What is Planning Variance? Things You Should Know

Analyzing planning variance is crucial to a business organization’s survival and successful performance. Therefore, an organization cannot bring necessary improvements without this analysis.

What is planning variance?

Planning variance is the difference between a predetermined plan and the results obtained from executing that plan. The difference or deviation is usually in one or all of the following elements: time, cost, production volume, quality, or expected income.

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Considering the importance of variance analysis, this article explains the whole concept in more detail. Let’s dig deeper into the concept to gain more understanding.

Explanation of Planning Variance

Now we shall gain a deeper understanding of the whole concept of variance. Let’s first revise the preliminary information:

Planning variance is the difference between a predetermined plan and the results obtained from executing that plan. The difference or deviation is usually in one or all of the following elements: time, cost, production volume, quality, or expected income.

Let’s break this down:

From the description of planning variance described before, we can see that the planning variance concept can be broken down as follows:

  1. The difference between a predetermined plan and executed plan
  2. Planning variance in time
  3. Planning variance in cost
  4. Planning variance in production volume
  5. Planning variance in quality
  6. Planning variance in income

In the sections below, we shall have a more detailed understanding of these concepts. Let’s start:

The difference between a predetermined plan and execution

A predetermined plan gives a course of action to obtain the desired results in a project. When implemented, it is not necessary that the predetermined course of action will provide the same results, which is actually the main difference between planning and execution.

Various uncertain and unexpected factors come into action at the time of execution. Therefore, the practical execution and implementation of the course of action might produce different results.

Planning variance in time

Planning variance in time is difficult and also critical to job performance. Variance in time refers to the difference between the standard hours assigned to a job and the actual hours. It means that the expected time to complete a particular job might be different than the time spent finishing it.

Calculating variance in time is crucial to production processes within an organization. You should identify the inefficiencies in a production process.

Planning variance in cost

Variance in cost is related to the analysis of the financial performance of a project. Variance in cost refers to the difference between the forecasted budget at the start of the project and the actual budget spent on it.

A difference between the Budgeted cost of work performance (BCWP) and Actual Cost of work performance (ACWP) provides the value of variance in cost. Planning variance in cost before a project helps in the accurate allocation of resources and capital.

Planning variance in production volume

You can calculate variance in production volume by analyzing the difference between two types of costs. The first cost is the expected cost of manufacturing the goods, as reflected in the budget. The second one is the actual cost of production of goods. So, it involves comparing the actual overhead costs per unit and the expected or budgeted cost per item.

Planning variance in quality

Planning variance in quality is an important concept in quality management. Variations in results, data, or any change in the quality of products all come under the domain of variance in quality.

Hence, Various reasons lead to variance in quality. Poor designing of the product, poorly designed processes, untrained operators, unfit operation, etc. can all lead to variance in quality.

Planning variance in income

Planning variance in income is necessary to remain safe from divergent factors. Variance in income refers to the difference between the expected and the actual income. It is of two types. These are favorable and unfavorable income variances.

If the actual figure of income is higher than the one that is expected, then it is called favorable variance. Contrary to this, when the expected income variance is higher than the actual figure, it is called unfavorable income variance.

Why do planning variances occur?

Several reasons are responsible for faulty planning of variances. Let’s have a look at them step by step:

Organizations prepare their budgets in advance. Companies usually create the budget for a whole fiscal year in advance for adequate resource allocation.

If the forecasted budget has not identified sufficient risk and uncertainty factors, then the actual budget deviates from the forecasted budget. Changes in regulations, costs of raw materials, and various other environmental and technological changes cause these deviations.

Errors and omissions in the planning process might also lead to variances. In addition, utilization and underutilization of available services also lead to deviations in planning variances. Therefore, organizations should use specific planning techniques to avoid major variances.

Technological changes and advancements lead to a change in the production processes. Technology is a major concerning factor because of continuous improvements. Technological changes cause changes in the operational systems, thus causing variances in production costs.

Another factor that causes variance is employee fraud. When planning variance, you should consider the probability of employee fraud. A strict control system can mitigate the effect of this factor.

Why is the analysis of plan variance important?

Analysis of planning variance in advance is extremely important to identify and forecast deviations in the organization’s processes, budget, and production volume. Therefore, calculating variance in advance helps in setting accurate and realistic standards. Variance analysis provides a fair reflection of the actual performance of an organization.

What are the two types of variance?

Variances are categorized into two types:

  1. Favorable variance
  2. Unfavorable variance

Let’s describe them individually:

Favorable Variance Unfavorable Variance
When the actual results are better than expected results, this is called favorable variance. Contrary to favorable variance, when the actual results are worse than expected, it is called unfavorable variance.
This occurs when revenue is higher than expected, and the estimated costs and expenditures are lower than expected. This occurs when revenue is lower than expected and expenses, production costs, etc., are higher than expected.
There is no need to reduce favorable variance. Unfavorable variance can be reduced by allocating expenses to other budget lines or analyzing costs.
Examples are:
Manufacturing costs are less than the budgeted amount
Expenses are less than the planned budget
Reported revenues are more than planned revenues.
For example, if the projected sales were 200000USD and the actual revenue turned out to be 170,000, the unfavorable variance amount will be 30,000USD.

How do managers use variances?

Managers can use variance data in a very productive manner. The reason is that variance data shows what has happened in the organization. It identifies the shortcomings in the organization’s performance.

Therefore, if the data shows positive variance, managers can concentrate on maintaining good performance. If the variance analysis shows negative trends, they need to identify the shortcomings and work on improvement.

How to reduce planning variances?

While calculating variances, it is important to sort out how variance can be reduced in case of occurrence. For example, in the case of planning variance in the budget, future variance can be reduced by taking corrective actions.

Secondly, adjustments can be made in the budget to match actual costs. The data should be as realistic as possible to reduce bias in variance while planning variance.

How do you calculate planning variance?

The process of planning variance involves the calculation of variance across cost, quality, volume, and income using the following formulas:

Variance in cost = budgeted cost of work performance (BCWP)- actual cost of work performance (ACWP)

Variance in income = Actual income – Expected Income

Variance in quality = Actual quantity used- standard quantity used x cost per unit

Variance in production volume = Actual quantity sold-budgeted quantity sold x standard selling price

Conclusion

Planning variance gives managers an insight into the organization’s actual performance. It is an important tool for analyzing the deviations from the expected results. Careful planning in variances can save organizations from performance setbacks.

Planning variance is the difference between a predetermined plan and the results obtained from executing that plan. The difference or deviation is usually in one or all of the following elements: time, cost, production volume, quality, or expected income.

To avoid variance, expectations should be set as realistically as possible. The focus should be on minimizing unfavorable variance and maximizing favorable variance.