Variance analysis is a process by which budgets of different organizations can be controlled. The variance analysis may be done on daily, weekly or even monthly basis where the actual figures of performance are recorded concerning an organization's budget. These entered figures of performance are used fro comparison with the already budgeted figures for evaluation of differences that occur almost inevitably (The Institute for Working futures, 2004). This difference is what is known as the variance and the whole process is thus referred to as variance analysis (Variance = standard budget - actual budget).
In an event where the budgeted figure exceeds that of the actual performance, then the variance realized is favorable implying that the money spent was less than the budgeted amount. Unfavorable variances occur when the actual figure of performance exceeds the budgeted amount. The hospital case represents an example of an unfavorable variance. The actual figure of performance exceeds the budgeted amount of funds that were supposed to be spent.
It should be understood that budgets are made for the primary reason of providing a base line against which the performance of any organization is measured. Variance analysis on the other hand evaluates the performance of the organization in reference to the budget. There are various factors that a manager should consider when preparing a variance analysis. There are many cases under which variances occur and each case has to be addressed differently in order to avoid mistakes. There are four reasons that cause variances on budgets and thus the main factors to consider when preparing a variance analysis report.
For proper variance analysis within an organization, one requires to undertake the task together with some simple calculations in four stages. One needs first do what is referred to as budget flexing. This is done through the introduction of a revised budget to compare it with the original budget and the actual budget obtained in the fiscal year. A column of the original, revised and actual budget is made for and the different profits are calculated. In the calculation of the profit, the total and fixed costs are deducted from the total sales volume. The profit obtained from the original and revised budgets are first compared to get the feel about the variance between the two. The next step involves comparison of the profits obtained from the actual and original budget to now obtain the real variance as witnessed in that fiscal year (Palmer, 2003).
The second most important factor is the analysis of the variance. After the data from the original, revised and actual budget are obtained, the variance can be simply analyzed. If the variance occurs due to the price at which the various sales were made, it is known as the 'Sales Price Variance". The Price of the product in question is compared in all cases to determine the difference and thus the variance.
One has to also identify the factors or causes that led to the variance. At this stage, blame games should be avoided at all costs because they do not lead to any solutions but just complicate issues further. It is very impossible for the management to be able to make any decisions if the main causes of the variance are not known. There are various situations that may lead to variances within a budget. There may be an arithmetic error during the computation of the budget figures. The errors may range from commission or some times duplication of figure and in some cases just a case of pure arithmetic errors. Once the cause of the problem is discovered, caution should be taken to ensure that a similar error does not occur in the future (Palmer, 2003).
An arithmetic error may also occur in the actual result presented and thus alter the final results. We can not rule out the fact that variance results can be reported wrongly. During presentation, the figures might be put in the wrong categories and double counting of the final income results. There is usually a peculiar behavior whereby people deliberately throw away the invoices they receive from their suppliers while some people charge invoices on other people's accounts. This sought of behavior should be avoided at all costs in an organization because it may hinder the decision making process.
Another case that should not be ignored is the possibility of the reality being wrong sometimes. There may be instances when the presented results are not the main indicator of what happened in a fiscal year. A strike or even the occurrence may alter the final results. This does not imply that the organization therefore should include an allowance in their budget to cater for natural disasters although some organizations, usually lager ones, have this allowance within there budget. Take an example where a business is disrupted for a period of one week, it will be very pointless for an organization to compare the three remaining months with a budget for a full month. Instead, the one week should be compared with a normal budget circumstance.
a factor that is of much importance in the creation of a variance report is the manager's duty of being able to take the appropriate actions regarding each situation presented to them. In the event when the figures come close or coincide with the budget, it is wise for a manager to say that they have nothing to report. If this is not the case, one needs to know the; cause of the variance and whether it will occur again, its effects on the organization's finances, what is to be done and its implications to the managerial staff.
Preparing variance reports and the task of analyzing the same reports are very important tasks to an organization. Variance analysis helps greatly in the process of decision making within an organization. This analysis helps managers prepare different operational plans to be able to improve performance and also in the assigning of different tasks to different employees. Variance analysis is also essential because it helps managers identify the causes of variances and thus take appropriate corrective measures to deal with the same (Beavers, 2007). Decisions taken by managers after looking at the variance reports may include the following. One may decide to not to take any action because there are certain levels of variances that are acceptable within an organization. Certain instances may be to increase the performance of the business in order to eliminate the variance causes. The last case may be to decide to increase the revenue or reduce the expenditure depending on the nature of the variance. Variance reports go a long way in simplifying the sales activities that took place within a given period of time and thus making it easier for the actual performance to be compared with the original budget.