# Financial Analysis: How to Calculate Variances

Variance analysis is a financial analysis technique that looks into why your actual results are different than your budget. By knowing why you missed your spending targets, you can make better plans for the future. Some variances look at whether you were efficient with how you make your products. Other variances look at the prices you are paying. By using variance equations, you can see where you are overspending. You can also see where you are doing better than your budget and try to copy that success other places in your business.

## Material Variances

You can use two different variances equations to see how well you are using your materials. First, the efficiency variance measures the difference between the amount of materials you expected to use and what you actually used. Pretend that you make clothes and bought 5 metres to make a dress. If you only needed to use 4 metres, you have a favourable efficiency variance because you didnt use all the material you expected. You can use this information to try and copy your efficiency in other places within your business. Another way to check your raw materials spending is by using the material price variance. You use this equation to see if the prices you paid were what you originally expected. When you bought the fabric to make the dress above, imagine you paid \$20 per metre. If you originally planned to spend \$18 per metre, you paid \$2 more per metre and have an unfavourable variance.. This information can help you understand the trend of prices and can set your expectations for spending in the future.

## Understanding Variance Relationships

The variances above have relationships that are useful to know for your small business. Take a situation where you spent \$26,000 on raw materials. At the beginning of the year, you planned to spend \$25,000 so you spent \$1,000 more than you planned. A critical part of variance analysis is understanding why you were off. Were you paying higher prices than expected? Were you using more materials than you had planned? Was there a combination of both? If you do variance analysis, you will get the valuable answers to these questions.

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