Variance Analysis for Indian Businesses: Complete Performance Guide

Introduction: When Numbers Don’t Add Up

Rajesh’s auto components factory budgeted ₹45 per unit for raw materials. At month-end, actual cost was ₹52 per unit—a seemingly small ₹7 difference. But with 50,000 units produced, the “small” variance meant ₹3.5 lakhs extra cost.

“I kept asking my team why costs were high, but nobody could pinpoint the reason,” Rajesh recalls. “Was it higher material prices? Did we use more material than needed? Was there wastage?”

When a cost accountant introduced variance analysis, the truth emerged: ₹2.5 lakhs was due to price increase from suppliers (price variance), and ₹1 lakh was from production inefficiency causing extra usage (usage variance).

“Now I knew exactly where to focus,” Rajesh says. “We renegotiated supplier contracts and fixed the production process. Both problems needed different solutions.”

What is Variance Analysis?

Definition

Variance analysis is the process of analyzing the difference between actual performance and budgeted/standard performance to identify causes and take corrective action.

Variance = Actual Result - Standard/Budgeted Result

Types of Variances

By Nature:

• Favorable (F): Actual is better than standard (higher revenue or lower cost)
• Adverse/Unfavorable (A): Actual is worse than standard (lower revenue or higher cost)

By Category:

• Cost variances (material, labor, overhead)
• Revenue/sales variances
• Profit variances

Why Variance Analysis Matters

1. Performance measurement – Actual vs. planned comparison
2. Cost control – Identify where costs are out of line
3. Responsibility accounting – Who is accountable for what
4. Decision support – Where to focus improvement efforts
5. Forecasting improvement – Better future budgets

Material Variances

Components of Material Cost

Standard Material Cost = Standard Quantity × Standard Price

When actual differs from standard, variances arise.

Total Material Variance

Formula: Total Material Variance = (Standard Cost for Actual Production) - (Actual Cost)

Or: = (SQ × SP) - (AQ × AP)

Where:

• SQ = Standard Quantity for actual output
• SP = Standard Price
• AQ = Actual Quantity used
• AP = Actual Price paid

Material Price Variance (MPV)

Formula: MPV = (Standard Price - Actual Price) × Actual Quantity MPV = (SP - AP) × AQ

Who is Responsible? Purchase department

Causes of Adverse Price Variance:

• Poor negotiation with suppliers
• Rush orders at premium prices
• Market price increases
• Buying non-standard quality
• Unfavorable contract terms

Causes of Favorable Price Variance:

• Good negotiation
• Bulk purchase discounts
• Market price decrease
• Finding new cheaper suppliers

Material Usage Variance (MUV)

Formula: MUV = (Standard Quantity - Actual Quantity) × Standard Price MUV = (SQ - AQ) × SP

Who is Responsible? Production department

Causes of Adverse Usage Variance:

• Wastage in production
• Poor quality materials
• Inefficient workers
• Machine breakdown causing spoilage
• Theft or pilferage

Causes of Favorable Usage Variance:

• Better quality materials
• Improved processes
• Skilled workers
• Better equipment

Complete Example

Standard: 2 kg material @ ₹50/kg = ₹100 per unit Actual Production: 1,000 units Actual Material: 2,200 kg @ ₹48/kg = ₹1,05,600

Calculations:

Verification: Price (4,400 F) + Usage (10,000 A) = 5,600 A ✓

Interpretation:

• Purchasing saved ₹4,400 through lower prices
• Production wasted ₹10,000 through extra material usage
• Net effect: ₹5,600 adverse

Labor Variances

Components of Labor Cost

Standard Labor Cost = Standard Hours × Standard Rate

Labor Rate Variance (LRV)

Formula: LRV = (Standard Rate - Actual Rate) × Actual Hours LRV = (SR - AR) × AH

Who is Responsible? HR/Personnel department

Causes of Adverse Rate Variance:

• Overtime premium
• Using higher grade workers
• Wage increases
• Unplanned bonus payments

Labor Efficiency Variance (LEV)

Formula: LEV = (Standard Hours - Actual Hours) × Standard Rate LEV = (SH - AH) × SR

Who is Responsible? Production department/supervisors

Causes of Adverse Efficiency Variance:

• Unskilled workers
• Poor supervision
• Machine breakdown
• Material quality issues
• Poor working conditions

Complete Example

Standard: 0.5 hours @ ₹200/hour = ₹100 per unit Actual Production: 1,000 units Actual Labor: 550 hours @ ₹190/hour = ₹1,04,500

Calculations:

Interpretation:

• Lower wage rate saved ₹5,500
• Extra hours cost ₹10,000 (possibly because lower-paid workers were slower)

Overhead Variances

Fixed Overhead Variances

Standard Fixed Overhead Rate = Budgeted Fixed Overhead ÷ Budgeted Output/Hours

Fixed Overhead Expenditure Variance: = Budgeted Fixed Overhead - Actual Fixed Overhead

Fixed Overhead Volume Variance: = (Actual Production - Budgeted Production) × Standard Fixed OH Rate

Variable Overhead Variances

Variable Overhead Expenditure Variance: = (Standard Rate × Actual Hours) - Actual Variable Overhead

