Variance analysis: Why and how

Measuring a set target is a basic principle. Imagine you decide to save $ 500 in a month and then
when the month ended you are not checking whether you were really able to reach your goal. Silly
thought, isn’t it? Of course, you would like to know and surely you will count your savings. The same
principle applies to companies. A certain budget is set and at the end of the period, it is time to check
it. In management accounting, this part is called variance analysis.

Why is variance analysis so important?

The main and straight forward idea of a variance analysis is to evaluate a company’s performance. If
the company aims for an EBITDA of $ 12 Mio in a year, management wants to know whether actual
figures are in line with the plan. It is likely that a monthly report is generated showing how the
EBITDA is developing. Deviations indicating that the $ 12 Mio could be underperformed will cause
management to worry and to take action.

Additionally, there are some more advantages of a variance analysis:

 Identifying issues in current trading: If negative variances result for some items, this can
indicate some operational issues which need to be further investigated and corrected.
 Identifying budgeting problems: If variances occur throughout the report, this may indicate
wrong assumptions during budgeting.
 Identifying bad management: Variances can be a reason of bad management. For example a
lack of proper sales training.
 Identifying criminal issues: Variance analysis can cover up internal crime like theft or overuse
of expenses allowance.

How should a variance analysis report be designed?

Generally, a variance analysis report should be a standardized and periodical document. Larger
companies produce these reports on a monthly base using a wide variety of management accounting
programs. In the end, however, the following points should normally be applied to such reports:

 Granularity according to audience (the board may not be interested in every little detail, the
product manager, on the other hand, is very keen for an in-depth analysis)
 Showing planned values and actual values
  Differences (variances) shown as absolute figure and percentage
 Year to date values and current period values should be shown
 Both negative but also positive variances should be commented to add insight. This can be a
difficult task for a management accountant but it is essential and time should be invested to
produce an insightful comment. Without it, the audience will not be able to understand the
reason behind a deviation.

On top of these, I personally recommend working with colors. Highlighting important parts of a
report help the receiver to focus on relevant data. Sometimes the audience could be very busy and
only briefly checking the report. In this case, colors a certainly a plus.

In the report example below, all the mentioned aspects are included:

Conclusion

This article showed why variance analysis is an essential part of management accounting and how
such reports should be designed. Management accountants should keep in mind that comments
transform data to valuable insight.

About the author

Adrian Leuenberger is a chartered management accountant with many years of practical experience.
He studied strategy, financial controlling and entrepreneurship in Switzerland and England. He is the
owner of http://www.hotspotfinance.com/, a management accounting blog.