Variance analysis is a financial management tool used as a yardstick for monitoring and analyzing expenditure or performance. It involves comparing actual financial results against budgeted or expected figures to identify discrepancies or variances. The main goal of variance analysis is to understand the reasons behind the differences between actual and budgeted amounts and take appropriate actions based on the findings.
In the context of monitoring expenditure, variance analysis can be applied to different areas such as project costs, departmental expenses, or overall organizational budgets. Here's how variance analysis works as a yardstick for monitoring expenditure:
- Budget Preparation: Before the start of a financial period, budgets are prepared based on projected revenues and expenses. The budget serves as a benchmark or target against which actual performance will be measured.
- Actual Performance: As the financial period progresses, actual expenses are recorded and tracked. These actual expenditure figures are then compared to the corresponding budgeted amounts.
- Identifying Variances: Variances are calculated by subtracting the actual expenses from the budgeted expenses. A positive variance indicates that actual expenses were higher than budgeted, while a negative variance suggests that actual expenses were lower than budgeted.
- Investigating Variances: Significant variances are investigated to understand the underlying reasons. The reasons for positive variances (over-spending) or negative variances (under-spending) could be attributed to factors such as changes in economic conditions, unexpected events, pricing fluctuations, inefficiencies, or changes in the scope of projects.
- Taking Corrective Actions: Based on the analysis of variances, management can take appropriate actions to address the issues identified. For example, if a department has overspent its budget, measures could be taken to control expenses, renegotiate contracts, or allocate resources more efficiently.
- Continuous Monitoring: Variance analysis is typically done on a regular basis, such as monthly or quarterly, to continuously monitor expenditure and performance throughout the financial period. It allows for early identification of potential issues and timely corrective actions.
Variance analysis is a valuable tool in financial management as it provides insights into the financial performance of an organization or project. By monitoring expenditure variances, businesses can maintain better control over their finances, ensure efficient resource allocation, and make informed decisions to achieve financial goals.