Variance Analysis: Assess KPI Deviations to Improve Results
Variance analysis is one of the most useful tools available to companies today for business planning, management and review. Used to assess deviations from results of various key performance indicators (KPIs), variance analysis can reveal many aspects and outcomes of financial and operational imperatives.
It has become especially helpful with improvements in information technology that provide data that can be sliced, diced and drilled down to its core to reveal a clearer picture of performance.
In pursuit of strategic goals, most organizations perform various methods of forecasting, projections and budgets to guide them in their planning phase. As initiatives commence and results become apparent, the comparisons to anticipated outcomes are made and analyzed with a critical eye toward favorable or unfavorable results.
A 3-Up Variance Walk
In a recent CFO.com article, the authors asked Fortune 500 finance leaders how important variance analysis is to their operations.1 Their average rating was 8.7 out of 10 with 10 being highest. Also, the authors identified three main uses of variance analysis by corporations, and they called this set the “3-Up Variance Walk”:
1. Comparing prior year to date (YTD) actual results to current YTD’s budget.
2. Comparing prior YTD actual results to current YTD actual results.
3. Comparing current YTD budget to current YTD actual results.
Among the senior finance executives surveyed, 100% said they use the third comparison and over 80% use the second comparison. Most of the surveyed executives apply variance analysis for drivers of profitability such as volume, price, cost, product mix, etc. And most apply variance analysis to cash flow, which is critical for emphasis on current and future cash requirements.
But only about half of the respondents said they use variance analysis for the first comparison. This represents what the authors called “a potentially large missed opportunity on the risk management front.”1 Variations in actual financial results from the current year’s budget can uncover risks involved in a specific plan, a benefit not achievable with history-based GAAP income statements.
In addition, just 42% said they break down volume variances into “share” and “true growth.”1 Doing this can help reveal a more complete performance picture since it is possible to lose market share while reporting a positive volume variance. And just 60% do variance analysis on cash flow which the authors note is surprising based on the way businesses emphasize free cash conversion.
Improving Real Decision Making
The challenge many companies face is implementing best practices in variance analysis that can help improve real decision making. Your company may experience negative impacts by failing to use variance analysis effectively, including the following:
- Ineffective internal controls.
- A failure to meet commitments.
- A lack of insight into risk management.
- Limited insight into productivity measurements.
To avoid these negative impacts, you should perform a 3-Up Variance Walk by determining which three main uses of variance analysis would be the most useful for your company to implement. In doing so, you should intermingle data analytics into all variance analyses and educate your team on variance analysis best practices. You should also segment volume variance into share growth to clarify incremental organizational growth as compared to rising overall market growth.
Your company may realize many positive outcomes by effectively implementing variance analysis, including the following:
- A competitive advantage in the demonstration of the prowess of your capabilities in clarity of structure and processes with defined roles and responsibilities.
- Enhanced risk management due to insights that reduce variances, both controllable and uncontrollable.
- Better decision making that can improve shareholder value.
- The elimination of behavioral and systematic biases in your forecasts and variance results.
- A better understanding of the correlation between profitability drivers and other indicators, such as price/volume.
Concluding Thoughts
Variance analysis is one of the most useful tools available to companies today for business planning, management and review. In a recent survey, senior finance executives rated the importance of variance analysis at 8.7 on a scale of 1 to 10. The challenge many companies face is implementing best practices in variance analysis that can help improve real decision making. Acting in an on-demand capacity, a part-time CFO or project CFO from a CFO services firm can help you implement variance analysis at your company.
1 Usage of Variance Analysis Is, Well, Variable; Thomas E. Conine Jr. & Michael B. McDonald IV; CFO.com; April 23, 2018
ww2.cfo.com/budgeting/2018/04/usage-of-variance-analysis-is-well-variable/
John W. Braine, Partner, CFO Edge, LLC
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