Variance - What is variance?
Variance is the difference between budgeted or planned costs or sales and actual costs incurred or sales made.
Debitoor invoicing software helps small business take control of accounting and finances with expense tracking, VAT reports and bank reconciliation.
Understanding and analysing variance helps businesses understand current outgoings and budget for future expenses. Businesses therefore carry out variance analysis - a quantitative investigation into the differences between planned and actual costs and revenues.
Variance analysis can be applied to both revenues and expenses. When actual results are better than planned, variance is referred to as ‘favourable’. If results are worse than expected, variance is referred to as ‘adverse’ or ‘unfavourable’.
There are four main forms of variance:
- Sales variance
- Direct material variance
- Direct labour variance
- Overhead variance
Sales variance is the difference between planned or expected sales and actual sales made. Analysing sales variance helps to measure sales performance, understand market conditions and evaluate business results.
The main two types of sales variance, and both can occur at the same time:
- Sales price variance: when sales are made at a price higher or lower than expected.
- Sales volume variance: a difference between the expected volume of sales and the planned volume of sales.
Direct material variance
Direct material variance is the difference between the expected cost and quantity of inventory materials to used in production compared to the cost and quantity of materials actually used in production. Direct material variance can result from two conditions:
- Purchase price variance: a discrepancy between the expected and actual prices paid for materials.
- Material yield variance: a difference between the quantity of materials expected to be used for the standard number of units produced, and the actual quantity of materials used.
Direct labour variance
Direct labour variance is the difference between the standard or expected cost for labour related to production, and the actual or incurred cost. Direct labour variance is made up of two components:
- Labour rate variance: the difference between the standard cost and the actual cost paid for the actual number of labour hours.
- Labour efficiency variance: a difference in the number of units expected to be produced in a standard hour of labour, and the actual number of units produced.
All businesses have ongoing business expenses, or overheads. Some overheads are fixed, meaning that the cost does not change depending on the level of production, whereas other overheads are variable, meaning that the cost varies according to the level of business activity.
Overhead variance occurs when the day-to-day costs of running a business differs from the amount budgeted and can occur with both variable and fixed overheads.