Part Two

TOOLBOX

UNDERSTANDING VARIANCE

Variance just means difference. It might be the difference between budget and actual for the month or year, between actual this month and actual last month, and so on. It can be presented in dollars or percentages, or both. Percentages are usually more useful because they provide a quick and easy basis of comparison between the two numbers.

The only difficulty with variance comes with determining whether a variance is favorable or unfavorable. More revenue than expected, for instance, is favorable, but more expense than expected is unfavorable. Sometimes your accountant or financial staff are helpful and let you know in a note that a variance enclosed in parentheses or a variance preceded by a minus sign is unfavorable. But often you have to figure it out on your own. We recommend doing a few calculations yourself, determining whether the indicated variances are bad or good and then checking to see how they are displayed. Be sure to do the calculations for both a revenue line item and an expense line item. Sometimes parentheses or negative signs indicate only the mathematical difference between two numbers. In that case, parentheses for a revenue line item might mean favorable, and parentheses for an expense line item might mean unfavorable.

CALCULATING PERCENT OF AND PERCENT CHANGE

When you’re studying the income statement, there are two simple yet powerful tools that can help you understand the meaning behind the numbers. The first is “percent of” calculations. Percent of determines what percentage something is of something else. The basic formula is:

For example, if you had $75 in your wallet and gave a friend $6, you’ve given him 8 percent of what you had.

(Remember that to convert a decimal to a percentage, you move the decimal point over two places to the right, so that .08 becomes 8 percent.)

So, for example, if you wanted to analyze your budget from last year, you might wonder how much of your budget was spent on supplies. Assume that your company spent $6,000 on supplies last year and that its total office budget was $50,000. So the calculation is as follows:

The second tool is percent change. (The percent change formula is also the formula for percent variance—so once you have percent change down, you can also do percent variance.) Percent change is simply the percentage something changed from one period to the next, from budget to actual, from forecast to actual, and so on (you get the idea).

The formula for percent change from one year to the next is as follows:

For example, if prior year revenue was $3,000 and current year revenue was $3,750, then the percent change is as follows:

In general, the formula for percent change is as follows:

You will find more opportunities to practice these percent of and percent change calculations in the practice exercises in appendix B.