What is Variance analysis?

Any activity humans perform they do it for betterment and get the benefit in one or the other. In business environment basic motive is profit maximization and this is ensured in every decision they take. To aid their decision making process humans are using the technique of comparison since early ages. Comparison helps human decide and act in a more meaningful manner as it provides useful information.

Subjects like accounting, economics and management that deals with finance or money follow a more formal method of comparison and over the time we have developed several techniques that are in essence comparisons. Comparison can either be:

  • between past and present results
  • between standards or budgets or expected results with actual results
  • between entity’s operations and its competitor
  • between any two financial values that gives relevant information e.g. sales and gross profit

And list can just continue forever.

However, in cost and management accounting comparison to compute differences between expected outcomes and actual outcomes, in simplest terms, is called variance and the study of reasons of such differences is called variance analysis.

That means variance analysis is:

  • computing differences between expected or budgeted or standard cost/revenues and actual cost/revenue
  • monetization of such differences i.e. measuring the financial impact of such difference
  • evaluation of the reasons of such differences whether it is favourable or unfavourable for the business and then looking into factors that caused such differences to arise so that control action, if needed, can be initiated

In cost and management accounting most of the time when variance analysis is referred it is usually meant comparison between standards i.e. outcomes that were expected to be achieved and the actual outcomes. Such comparison helps entity and the personnel with authorities to take reasonable steps to keep the course of business operations in the right direction by taking timely steps as such comparison helps them identify the deviations from expectations or the requirements to achieve a certain objective.

Variance analysis is a bit different from ratio analysis as it compares the standard values with actual values and evaluation is done on the basis of the difference being favourable or unfavourable whereas ratio analysis compares compares two financial values usually related or connected to each other and provide information in terms of times, percentages or simply ratio.

In cost and management accounting variance analysis holds great value and with lots of advancements cost accountants of today are able to analyse different aspects of entity’s operations in great depth like material cost variance analysis and then getting deeper whether cost variance is because of material price variance or material usage variance and getting even deeper if it is due to usage variance then is it because of material usage effeciency variance or material usage capacity variance. This indepth quantitative analysis certainly provides valuable information to users of such information and aid them in their decisions.