What is Variance Analysis: A Frontier for Analysis

Data Analysis
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There are a variety of ways by which you can assess your business’ overall financial health and success. By utilising data analytics and performing variance analysis, you may become aware of business practices or decisions that need to be amended. But, many times, most businesses have a hard time conducting variance analysis because data is in many places, running analytics hasn’t yet been optimised to glean useful insights, and manipulating the data takes too much time. 

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We’ll outline what variance analysis means, the ways in which you can carry it out smarter so it is more useful and how automation tools can help perform the work for you so that you can use variance analysis to a greater advantage.

Table of Contents

1. What is the Variance Analysis?

2. Importance of Variance Analysis

3. The Role of Variance Analysis

4. Example of Variance Analysis

5. What are the Key Terms of Variance Analysis?

6. What are the Most Common Types of Variance Analysis?

7. Challenges of Variance Analysis

8. How Automation Tools Can Help

9. Wrap Up

What is the Variance Analysis?

Variance analysis is a method of assessing the difference between estimated budgets and actual numbers. It’s a quantitative method that helps to maintain better control over a business. When using variance analysis, one best practice is to review variances on a trend line so that you can readily pinpoint any dramatic shifts. Once you find anything that is suspect, variance analysis can help you to investigate the reason behind the big difference in what’s planned and what happened financially. 

During a reporting period, you can sum all variances to see if your business is over or under-performing. When you notice a significant shift in the variance trend line, then you can become aware of dysfunction and work to resolve it. But, where do you begin and how can you pinpoint what’s causing the variance? This is where automation can help to assess the data points and highlight the issues. 

The variance analysis that you choose to focus on will depend on the type of business you operate. The reason for variances also are dependent on certain factors, like:

  • Market conditions 
  • Budgeting standards 
  • Difficulty benchmarking 
  • Material variances
  • Overhead variances 
  • Labour variances 

Importance of Variance Analysis

Variance analysis provides organisations with a lot of benefits, including:

  • Planning: Helps managers to budget smarter and more accurately
  • Control: Assists in more significant control management of departments and budgeting 
  • Responsibility: Helps with the assignment of trust within an organisation 
  • Monitoring: Helps to monitor success and failure 
  • Sets Expectations: Encourages forward-thinking and helps to set benchmarks 

Variance analysis becomes an integral part of an organisation’s information system. Not only does it help to regulate control across departments, but it also provides a running tab of what can be realistically expected versus what occurs. 

The Role of Variance Analysis

Variance analysis is used to assess the price and quantity of materials, labour and overhead costs. These numbers are reported to management. While it’s not necessary to focus on every variance, it becomes a signalling mechanism when a variance is salient. In this way, management can rely on variance analysis to help to improve the company’s overall performance or process improvement protocol. 

More importantly, variance analysis plays a significant role in decision-making and how managers approach tasks and projects. When performed correctly and consistently, it can help to keep teams on the right path to achieve long-term business goals. However, many businesses fail to reap the benefits of variance analysis because it has to be performed consistently and promptly to work. 

To accurately forecast future revenue or costs, it is necessary to have organised data from history.  This calls for automation solutions such as SolveXia that can store all data in a centralised location and can automatically be pulled, manipulated and transformed into insights for decision-making. When your financial team is being pulled in so many directions and spends time on low-value time-consuming data entry and repetitive tasks, then variance analysis can easily fall by the wayside. A data automation tool can maximise your team’s productivity by pulling data from various sources, providing real-time analytics and reports to key stakeholders. 

Example of Variance Analysis

Let’s take a look at how this works in a real-world scenario with a sample of variance analysis. 

A business uses variance analysis to find there is a $50,000 variance in one of its cost centres. 

To determine how and why this happened, it requires further variance analysis to understand if the difference came from price changes or a difference in the quantity of materials being used. Maybe it is a growing trend or a one-off event. It could also be erroneous data entry. Either way, if the company aims to keep costs low and operate at its maximum efficiency, then it’s necessary to have these results immediately to help manage future operations. 

For accurate variance analysis, data must be correct to reflect what happened. With automation, you will be able to quickly link up all your data systems and compare historical data with current data without human interference and the system will highlight what has since changed allowing the business to find the source of the issue fast and understand quickly if it is a cause for concern, or if there is a risk or opportunity in the business.

What are the Key Terms of Variance Analysis?

With these variance analysis examples in mind, there are some key terms to remember when performing your own analysis and to better understand its purpose. Take a look:

  • Overhead costs: Overhead costs are a business; operating expenses, such as office rent costs, insurance costs, and the like. In order to minimise expenses, companies audit their own operating expenses to see where overhead costs may be cut.
  • Variable price and rate variance: These refer to the changes in the cost of products or services. They may change because of unforeseen reasons or be adjusted to better reflect consumer demands and supply rates.
  • Budgets: Budgets are financial plans used to allocate spending and mitigate against overspending. Budgets can be revised in real-time to meet goals.
  • Fixed budget variance: Fixed budget variance refers to the difference between overhead costs in a budget and the actual amount of overhead costs in a variance period.