Variable Overhead Efficiency Variance: = (Standard Hours - Actual Hours) × Standard Variable OH Rate

Complete Example

Budget:

• Fixed Overhead: ₹2,00,000 for 10,000 units
• Variable Overhead: ₹20 per unit
• Standard Fixed OH Rate: ₹20 per unit

Actual:

• Production: 9,500 units
• Fixed Overhead: ₹2,05,000
• Variable Overhead: ₹1,85,000

Fixed Overhead Variances:

Variable Overhead Variance:

Sales Variances

Sales Price Variance

Formula: Sales Price Variance = (Actual Price - Standard Price) × Actual Quantity Sold SPV = (AP - SP) × AQ

Sales Volume Variance

Formula: Sales Volume Variance = (Actual Quantity - Budgeted Quantity) × Standard Profit per unit SVV = (AQ - BQ) × Std. Profit

Complete Example

Budget: 10,000 units @ ₹150/unit; Cost ₹100/unit; Profit ₹50/unit Actual: 9,000 units @ ₹160/unit; Cost ₹105/unit

Sales Variances:

Interpretation:

• Sold fewer units (adverse volume)
• But at higher prices (favorable price)
• Net effect: ₹40,000 favorable

Comprehensive Variance Analysis

Operating Statement Format

Variance Investigation

When to Investigate

Not every variance warrants investigation. Consider:

1. Materiality

• Absolute amount (e.g., variances >₹50,000)
• Percentage (e.g., variances >5%)

2. Controllability

• Can management influence the variance?
• External factors vs. internal issues

3. Trend

• One-time vs. recurring
• Getting worse or improving?

4. Cost-Benefit

• Will investigation cost exceed potential savings?

Investigation Decision Matrix

Root Cause Analysis

Steps:

1. Identify the variance
2. Gather detailed data
3. Interview responsible persons
4. Analyze processes
5. Identify root cause (not just symptoms)
6. Develop corrective action
7. Implement and monitor

Tools:

• 5 Whys technique
• Fishbone diagram
• Pareto analysis
• Process mapping

Variance Reporting

Monthly Variance Report Format

Dashboard Indicators

Key Variance Metrics:

• Material cost per unit vs. standard
• Labor hours per unit vs. standard
• Overhead recovery rate
• Gross margin variance
• Revenue per employee

Practical Tips for Indian Businesses

Setting Good Standards

1. Be realistic – Achievable but challenging
2. Update regularly – At least annually
3. Consider local factors – Inflation, seasonal variations
4. Involve stakeholders – Those who’ll be measured

Common Indian Business Challenges

1. Volatile Input Prices

• GST rate changes
• Import duty fluctuations
• Commodity price swings

Solution: More frequent standard updates; flexible budgeting

2. Labor Issues

• Minimum wage revisions
• Seasonal worker availability
• Skill variations

Solution: Include buffer in labor standards; track productivity

3. Power Cost Variations

• Electricity tariff changes
• DG backup usage

Solution: Separate energy variance analysis

4. Currency Fluctuations

• Import price impacts
• Export revenue changes

Solution: Separate exchange variance; hedge where possible

Integration with Other Systems

1. ERP Systems

• Automatic variance calculation
• Real-time monitoring
• Drill-down capability

2. Costing Software

• Standard cost maintenance
• Variance reports
• Trend analysis

3. Business Intelligence

• Dashboard visualization
• Predictive analytics
• Benchmarking

Limitations of Variance Analysis

Recognize the Constraints

1. Backward-looking – Tells you what happened, not what will happen
2. Standard quality – Only as good as the standards set
3. Blame culture risk – Can become punitive rather than constructive
4. Interdependencies – One variance may cause another
5. Time lag – Information may be delayed
6. Overemphasis on financial – May ignore quality, customer satisfaction

Balanced Approach

Combine variance analysis with:

• Non-financial KPIs
• Quality metrics
• Customer feedback
• Employee engagement scores
• Process improvement initiatives

Key Takeaways

1. Variance = Actual - Standard – Foundation of analysis
2. Price and efficiency – Two main variance components
3. Favorable isn’t always good – Lower price may mean lower quality
4. Investigate selectively – Material, recurring variances
5. Identify responsibility – For effective action
6. Look for root causes – Not just symptoms
7. Use for improvement – Not punishment
8. Update standards regularly – Keep them relevant

Disclaimer

This article is for educational purposes only and does not constitute professional accounting advice. Variance analysis methods may need customization based on specific business contexts. Consult a cost accountant for implementing variance analysis systems.

Variance Analysis Checklist

Setting Standards:

• Standards are realistic and achievable
• All cost components covered
• Standards documented and approved
• Review schedule established

Monthly Analysis:

• Calculate all variances
• Classify as favorable/adverse
• Identify material variances
• Investigate significant items
• Document causes

Reporting:

• Prepare variance summary
• Present to management
• Discuss action items
• Track corrective actions
• Monitor trends

Annual Review:

• Assess standard accuracy
• Update for changed conditions
• Review variance thresholds
• Improve processes based on learnings

Variance analysis is like a medical check-up for your business—it tells you where you’re healthy and where you need attention. The key is not just measuring, but acting on what you find.