What Is a Variance Analysis (and Why Should You Create One)?

Charlie Miracle

Charlie Miracle, CPA, Member, and Director of Client Accounting Services

By: Charlie Miracle, CPA, Member, and Director of Client Accounting Services

Creating a budget is a crucial task for any business. It helps owners, executives, and managers estimate revenues and expenses, set goals, and closely monitor costs throughout the year.

Of course, budgets are just that — estimates. The actual amounts for revenues and expenses at the end of the month, quarter, or year will almost certainly differ from budget projections. Those differences are called variances and analyzing those variances can give leaders a deeper understanding of a company’s financial well-being. 

What is variance analysis?

Variance analysis investigates the differences between budgeted and actual results.

For example, if you budget for $1 million in sales and actual sales are $800,000, your variance is negative $200,000. Comparing your budget to actual results is a helpful first step but investigating the reason for the difference is essential.

  • Why did the company not meet its revenue goal?
  • Did they lose a big customer?
  • Is demand for the product or service waning?
  • Is a new marketing campaign not having the desired result?
  • Are high prices turning customers away?

These factors and others can contribute to variances, so taking the time to understand why fluctuations occur can help management know what they need to do to change the situation. 

What causes budget variances?

Variances can occur for various reasons. Some of the most common include:

  • Economic changes. Inflation, recessions, consumer confidence levels, and other market changes can impact sales and costs.
  • Errors. Humans and computers may make errors, such as transposing numbers, misplacing a decimal, missing a transaction, or posting the same transaction twice.
  • Pricing changes. A supplier may increase prices after you’ve finalized your budget, leading to an unfavorable variance in the cost of goods sold.
  • Fraud. Employees may misappropriate assets, engage in payroll fraud, or manipulate numbers to make their results appear better than they are. Dishonest vendors or suppliers can engage in billing schemes, check tampering, or price-fixing, resulting in overinflated expenses.
  • Process improvement. Improving processes can increase efficiency and lower costs, creating favorable variances.
  • Competition. New competitors entering the market can negatively impact sales. On the other hand, a competitor going out of business can lead to an unexpected influx of customers.

How is a variance analysis created?

Modern accounting software makes creating a variance analysis relatively straightforward. Most solutions include a budget-to-actual report that compares actual results to the budget and finds the difference between the two values as a number and a percentage.

You can then export this report to an Excel or Google spreadsheet, adding a column for explanations for any budget deviations.

The following best practices can make this process more manageable.

  • Implement thresholds for materiality. To avoid wasting time investigating minor variances, determine a materiality threshold. That threshold will be different for each company. For example, a company with $200 million in revenue might not be concerned with a $200,000 variance, but the same variance could be very significant for a company with $2 million in revenue. You can define your materiality levels in terms of absolute figures (i.e., investigate all variances of more than $1,000) or percentages (i.e., investigate all variances higher than 10% from budgeted amounts).
  • Work with a cross-functional team. Accounting and finance professionals usually are tasked with creating and reporting on variances. However, getting to the bottom of those variances requires input from several departments, including sales, operations, marketing, human resources, and purchasing.
  • Investigate positive and negative variances. Negative variances are those unfavorable regarding the company’s profits, while positive variances are those favorable for company profits. It’s tempting to look only at negative variances; however, it’s just as important to analyze favorable variances, as this can help business leaders identify what is working and lead to more accurate budgets in the future.
  • Compile a variance report. Compile the results of your analysis into a variance report for management. The report should include the variances identified, the root causes of each variance, and corrective actions or recommendations.

How often should you prepare variance reports?

The cadence with which you prepare variance reports will depend on the size of your company and management needs. A small business might only go through the process quarterly or annually.

On the other hand, a larger company or one that is experiencing rapid growth might perform the analysis every month.

At a minimum, you should review your budget to actual numbers every month, looking for unexpected discrepancies. This high-level review can help you quickly spot errors or identify trends so you can take action to keep the business on track.

Do you need help analyzing or setting up your variance reports? Give our team of professionals at Cordell, Neher & Company, PLLC a call at (509) 663-1661 to set up a strategy.

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