Variance analysis refers to analyzing the difference between an expected cost and the actual cost. In economics, this concept is important for success. Entrepreneurs must be able to accurately estimate costs in order to set appropriate prices and maximize their profits.
What Is Variance?
Variance refers to the difference between the expected cost of an item and its actual cost. For example, if you expected to pay $50 for a phone and ended up paying $60, the variance would be $10.
Entrepreneurs encounter many variances every day. Some variances are glaringly obvious, such as expense reports or other large ticket items that are over budget. Other variances appear quite small, such as production costs that vary by only a few cents.
It is important for business owners to pay the most attention to important variances. For example, those few cents can quickly add up if the business mass produces the item that is over cost, whereas an expense report that is over budget may not be a big deal if it occurs only once a year.
Estimate to Planned Variance
When there is a difference between the estimated cost quoted to a customer and the actual cost set into a plan to do the work, it is known as an estimate to planned variance. When this type of variance occurs, it is important for business owners to analyze the reason for the variance. Sometimes the estimate was too low or too high due to lack of planning; this problem can be easily corrected by planning more thoroughly in the future.
Planned to Actual Variance
When there is a difference between the planned cost of a project and its actual cost, this is known as planned to actual variance. It is important to analyze the reasons for this variance in order to ensure that money has not been wasted and that unnecessary costs are not being passed on to customers.
Estimated to Actual Variance
When there is a difference between the estimated cost quoted to the customer and the actual cost of a project, that is known as estimated to actual variance. This variance is top priority; hidden costs can interfere with profit margins or even cause a company to lose money instead of making it. Entrepreneurs must analyze the reasons for this variance and take corrective action as soon as possible.
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