an unfavourable variance in labour costs, the business could look into ways to better manage employee overtime or consider automating certain tasks.
On the other hand, a favourable variance in sales revenue might suggest a market opportunity to expand or invest more in a certain product or service.

Benefits of Variance Analysis

Variance analysis facilitates continuous improvement by allowing a business to review performance against targets regularly.
It helps businesses to forecast more accurately for future periods, as it provides insight into the trends and factors that are impacting financial performance.
By identifying specific areas where a business is spending more or less than planned, variance analysis guides strategic decision making, aiding in resource allocation and future business planning.

Limitations of Variance Analysis

Despite its benefits, variance analysis has its limitations. It is a historical analysis, meaning it’s based on past data, which may not always accurately reflect future trends or market conditions.
Variance analysis can often lack the context necessary to understand variances. For instance, an unfavourable variance might be due to an uncontrollable external factor like a natural disaster, or it might be a result of poor performance.
It’s also important to remember that variance analysis should be used as a tool for understanding and explaining differences in performance, rather than as a means of attributing blame or praise. It is the use of this information to make future improvements that is the real benefit of the analysis.