Understanding profit variance

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Simon Chave
by Simon Chave 26 March 2018

Many organisations track and measure the variance between budget, forecast and actual gross margin, often with the ability to drill into variance degrees of detail and dice and slice data in a plethora of ways. However, I have been lucky enough to work with a series of great management accountants in my career and they introduced me to the concept of Gross Profit Variance Analysis that provide insight into why an target was missed. This technique delivers real insight into what is influencing profit variation. Are targets missed (or exceeded) through decreased sales volume, sale price reduction or cost increases.

A set of accounting equations will provide such insight and allow corrective action plans to be formed that directly influence future performance. Although these accounting formula’s provide fantastic insight, it is what your organisation does with the information that is important. As such, I will append my own formula and this is really simple:

  • No action = no improvement.

It is the ability of your organisation to react to ever changing circumstances that makes the difference, not a set of numbers. Empowering teams through the provision of high quality, targeted information that leads to action plans that are followed up is the reason organisations should implement management reporting regimes.

Formula

There are many different accounting equations that give insight into profit variance. To check my calculations I used the following website whilst preparing this blog (http://accounting-simplified.com/management/variance-analysis/) and if interested in further formulas I recommend you review this material. However, the purpose of this blog in to draw your attention to the art of the possible and not re-do the work of experts. As such, I will concentrate of three key metrics of

  • Sales Volume Variance – are we selling enough?
    • Sales Volume Variance = (Actual Unit Sold – Budget Unit Sold) X Budget Unit Margin
  • Sales Price Variance – are we discounting to much?
    • Sales Price Variance = (Actual Sales Price – Budget Sales Price) X Actual Units Sold
  • Cost Price Variance - are negotiating well with suppliers?
    • Cost Price Variance = (Actual Cost Price – Budget Cost Price) X Actual Quantity Sold

Example

Download the Excel spreadsheet to view the example.

Profit Variance Screenshot.png

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Topics: data insights