Need For Variance Analysis

By:T. Madhavi RaoVikash RathourUtkarsh Singh BaghelRahul Kumar

What is variance analysis?

Variance analysis is usually associated with explaining the difference (or variance) between actual costs and the standard costs allowed for the good output. For example:- If you expected something to cost Re.1 and

it, in fact, cost Rs.1.25, then you have a variance of Re.0.25 more than expected. This, of course, means that you spent Re.0.25 more than what you planned.

Variance analysis is also used to explain the difference between the actual sales and the budgeted sales. Examples include sales price variance, sales quantity (or volume) variance, and sales mix variance. A difference in the relative proportion of sales can account for some of the difference in a company’s profits.

Types of Variances

Estimate to Plann

ed

Planned to Actua

l

Estimate to Actua

l

Estimate to Planned

This is the difference between what we quoted and how we actually planned to do the work. We look at what has changed and why. It may be that there are new processes, vendors, materials, technology, laws, etc. If the variances are significant, We search for alternatives before work commences whenever possible. If alternatives are not possible, then we learn from the situation and communicate what not to do for subsequent work. You may wonder why there is a difference between planned and estimated. This is due to situations where projects are quoted without formal detailed planning often by a group who will not actually do the work. As you can imagine, it is advantageous to keep the quoting and planning teams in synch over time.

Planned to Actual

This variance looks at the difference between how work is planned and how it actually is executed. By comparing planned to actual, we can see how the work changed once in progress. There may be changes brought on by the project team, by the customer, by vendors or by a change in the environment, such as new regulations. Regardless, the changes need to be analyzed so issues can be identified and mitigation strategies can be developed to protect future work.

Estimate to Actual

Here, we compare what we quoted to what we actually did. This is a crucial comparison. If jobs are estimated in a manner that operations cannot support, then there are substantial risks including profit losses and even project failures. Again, by analyzing the numbers, we can determine what changed, why and then take corrective action. For subsequent work, we may need to change vendors, processes, materials, contractual stipulations, etc.

Why do we do this?

In short, we want to do variance analysis in order to learn. One of the easiest and most objective ways to see that things need to change is to watch the financials and ask questions. You cannot and should not base important decisions solely on financial data.

  You must use the data as a basis to understand areas

for further analysis. Use the numbers to highlight areas to investigate, but do not make decisions without first investigating further.

Conclusion

By using variance analysis to identify areas of concern, management has another tool to monitor project and organizational health. People reviewing the variances should focus on the important exceptions so management can become aware of changes in the organization, the environment and so on. Without this information, management risks blindly proceeding down a path that cannot be judged as good or bad.

Thank You