Variance Report - definition & overview

A variance report, in the context of small business operations, is a document that provides a detailed comparison between actual and budgeted financial performance. It is a critical tool for business owners, managers, and financial controllers, enabling them to understand the deviations in their financial operations, identify the causes, and take corrective actions. The variance report is not merely a financial document; it is a compass that guides the business towards its financial goals.

Understanding the variance report is akin to understanding the pulse of your business. It tells you where your business stands today, where it was expected to be, and what steps you need to take to bridge the gap. It is the mirror that reflects the financial health of your business, helping you make informed decisions and strategic moves. In the following sections, we will delve deeper into the world of variance reports, exploring its different aspects and their significance in small business operations.

Components of a Variance Report

A variance report is composed of several key components, each serving a specific purpose in the overall analysis. These components include budgeted figures, actual figures, and variances, which are further broken down into favourable and unfavourable variances. Understanding each of these components is crucial to interpreting the report and making informed business decisions.

Let's take a closer look at these components and their roles in the variance report.

Budgeted Figures

The budgeted figures in a variance report represent the financial targets set by the business for a specific period. These figures are derived from the business's budget, which is a financial plan outlining the expected income and expenses. The budgeted figures serve as a benchmark against which the actual performance of the business is compared.

It is important to note that the accuracy of the variance report largely depends on the accuracy of the budgeted figures. Therefore, businesses must ensure that their budgets are realistic and based on sound financial analysis.

Actual Figures

The actual figures in a variance report represent the real financial performance of the business during a specific period. These figures are derived from the business's financial records and reflect the actual income earned and expenses incurred. The actual figures are compared with the budgeted figures to calculate the variances.

It is crucial for businesses to maintain accurate financial records to ensure the reliability of the actual figures. Any errors or discrepancies in the financial records can lead to inaccurate variance reports, which can mislead the business decision-making process.

Types of Variances

In a variance report, the differences between the actual and budgeted figures are classified as variances. These variances are categorised as favourable or unfavourable, depending on whether they have a positive or negative impact on the business's profitability.

Let's delve deeper into the concept of variances and their types.

Favourable Variances

Favourable variances occur when the actual figures are better than the budgeted figures. For example, if a business's actual income is higher than its budgeted income, it results in a favourable variance. Similarly, if the actual expenses are lower than the budgeted expenses, it also results in a favourable variance.

Favourable variances indicate that the business is performing better than expected, which is a positive sign. However, businesses should not become complacent with favourable variances. They should analyse the reasons behind these variances and use the insights to further improve their performance.

Unfavourable Variances

Unfavourable variances occur when the actual figures are worse than the budgeted figures. For example, if a business's actual income is lower than its budgeted income, it results in an unfavourable variance. Similarly, if the actual expenses are higher than the budgeted expenses, it also results in an unfavourable variance.

Unfavourable variances indicate that the business is not performing as expected, which is a cause for concern. Businesses should analyse the reasons behind these variances and take corrective actions to improve their performance.

Importance of Variance Reports in Small Businesses

Variance reports play a crucial role in the financial management of small businesses. They provide valuable insights into the business's financial performance, helping business owners and managers make informed decisions. The importance of variance reports in small businesses cannot be overstated.

Let's explore some of the key reasons why variance reports are important for small businesses.

Performance Evaluation

Variance reports are a powerful tool for evaluating the performance of a business. They provide a clear picture of how the business is performing against its financial targets. By analysing the variances, businesses can identify their strengths and weaknesses, and take appropriate actions to improve their performance.

Performance evaluation is not just about identifying problems; it's also about recognising successes. Favourable variances highlight areas where the business is performing well, providing an opportunity to celebrate successes and motivate the team.

Decision Making

Variance reports play a crucial role in the decision-making process of a business. They provide valuable data that can be used to make informed decisions about various aspects of the business, such as pricing, cost management, investment, and strategic planning.

For example, if a variance report shows a significant unfavourable variance in the cost of goods sold, the business might decide to renegotiate with suppliers, find alternative suppliers, or look for ways to reduce production costs. Similarly, if the report shows a favourable variance in sales, the business might decide to increase investment in marketing to further boost sales.

Creating a Variance Report

Creating a variance report involves several steps, including gathering data, calculating variances, and analysing the results. It requires a good understanding of financial management and a keen eye for detail.

Let's walk through the process of creating a variance report.

Gathering Data

The first step in creating a variance report is gathering the necessary data. This includes the budgeted figures and the actual figures for the period under review. The budgeted figures can be obtained from the business's budget, while the actual figures can be obtained from the financial records.

It is important to ensure that the data is accurate and complete. Any errors or omissions in the data can lead to inaccurate variance reports, which can mislead the business decision-making process.

Calculating Variances

Once the data is gathered, the next step is to calculate the variances. This involves comparing the actual figures with the budgeted figures and determining the differences. The differences are then classified as favourable or unfavourable variances, depending on whether they have a positive or negative impact on the business's profitability.

Calculating variances can be a complex task, especially for businesses with multiple income and expense categories. Therefore, it is advisable to use financial management software or hire a professional accountant to ensure accuracy.

Analysing the Results

The final step in creating a variance report is analysing the results. This involves interpreting the variances and understanding their implications for the business. The analysis should not just focus on the numbers; it should also consider the reasons behind the variances and their potential impact on the business's future performance.

Analyzing the results of a variance report requires a deep understanding of the business and its financial operations. Therefore, it is advisable to involve key stakeholders in the analysis process, including business owners, managers, and financial controllers.

Conclusion

A variance report is a powerful tool for small businesses, providing valuable insights into their financial performance. It helps businesses evaluate their performance, make informed decisions, and steer their operations towards their financial goals. Understanding the variance report is not just about understanding numbers; it's about understanding the story behind the numbers, the story of your business.

So, embrace the power of variance reports. Let them guide you on your journey to business success. Remember, the road to success is always under construction, and the variance report is your blueprint.