How to Calculate and Verify Variances in Financial Analysis

Calculating Variances:

Step 1: Determine the Standard Costs or Budget: The first step in calculating variances is to establish the standard costs or budget for the specific line items or activities being analyzed. This serves as the benchmark against which actual performance will be compared.

Step 2: Gather Actual Data: Next, gather the actual data related to the costs or activities under examination. This could include actual expenses, labor hours, production quantities, or any other relevant data points.

Step 3: Calculate Variances: The variances are calculated by subtracting the actual costs or performance from the standard costs or budget figures. There are four main types of variances: material price variance, material usage variance, labor rate variance, and labor efficiency variance.

Step 4: Analyze and Interpret Variances: Once the variances are calculated, analyze the results to understand the reasons behind the discrepancies between standard and actual performance. This analysis can provide insights into areas of strength and weakness within the organization.

Verifying Variances:

Step 1: Comparing with Historical Data: One approach to verifying the accuracy of calculated variances is to compare them with historical data. By looking at past performance trends, you can assess whether the variances are in line with historical patterns.

Step 2: Benchmarking Against Industry Standards: Another method is to benchmark the calculated variances against industry standards or established targets. This can help determine whether the variances fall within an acceptable range based on industry norms.

Step 3: Investigating Significant Deviations: If there are significant deviations between the calculated variances and historical data or benchmark values, further investigation may be needed. This could involve identifying root causes and implementing corrective actions to improve future performance.