Dear Will

Last time in Forecast we looked at how to put a fair valuation on your product and your time. Click here if you would like to read the December issue. This month I’m exploring another aspect of this: variance analysis

Please forward this issue to anyone you think will enjoy reading it and find it useful. If you’ve been forwarded this issue of Forecast and would like to receive your own free monthly copy, you can subscribe by clicking here.

With best wishes,

Graham

What is Variance Analysis?

A variance is the difference between the amount you budgeted or planned and the actual amount you incurred or sold. Variances can be computed for both costs and revenues. Variance analysis is a tool to evaluate your business’s performance by looking at these variances.

Why use Variance Analysis? 

You can use variance analysis to put together your experience of a job for use next time you have to quote for or do a similar piece of work.

In a manufacturing environment, it’s very concrete: you use a ‘cost card’ for each product. Record all the details of the work, including  material and labour amounts and unit costs,  Then look at how many  you expect to produce in a month.

With variance analysis, you can then compare the actual number you made, and the amount of raw materials and labour you used, with the amount you budgeted for these. For example, the labour might be more than last time, but maybe you used less raw material, therefore both offsetting the labour cost and producing less waste and a better quality product. Looking at how you varied from the budget through variance analysis, you can see if the variances are good or bad and whether you should worry!

Can You use  Variance Analysis in a Service Business? 

Variance analysis is just as relevant if you run a service business. Your budget or business plan can soon become out of date, so you need to keep your eye on the figures at all times. Follow these steps:

• record actual figures (hours spent, fuel cost, travel time etc)
• compare the actual figures with the budget or plan
• record variances
• investigate the reasons for variances
• see if the budget or plan should be updated

Some examples:

• Sales and sensitivity to sales. Is it worth putting effort into your sales force to raise sales volume?  If you increase hours do sales rise?
• Fuel cost for driving jobs. You can estimate the fuel cost to get from A to B, and use it to set the fee for a job. After the job, you can look at the cost of fuel to check if the mileage is correct.
• Consultancy. If your fee is fixed, there is no way of making cost savings even if the work is done in less time. But take the example of overhead absorption, where you spread the overhead over time. If you don’t sell as many days as you planned, your overhead is higher - variance analysis will show you need to raise your day rate. If you sell more days, it’s not always a good thing – perhaps you need to outsource the work you don’t have time to do?
• Training. You can do a cost card for a training course, recording the number of places, the cost of the venue etc. Before the course you can use variance analysis to know when to cancel if there aren’t enough people. Afterwards, you can use it to check whether your fees were set at the right level.

Why do Variances Arise?

Start by looking at inconsistencies and assess their significance. Some possibilities might include:

• It’s a one-off that will not happen again
• It’s due to a seasonal variation such as Christmas
• it could be a continuing trend
• it could self-correct, for example a surge in demand followed by a slump, with the end result being the same in the long run
• it might not be self-correcting, but you are taking steps to correct it

But don't just consider discrepancies. You should also consider completely new factors such as an unexpectedly large order or the arrival of a new competitor. If changes are needed, you might choose to:

• Keep the original budget but measure and understand any variances in the actual figures against the original budget and new forecasts.
• Use rolling budget forecasts - as each month's actual information is finalised, update the budget to provide another month's data. This means that you will always have a 12-month projection.

To do variance analysis you need a budget to work to, and also a way of collecting information. Whatever your system, keep your eye on your forecasts and keep them up-to-date. If you’d like more information, please contact me on 01993 77 11 00 and I’ll be happy to help.