Variance Analysis: Finance Essay

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Finance: Variance Analysis

Describe how variance analysis can be applied to flexible and static budgets

A variance is the difference between an actual amount and a budgeted amount. Budget variances are used by management in their control and planning decisions, particularly in the case of management by exception, which entails identifying areas that are not performing according to plan, and dedicating more attention to the same. Variance analysis has to do with the calculation of variances, and identification of the possible causes of the same. It essentially involves comparing and monitoring actual vs. planned costs, with the aim of identifying trends, threats, and opportunities - and adjusting strategies, goals and objectives if need be (Steffan, 2008). Towards this end, variance analysis helps managers evaluate business performance by assessing the level of effectiveness -- the degree to which targets have been met; and the level of efficiency -- the input cost being incurred in production vis-a-vis the revenues being realized from output.

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Its main components are sales volume variances and price and efficiency variances.

Sales volume variance = flexible budget amount (actual sales volume) -- static budget amount

Price variance = (actual input price -- budgeted input price) x actual quantity of output

Efficiency variance = (actual input usage -- budgeted input usage) x budgeted input price

Sensitivity Analysis and Forecasting

Sensitivity analysis entails systematically changing the quantitative computation (s) underlying a project, estimate, or decision, with the aim of evaluating its impact on the final outcome. It involves evaluating a set of possible scenarios, and determining how changes in the independent variable could affect the dependent variable. Sensitivity analysis basically forms the basis of forecasting; because forecasting is based on financial models, and financial models are developed from sensitivity analysis. Take for instance, an analyst who wishes to make forecast on the values of a company's equity over a certain period of time, based on the price-to-earnings ratio -- they would base.....

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