What are the Most Common Types of Variance Analysis?

Here’s a look at the most common types of variance that occur within organisations: 

1. Material yield variance:

This is the difference between what you expected to use and what you used, multiplied by the cost of the materials. You can calculate this with this formula: (the actual unit used - standard unit usage) x standard cost per unit.

This helps companies determine if they are using more materials than they actually need to be. With this variance known, companies can adjust their purchase orders from suppliers and reduce waste.

2. Labour efficiency variance:

This is a measure of how well you utilise labour relative to what you expect to need. The variance is calculated by (actual hours - standard hours) x standard rate.

With this number in mind, companies can assess how efficiently their labour is being used and if the pricing is a good fit for the business’ needs.

3. Fixed overhead spending variance:

The difference between the actual fixed overhead expense and the budgeted overhead expense. Since this is supposed to be a fixed amount, it shouldn’t vary so much from the budget.

If the variance is high between the budget and the actuals, it signals room for improvement in which the company can revisit its budget plans. It’s useful to more accurate budget allocation to see if more money can go to different places for the business to function more effectively.

4. Purchase price variance: 

Take the actual price paid for raw materials and subtract the standard cost times the number of units used. 

5. Labour rate variance: 

Same as above, but with labour instead of products. Take the actual price paid for a direct job, subtract the standard cost and multiply by the number of units used (wages). 

6. Variable overhead spending variance: 

Subtract the standard variable overhead cost per unit from the actual cost incurred. Then, multiply the remainder by the total unit quantity of output.  

7. Variable overhead efficiency variance: 

This is the difference between how many hours were worked versus what was budgeted for the work. It is calculated by standard overhead rate x (actual hours - standard hours). 

Not every organisation will focus on the same variance calculations. Depending on your service line and business goals, you will choose what variance analysis makes the most sense to track to ensure you are maximising efficiency and minimising costs. 

Challenges of Variance Analysis 

From all we know, there is a lot in favour of using variance analysis to help control business and manage finances well. However, there are challenges to variance analysis. 

  • Time delay: Variances are calculated at each month’s end by the accounting team. Then, the information is shared with management teams. But, organisations don’t pause their inputs and outputs while waiting for variance analysis to happen so that this time delay could result in delayed red flags. 
  • Source information: Some of the information needed to calculate variances don’t always appear in regular accounting reports. Therefore, it may take extra effort on behalf of a finance team to find this information. If management won’t correct problems by using this information, then it is more of a cost (in time) than it is a benefit (in solutions). 
  • Standard-setting: Setting benchmarks and estimations could come from different sources and standards or even be affected by politics. So, when a variance is recorded, it may be possible that it doesn’t also result in useful information.  

How Automation Tools Can Help 

Variance analysis is based on numbers and data. When you have data spread out across spreadsheets and in different records within an organisation, then compiling and assessing data becomes tricky and timely. One of the challenges with variance analysis from the get-go is the timeliness of reporting, so this is where automation tools can come in to maximise efficiency. 

Automation tools such as SolveXia help to benefit variance analysis by providing:

  • Data integrity: Allow the software to compile and store data that is unaltered, accurate and safe from errors. It also removes low-value manual tasks so staff can focus on high-value analytics to drive more significant insights and success.
  • Visibility: Anyone who is granted access to an automation tool can take a look at the numbers themselves, which helps to improve transparency within a business. It provides real-time dashboards and real-time alerts so that variances that pose strategic risks or opportunities are flagged up as they happen, and the correct people are notified in real-time. This also improves compliance and enables processes to be mapped out, removing critical man dependency.
  • Timeliness: Automation tools can collect, transform and process data in seconds. This means that information can be accumulated and shared much more quickly than when relying on it being done manually. Reports can be sent out by the system automatically to designated people, so the right people have the correct information at their fingertips. 
  • Connected data: Data is connected and all in one place when it’s being stored in an automated software solution. It connects with all legacy systems, so everything is in one place to run analytics to gain more precise insights than ever before.
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Wrap Up: Measure to Manage 

Managing a business comes down to measuring inputs and outputs. By keeping track of budgets and actuals, you can utilise variance analysis to flag any significant fluctuations from what was otherwise expected. 

You can leverage automated software solutions like SolveXia to help store and manage data and information. These tools also help businesses thrive by maximising productivity and lowering costs. Automation solutions can quickly collect, transform and process mass amounts of data in seconds, relieving your team of having to perform time-consuming data entry and manual manipulation. With all data stored and centralised, you can standardise processes and automate workflows to reduce errors and adhere to compliance. There’s a lot you can accomplish when you include automation solutions into your day-to-day workflows. Stakeholders, customers and employees all reap the benefits of automation solutions.

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