Variance Analysis: Definition, Types, Formulas and Examples

Variance analysis can help companies manage projects, productions or operational expenses by monitoring planned versus actual costs. Creating an effective analysis can help businesses maintain and improve operations. Learning how to calculate variance analysis is useful if you want to help a business better understand its costs and performance.

In this article, we explain what variance analysis is, define key terminology for understanding it, discuss three types of variance analysis and their formulas and share calculation examples.

Key takeaways:

• Variance analysis compares the predicted costs or behavior of a business with its actual numbers and outcomes.

• This comparison can help businesses analyze past data, monitor their costs and better plan for future expenses.

• The three main types of variance analysis are material variance, labor variance and fixed overhead variance.

What is variance analysis?

Variance analysis is the comparison of predicted and actual outcomes. For example, a company may predict a set amount of sales for the next year and compare its predicted amount to the actual amount of sales revenue it receives. Variance measurements might occur monthly, quarterly or yearly, depending on individual business preferences.

The more frequently a company measures these variances, the more likely it may be to discover trends in its data. Whether a variance works can depend on the type of variance analysis you calculate and the predicted variances a company expects.

Businesses may use this type of analysis to calculate variance in the following categories:

• Purchase variance

• Sales variance

• Overhead variance

• Material variance

• Labor variance

• Efficiency variance

Related: 7 Types of Financial Analysis (With Definition and Examples)

Key terms for variance analysis

Here are some helpful terms to help you gain a better understanding of variance analysis:

• Overhead costs: Overhead costs can refer to a business's operating expenses, like rent for an office space or insurance costs. Companies may audit their operating expenses to save money and help decrease overhead costs.

• Budgets: Budgets are financial plans that companies can use to allocate spending internally and prevent overspending. Like overhead costs, businesses may revise budgets as needed to ensure they meet set goals.

• Variable price and rate variance: Variable price and rate variance refer to the changes in the cost for a product or service. They can be unpredictable, and companies might change these cost values to reflect current consumer demands or supply rates.

• Variable quantity and efficiency variance: Variable quantity and efficiency variance refer to fiscal differences between a company's actual input of materials and labor and the amount of overall allowed material and labor input.

• Fixed budget variance: Fixed budget variance refers to the fiscal differences between fixed overhead costs included in company budgets and the actual amount of overhead costs for a variance period.

• Fixed volume variance: Fixed volume variance is the fiscal differences between the amounts of fixed overhead costs a company applies during a variance period and the fixed amount of recorded overhead costs in a company's budget.

Related: Guide to Overhead

Types of variance analysis

The type of variance analysis you perform depends on the information you're examining. Here are three different types of variance analysis:

1. Material variance

The material variance helps companies identify where they may be using more materials than they actually need. For example, if a company reorders materials because of quality concerns, the additional costs may show variance in the analysis.

The company might use this information to determine whether to continue using the same material supplier or search for a new one. This analytical process can require the use of the following material formulas to find individual and overall variances:

Quantity variance = (Actual quantity x Standard price) − (Standard quantity x Standard price)

Price variance = (Actual quantity x Standard price) − (Actual quantity x Actual price)

Overall variance = Quantity variance + Price variance

Related: Quantity Variance: Definition and Examples

2. Labor variance

The labor variance helps businesses identify how efficiently they use labor and the effectiveness of their pricing. For example, if a company calculates variance and finds inefficiencies or higher labor pricing, it might consider making changes for the upcoming fiscal year.

This information may help the company further streamline its operations and save money. Here are the formulas involved in finding individual and overall variances for labor variance:

Rate variance = (Actual hours x Actual rate) − (Actual hours x Standard rate)

Efficiency variance = (Actual hours x Standard rate) − (Standard hours x Standard rate)

Overall variance = Rate variance + Efficiency variance

Related: Comparing Labor Efficiency Variance vs. Labor Price Variance

3. Fixed overhead variance

The fixed overhead variance helps a company identify differences between its budgeted overhead costs, which it may determine based on production volumes, and the number of used overhead costs.

For example, if a company wants to revisit its budget plans, it might use fixed overhead variance to determine whether it can reduce its current allotted budget. This information may help the company save or allocate money to other areas of the business. Here are the formulas involved in calculating fixed overhead variance:

Budgeted fixed overhead cost = Denominator level of activity x Standard rate

Budget variance = Actual fixed overhead cost − Budgeted fixed overhead cost

Fixed overhead cost applied to inventory = Standard hours x Standard rate

Volume variance = Budgeted fixed overhead cost − Fixed overhead cost applied to inventory

Overall variance = Budget variance + Volume variance

Related: What Is a Business Budget (With an Example)

Examples of variance analysis

Here are some example calculations of variance analysis:

Material variance example

Feminine Fashionista, a clothing company, is interested in calculating its overall material variance. It has an actual quantity of 30,000 pieces of fabric at a standard price of $0.65 per fabric and a standard quantity of 25,000 pieces of fabric at an actual price of $0.50 per fabric. This information allows the company to first calculate its quantity variance:

Quantity variance = (30,000 x $0.65) − (25,000 x $0.65) = $19,500 − $16,250 = $3,250

Next, the company uses those numbers to calculate the price variance:

Price variance = (30,000 x $0.65) − (30,000 x $0.50) = $19,500 − $15,000 = $4,500

Finally, adding the quantity variance of $3,250 and the price variance of $4,500 provides Feminine Fashionista with the overall variance:

Overall variance = $3,250 + $4,500 = $7,750

This means the company has an overall material variance of $7,750.

Labor variance example

Bluelow Builders, a construction company, wants to calculate its overall labor variance. The company's actual hours are 5,000 at an actual rate of $15 per hour, and its standard hours are 4,800 at a standard rate of $12 per hour. Using these numbers, Bluelow Builders calculates the rate variance:

Rate variance = (5,000 x $15) − (5,000 x $12) = $75,000 − $60,000 = $15,000

Next, the company calculates the efficiency variance:

Efficiency variance = (5,000 x $12) − (4,800 x $12) = $60,000 − $57,600 = $2,400

Finally, adding the rate variance of $15,000 and the efficiency variance of $2,400 provides Bluelow Builders with its overall variance:

Overall variance = $15,000 + $2,400 = $17,400

The labor variance outcome of $17,400 may be unfavorable if the company didn't expect to spend that additional money on labor costs. Bluelow Builders may choose to review its labor costs and plans to ensure it doesn't overspend in the upcoming fiscal year.

Fixed overhead example

Wheeler PR is a marketing and public relations agency that wants to find its overall fixed overhead variance. The organization's level of activity is 8,000 hours at a standard rate of $10 per hour and 6,300 standard hours at an actual fixed overhead cost of $82,200.

Multiplying the denominator level of activity of 8,000 hours by the standard rate of $10 per hour provides Wheeler PR with the budgeted fixed overhead cost:

Budgeted fixed overhead cost = 8,000 x $10 = $80,000

The company then calculates its budget variance:

Budget variance = $82,200 − $80,000 = $2,200

Next, Wheeler PR finds the fixed overhead cost applied to inventory:

Fixed overhead cost applied to inventory = 6,300 x $10 = $63,000

After this, the company calculates the volume variance:

Volume variance = $80,000 − $63,000 = $17,000

Finally, adding the budget variance of $2,200 and the volume variance of $17,000 provides Wheeler PR with the overall variance:

Overall variance = $2,200 + $17,000 = $19,200

From these calculations, Wheeler PR determines that it has an overall fixed overhead variance of $19,200.