Variance analysis shows why your budget numbers don’t match expectations – whether it’s rising costs, lower sales, or cash flow swings. What is more, it doesn’t just tell you where things went off track, but also why. And the best part? It helps you fix issues before they turn into real problems.
Read Strategic Financial Planning: How to Plan for Success
Think about it: if a company like Unilever notices a spike in material costs, is it because of supplier price increase, inefficient production, or something completely different?
Variance analysis finds the answer. In this blog, we’ll break down how it works and how to use it to stay ahead of the numbers.
Key takeaways
- Variance analysis compares what has been planned, what actually happened and gets to the root why it happened
- There are four key variances that Impact business performance – revenue (sales volume, pricing shifts), cost (material, labor, overhead), profit (net revenue vs. costs), cash flow (liquidity challenges despite strong sales)
- A structured approach improves accuracy – compare actual vs. budgeted data, find root causes, prioritize big impacts, and take action.
- Technology speeds up and improves analysis
Variance Analysis - Definition and Types
As mentioned before, variance analysis involves comparing what you planned financially with what actually happened – and then figuring out why these two don’t match. Was revenue lower because of a dip in sales volume or a pricing issue? Are higher costs due to rising supplier prices or some inefficiencies? The answers matter because they make you rethink your plans and consequently adjust your strategy.
There are four key types of variances that finance teams focus on:
- Revenue Variance – This happens when actual revenue doesn’t match expectations. Maybe sales dropped because of lower demand, or maybe discounts were too high. On the other hand, revenue might be higher than expected due to market demand or better conversion rates.
- Cost Variance – This one is focused on the differences in material, labor, or overhead costs. If a manufacturer notices a spike in production costs, is it due to higher raw material prices or inefficiencies in operations? When you spot these trends early, you can protect profit margins more easily.
- Profit Variance – It refers to the difference between planned and actual profit, based on revenue and cost changes. A company might hit its revenue goal but still miss its profit target if costs get too high.
- Cash Flow Variance – Even if revenue and profit look fine, cash flow can tell a different story. Late payments from customers, unexpected expenses, or simply too much inventory can all drain cash, which makes daily operations harder to manage.
Each of these variances provides a piece of the puzzle. The key is to connect them, uncover the real reasons behind the numbers, and take action before small issues become big problems.
How to Actually Do Variance Analysis (Step by Step)
Variance analysis is only useful if it leads to insights and action. Now that we know what to look at, here’s how to go beyond the numbers, step by step.
- Collect actual vs. budgeted data – Start by pulling in the numbers. Compare actual revenue, costs, and cash flow against what was budgeted. This is where you first notice, “Wait, something’s off.”
- Break down variances into categories – Not all variances are created equal. Some are driven by volume (more or fewer units sold), others by price (selling price changes or supplier cost fluctuations), and some by efficiency (how well resources are used). Categorizing variances helps pinpoint what’s really causing the gap.
- Identify root causes – Now comes the detective work. Ask: Is this variance caused by internal factors (like operational inefficiencies or pricing decisions) or external ones (market shifts, inflation, supply chain issues)? Violeta faced this challenge when planning sales goals across 30 brands and had to refine forecasting with Farseer to prevent revenue gaps.
- Prioritize significant variances – Not every variance needs a deep dive. Focus on the ones that actually impact profitability or cash flow the most. A 1% increase in office supplies? Probably not a big deal. A 10% jump in raw material costs? That needs attention now.
- Recommend corrective actions – Once you know what’s causing the variance, it’s time to act. If costs are climbing due to supplier price increase, is it time to renegotiate contracts? If sales are slow, should you adjust pricing or marketing efforts? The goal isn’t just to explain variances – it’s to fix them.
How to Improve Variance Analysis with Technology
This whole process can be extremely time-consuming if you’re buried in spreadsheets, manually pulling data, and chasing down explanations. There are several ways modern FP&A software can help you here.
Automating variance calculations with FP&A software.
Instead of spending hours comparing actuals vs. budget in Excel, FP&A tools pull real-time financial data directly from ERP and accounting systems. This means variances are calculated automatically, giving finance teams more time to focus on why things changed rather than just identifying the change itself.
Rolling forecasts and predictive analytics to help you detect variance in advance
Traditional budgeting looks at a fixed plan, but rolling forecasts update projections continuously based on actual performance. Combine this with predictive analytics, and companies can spot variance trends before they become major problems. For example, if a company sees a pattern of rising supplier costs, predictive models can forecast how this will impact margins in the next quarter. In the end, this gives leadership time to adjust pricing or sourcing strategies.
Common Mistakes in Variance Analysis (And How to Fix Them)
Ignoring small but recurring variances
It’s easy to overlook small variances, especially if they seem insignificant on their own. But small, recurring discrepancies add up over time. For example, if supplier costs rise by just 1% every month, that might not raise alarms at first – but by the end of the year, it could take away from the margins significantly.
The fix? Track recurring variances over multiple periods and flag any that show a consistent upward (or downward) trend.
Focusing only on negative variances
Most finance teams are quick to investigate negative variances – higher costs, lower revenue, shrinking margins. But positive variances, often revealed in YoY calculations, deserve just as much attention. If sales outperform projections, is it due to better marketing, strong demand, or a one-time event? Understanding why things go right is just as valuable as diagnosing problems.
The fix? Treat positive variances as learning opportunities – it will be easier to replicate success in future forecasts.
Lack of alignment between finance and operations
As you can see, variance analysis has an overall impact – on sales, supply chain, and operations. Companies that struggle with misaligned financial plans often find that a strict top-down budgeting approach contributes to these barriers. Shifting to a bottom-up approach helps bridge this gap, ensuring variance analysis is more accurate and planning becomes more collaborative and data-driven.
The fix? Collaborate with operations, sales, and procurement teams to get context on variances. A revenue shortfall might be due to a supply chain issue, not weak demand. And this is something you can’t find out if you’re not communicating properly with other teams.
Conclusion
To wrap it up, variance analysis is all about spotting the gaps between your financial plan and what actually happened, and then figuring out why. It helps you tackle problems early, whether it’s rising costs or a decrease in sales. By focusing on the big issues, working closely with other teams, and using tech to make things faster and easier, you can make smarter decisions and stay ahead of the game.
