Variance analysis is the accounting process that compares planned or projected performance in the business to actual results.
It is a quantitative tool that is intended to identify deviations and their underlying causes.
Variance analysis looks at total costs or volumes for a particular account, such as purchases or sales, to identify differences between planned and actual numbers.
It is not uncommon for actual numbers to deviate. A variance analysis will also look at trend lines (patterns of deviation over time) from one reporting period to the next, to identify dramatic changes or spikes.
These are the significant results that will demand further examination. Depending on the numbers examined, the analysis will also offer an interpretation or explanation for the variance.
A variance analysis involves several steps:
The first step is to gather all relevant information in a centralized location. For example, if a sales variance analysis is to be performed, then sales totals for a particular unit in the business will be gathered. The information will be aggregated for a particular time frame or reporting period and include similar numbers for previous reporting periods to establish trends.
Next, accountants will compare data sets to establish variances. This may be as simple as subtracting totals for one set from another. In the sales example above, actual sales totals would be subtracted from the total for projected sales. Usually, a positive variance—actual sales are greater than projected—is considered a favorable variance. A negative difference is considered an unfavorable variance.
After variances have been established, accountants will attempt to evaluate and ascertain the cause of the discrepancies. Some businesses establish thresholds to determine at what point a variance is a cause for concern or requires further analysis. Factors such as profit margin (low or high) or materials costs can influence where those thresholds are set. Accountants will also drill down to the lowest common denominator, such as vendor prices, to determine the root cause of a variance.
Once the variance has been identified, isolated, and analyzed, accountants can prepare reports for upper management which will inform its decision-making and support future planning adjustments.
As an example of a variance analysis, if a manufacturing company budgeted for 1,000 widgets at a cost of $.50 per widget, its total budgeted costs for widgets would be $500. If the company actually spent $700 on widgets, the variance analysis would reveal that the company had an unfavorable (negative) variance of $200.
The company would then break down the analysis and compare budgeted and actual figures for both costs and volume of widgets purchased to determine the root cause of the variance.