Cost control is the practice of identifying and reducing business expenses to increase profits, and it starts with the budgeting process. A business owner compares actual results to the budget expectations, and if actual costs are higher than planned, management takes action.
Variance Analysis is a technique used for:
a. Cost Control – Monitor Actual Expenditures against, should cost.
b. Profit Control – Which a large part is facilitated by cost control.
1)How can variance analysis be used to control costs?
Variance analysis can be used to control costs it involves assessing the difference between two figures. It is a tool applied to financial and operational data that aims to identify and determine the cause of the variance some of them given below :
1. It Calculates the difference between an incurred cost and an expected cost
2. It investigates the reasons for the difference
3. It reports this information to management
4. It takes corrective action to bring the incurred cost into closer alignment with the expected cost
The most simple form of cost variance analysis to subtract the budgeted or standard cost from the actual incurred cost, and reporting on the reasons for the difference. A more refined approach is to split this difference into two elements:
(1) Price variance – This portion of the variance caused by a difference between the actual and expected price of the goods or services acquired.
(2) Volume variance – This portion of variance caused by any change in the volume of goods or services ordered.
Variance analysis is important to assist by controlling budgeted versus actual costs. In program and project management it is evaluated that what is the difference of the actual cost and standard cost. If difference is favourable then there is no worry but if the difference is adverse then the cost can be controlled by taking further steps of management like fire the defaulter. Let’s take an instance, a monthly closing report might provide quantitative data about expenses, revenue and remaining inventory levels but the Variance analysis can evaluate it. Variance between planned and actual costs would lead to adjusting business goals, objectives or strategiesas well as the cost control by evaluating the variance.
2) How are variances utilized to evaluate managers’ performance?
Variances are utilized to evaluate managers performance as variance analysis provides detailed data about differences between standard and actual costs and thus helps identify the causes differences.
It is usually more effective at pinpointing efficient and inefficient operating areas that are basic comparisons of budgeted and actual data. A managerial performance report based on standard costs and related variabces should identify the causes of each significant variabce, the personnel involved, and the corrective actions taken.
It should be tailored to the cost center manager’s specific area of responsibility and explain clearly how the manager’s departmebt met or did not meet operating expectations. Managers should be held accountable only for the cost areas under their control.
Thus the variabces are utilized to evaluate managers’ performance which is related to their area and furhter steps can be taken.