What is Variance Analysis?

We see variance anlysis as a anchor to Financial Planning and Analysis (FPA). Is it really that big a deal? Let’s take a look at what it really is.

If budgeted sales for this month to be $1,000 and it came in at $900, this is a variance of $100. Pretty straightforward. But there are layers of this onion to peel off, and at the center is an impressively valuable financial management toolkit. Let’s look at a couple of headliners as food for thought . . . .

Right off, in our example, the $100 is either good or bad. It can’t be left as just a $100 variance. This one was obviously unfavorable. Remember that “favorable vs unfavorable” is necessary as the labeling because “plus or minus” does not work. Actual higher than budget for revenue is favorable while actual higher than budget expense is unfavorable.

Now, to move forward, who says that variances are just for “actual vs budget” or its sibling “this year vs previous year?” In fact, we can take any result from any path and compare it to another and calculate a variance. We also have a choice of level - total company revenue, branch 12 revenue, branch 12 product 100 revenue, branch 12 product 100, customer B revenue and so forth. There is a variance calculation for all.

One more note on breadth is that variances can be non-dollar. They can compare per unit, percent of sales, growth rate and more.

Now, to double the exercixe, we can also comlare future line items in similar ways to what we do for historical ones. For example, you know “YTD” for “year to date” as something to run a variance on, vs last year, say. Think forward to “YTG” or “year to go” and you can see the potential.As we use variance analysis ot future periods, what cause a vatiance on something that has not happened yet?” The answer is that variances change in this case when we change our projection for a future period. We redo the path and compare to the previous path.

And it is this one, comparing the calculations for the future, that is ultimately the most powerful tool for independent businesses to employ.

So we quickly get to the need to efficiently manage the calculation burden if we are going to employ the technique.

Which leads us to Pac Car. Here we have selected a variance calculation to use pervasively. We are taking two paths for the company going out from at least “YTG” to possibly another year (3 or 5 is supporting long range plans). We are cslling this the “Prime” variance.

What are the two paths? One is the Pace Car Path and the other is the “Headed Here Path”