What is a variance and why do we calculate it?
A variance is the difference between the actual figure and the figure planned in the budget. It is described as favorable if it works in favor of profit, such as higher revenue or lower expense, and unfavorable if it works against it. The goal is not to hold staff accountable for every riyal, but to understand the reason for the difference and make a decision: do we correct the execution, adjust the plan, or ignore it because it is not significant?
Sales variance analysis: price and volume
Knowing that sales fell by 39,200 SAR is not enough. Did we sell a smaller quantity, or did we sell at a lower price? Each cause has a different remedy. We split the variance into:
- Volume variance = (Actual quantity − Planned quantity) × Planned price
- Price variance = (Actual price − Planned price) × Actual quantity
A small appliances store planned to sell 10,000 units a month at a price of 50 SAR, i.e. 500,000 SAR. Actual: 9,600 units at an average price of 48 SAR, i.e. 460,800 SAR.
| Variance | Calculation | Amount (SAR) |
|---|---|---|
| Volume variance | (9,600 − 10,000) × 50 | 20,000 unfavorable |
| Price variance | (48 − 50) × 9,600 | 19,200 unfavorable |
| Total sales variance | 460,800 − 500,000 | 39,200 unfavorable |
About half of the problem lies in discounts. If it turns out that branches granted discounts without authority, the remedy is managerial. If a competitor cut its prices, the remedy is a pricing decision.
The flexible budget: a fair comparison for variable costs
Comparing actual cost of goods with the original plan can mislead you. If you sold less, it is natural for cost to be lower, and that is no achievement. The solution is the flexible budget: recalculate variable costs based on the actual level of activity, then compare.
The planned cost of sales ratio is 70%. Actual cost is 330,000 SAR.
- Compared with the static budget: 70% × 500,000 = 350,000 SAR, showing a favorable variance of 20,000 SAR.
- Compared with the flexible budget: 70% × 460,800 = 322,560 SAR, showing an unfavorable variance of 7,440 SAR.
The picture is reversed. The real cost is higher than expected relative to sales, due to a supplier price increase, waste or an inventory shortage, and this is what deserves investigation.
The monthly expense variance report
| Item | Planned | Actual | Variance | Percentage |
|---|---|---|---|---|
| Salaries | 80,000 | 82,000 | 2,000 unfavorable | 2.5% |
| Rent | 30,000 | 30,000 | 0 | 0% |
| Electricity | 8,000 | 11,500 | 3,500 unfavorable | 43.8% |
| Marketing | 15,000 | 9,000 | 6,000 favorable | 40% |
The electricity variance is small in SAR but large as a percentage, and may be due to the summer season not being taken into account in the monthly phasing. As for the “favorable” marketing variance, it may be part of the reason for the lower quantity sold; the saving here is not necessarily good news.
What do you do with the result?
- Set a materiality threshold: for example, investigate only variances that exceed both 5% and 5,000 SAR, so you do not drown in detail.
- Keep asking “why” until you reach an actionable cause: “electricity went up” is not a cause; “the air conditioners run outside working hours” is a cause.
- Distinguish between an execution error and a planning error: if the planned figure was unrealistic from the start, adjust your forecasts for the coming months instead of blaming the team.
- Link variances to each other: a saving in marketing alongside a drop in volume, or higher salaries due to overtime alongside higher sales.
- Document the decision: for each significant variance, record the cause, the action and the person responsible, and check the following month whether the action worked.
Who reads the report?
Design the variance report so that each manager sees only the items they control. The branch manager is accountable for sales, discounts and overtime hours in their branch, but does not control the rent agreed centrally. This principle is called responsibility for controllable items; it prevents unproductive discussions and focuses each person on what they can change.
Show the year-to-date cumulative figure alongside each variance. A small monthly variance may seem unimportant, but if it recurs for six consecutive months, it points to a persistent problem in the assumption or the execution, not a passing circumstance.