3.

Variance Analysis
Variance Analysis deals with an analysis of deviations in the budgeted and actual
financial performance of a company. The causes of difference between the actual
outcome and the budgeted numbers are analyzed to showcase the areas of
improvement for the company. At times, it is also a sign of unrealistic budgets and
therefore in such cases budgets can be revised.
In other words, variance analysis is a process of identifying causes of variation in the
income and expenses of the current year from the budgeted values. It helps to
understand why fluctuations happen and what can / should be done to reduce the
adverse variance. This eventually helps in better budgeting activity.

7. Benefits of using variance analysis

Using variance analysis in the decision-making process renders the following positive
impacts:
a. Competitive advantage: Variance analysis helps an organization to be proactive in
achieving their business targets, helps in identifying and mitigating any potential risks
which eventually builds trust among the team members to deliver what is planned.
b. Identifying the changes required in the business strategy: In some of the cases,
comparing budget with actual results may point out the requirement for re-evaluating the
target customer base or product line of the company. Several assumptions go into
developing a budget. In case those assumptions are blowing up the budget, it could be
because the budget-related projections are wrong for a variety of reasons. It could also
be due to changes in the economy or delays in getting the products/services sent to end
customers.
c. Identifying any managerial concerns: At times, variance analysis could also
provide insight as to how well an organization is being managed. For instance in the
case of purchasing, the inability to negotiate volume discounts or securing the
competitive bids could indicate managerial problems within the purchasing department.
Moreover, weak sales could also be an indication that the salespersons are not trained
properly or they lack motivation. By addressing such issues, the variances could
disappear as the organization gets on track.
d. Managing risk: With the help of variance analysis, the finance heads gather insights
which they require to understand the reasons for controllable and uncontrollable
variances. Once they’re aware of such variance, they’re in a position to implement
policies to mitigate such risks arising from such variances.  
e. Creating shareholder value: When an organization brings in proper internal
controls, a cross-functional environment, efficient internal audit process, and the culture
of meeting commitments, it increases the chances that the variances would be
 favorable which means that the business commitments would be met or even exceed
the expectations.

What are the limitations of variance analysis? 

 Variance analysis is done by the accounting staff at the end of each month. But it is not
helpful in case of management requires the feedback much faster.
 It is a much expensive activity for small businesses. Therefore, a detailed analysis of
variance for each cost component might not make sense.
 It is based on the predetermined standard. Standards limit the operating improvement
upto a certain limit.
 Variance analysis as an activity is based on financial results which are released
much later after quarterly closing; there may be a time gap which may affect the
remedial action taking an ability to a certain extent. Also, not all sources of variance
may be available in accounting data which makes acting upon variances difficult.
 If the budgeting is not made taking into consideration the detailed analysis of
each factor, the budgeting exercise may be loosely done which is bound to deviate from
the actual numbers. Thereafter analyzing variances may not be a useful activity.