Variance analysis

What it means

Variance analysis compares actual figures with what a company planned and looks for why they differ. The starting point is the budget or the latest forecast, against which actual sales, costs, margin or cash for the month and the year to date are set.

The difference alone is not enough; what matters is breaking it down into causes. For sales, the effects of price, volume and sales mix are separated, and for costs the effects of input prices and consumption. In manufacturing the comparison is with standard costs, in services with planned hours.

A variance can be favourable or adverse, but even a favourable one is not always good news. Marketing costs below plan may simply mean a campaign has slipped, and its costs will arrive next month together with lower sales.

How it works in practice

Variance analysis is the core of monthly management reporting. A clear report shows plan, actual, the difference in euro and per cent and a short comment on each significant line. Management then discusses not twenty numbers but the three that really moved.

For the comparison to make sense, plan and actual must be accounted for the same way. If the annual insurance premium is booked in one go in January while the plan spreads it by month, an artificial variance appears. That is why we use accruals and deferrals and estimated items so that monthly figures are comparable.

With larger gaps we do not stop at stating them. Together with the client we work out whether it is a one-off or a lasting trend and adjust the forecast for the rest of the year accordingly, so that decisions on investment and hiring rest on realistic numbers.

What to watch out for

The most common mistake is a plan nobody updates. If energy prices have changed since January or the main customer has left, comparing with the old budget produces variances that explain nothing. Alongside the original plan, an updated forecast has to be kept too.

The second mistake is looking for someone to blame instead of a cause. If variances are used only for reproach, managers start planning with padding and the budget loses its meaning. Controlling should serve decisions, not punishment.