Analyzing Financial Performance Reports

a. Variance analysis Variance analysis is one of the tool for the performance measurement of any business unit. Which compares the actual results and the standard results and shows the interpretation of the same.But, a thorough analysis identifies the causes of the variances and the unit responsible. Variances are hierarchical and begin with total business performance. The business performance is divided into two broad categories revenue variances and expense variances.

Variance Analysis Disaggregation

The analytical framework we use to conduct variance analysis incorporates the following ideas: Identify the key casual factor that effect profit Breakdown the overall profit variance by these key causal factors Focus on profit impact of variation in each causal factor Try to calculate the specific, separable impact of each causal factor by varying only that factor while holding all other factor constant

1. Revenue Variances: Revenue variances are taking the volume and selling price into consideration also with sales area.

Revenue variances can be divided into two parts, selling price, volume and mix variance. The selling price variance can be calculated by multiplying the difference between the actual price and and the standard price by the actual volume. (actual price Standard price) * actual volume

While the mix and volume variance is calculated by using following formula. Mix and Volume Variance = (Actual Volume-Budgeted Volume) * Budgeted Unit Contribution Mix Variance:

the mix variance for each product is found from the following equation: Mix Variance: [(total actual volume of sales*Budgeted proportion)-(Actual volume of sales)]*Budgeted unit contribution Volume Variance:

the volume variance can be calculated by using following formula: Volume Variance: [(total actual volume of sale)*(Budgeted percentage)]- [(Budgeted sales)*(Budgeted unit contribution)] Expense Variance: Fixed Cost Variance: variances between actual and budgeted fixed costs are obtained simply by subtraction. Variable Cost Variance: variable costs are costs that vary directly and proportionately with volume. The budgeted variable manufacturing expenses must be adjusted to the actual volume of production. The other variances under the head of non-manufacturing costs are Administration, marketing and research and development.

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Variations in practices The variance analysis is taking the difference of the monetary transaction in terms of budgeted and actual, but in practices there are many variations in this process too. 1. Time period of the comparison: The time period taken can be a year long also, which takes the extremes and can give the average results.

The business unit manager is not judged on the basis of a month but for the long period which may overcome the problems of extremes.

2. Focus on Gross Margin Unit gross is difference between selling prices and manufacturing costs. 3. Evaluation Standards: - Predetermined standards or budgets - Historical standards - External standards - Limitation of standards 4. Full Cost System: - If the company uses the full cost system than the variable and fixed overheads both are included in the inventory to calculate the standard cost per unit. - Thus the problem of the variance calculation for the fixed overheads remain a problem. 5. Engineered cost and discretionary cost

Limitations of variance analysis 1. Once the variance is found but it does not explain that why the variance created. 2. The second problem is to find out that the variance is significant or not. Because if the variance is significant but uncontrollable than there is no point of investigation. 3. A third limitation is that, one units poor performance can be offset by the other units good performance for the organization as a whole, but no motivation to the unit. 4. Finally, the reports show what happened and not the future actions of the same. Management Action There is one cardinal principle in analyzing formal financial report : the monthly profit should contain no major surprises. Significant information about the financial performance should be informed very quickly. One of the most important benefits of financial reporting is that it provides the desirable pressure on subordinate managers to take corrective actions on their own initiative. The discussion between the business unit manager and the supervisor explains the reasons for significant variances.