So here’s the significant view, the variance. Sales are below plan, but costs are also below plan, and let’s stop there and make a point. You can see in the illustration how sales are negative and costs are positive. If you weren’t careful, you could interpret that as sales are down and costs up, which would be a disaster. But variance analysis is fairly specific, defined by accountants and financial analysts, so the positive in the direct costs lines means less costs, not more. That can be tricky.

You can check on that by looking at the gross margin. The gross margin is disappointing, below plan, but not horribly so. It seems like the cost controls helped soften the blow of lower sales.

Then you start looking at the expense rows, and there are several interesting surprises.

This is where we go from the accounting details, the actual calculation, to the human details. What happened here? What should be changed? Does the plan need revision? Have assumptions changed. How have the people performed?

Let’s look at a simple example of how plan vs. actual analysis works.

For the record, in accounting and financial analysis they call the difference between plan and actual variance. It’s a good word to know. Furthermore, you can have positive or negative variance, as in good variance and bad variance.

Positive variance:

• it comes out as a positive number.
• If you sell more than planned, that’s good. If profits are higher than planned, that’s good too. So for sales and profits, variance is actual results less planned results (subtract plan from actual).
• For costs and expenses, spending less than planned is good, so positive variance is when the actual amount is less than the planned amount.
• For these elements, variance is actual less plan. Subtract plan from actual.

Negative variance:

• the opposite. When sales or profits are less than plan, that’s bad.
• That’s why you get variance on sales and profits by subtracting plan from actual.
• When costs or expenses are more than planned, that’s also bad.
• So on costs and expenses, you subtract actual results from the planned results. It seems logical to me.

I’d like to show you that with a simple example. Let’s start with a beginning sales plan, then look at variance, and explore what it means. This is a simple sales forecast table — a portion, showing just three months — from a standard sales forecast.

Beginning Sales Plan

To set the scene, this illustration shows the sales forecast as the business plan is finished.

Actual Results for Sales

Here we see the actual results for the same company for the first three months of the plan.

The numbers at the end of March show actual sales numbers plus adjustments and course corrections.

So the calculations are simple enough. You calculate the variance in sales by subtracting the planned amount from the actual amount, which gives us the table shown here, the variance for the sample company.

I use the classic accountants’ red to indicate negative numbers, as in the phrase “in the red.” The negatives are also in parentheses. For those cases, the actual sales were lower than planned. Positive numbers here mean actual sales were higher than planned.

You probably see some obvious conclusions. These are just numbers, but they are also indicating areas for more management.

1. The negative results for unit sales of systems. Well below plan. And the per-unit revenue is down too.
2. Although units of service are disappointing, the price per unit was up, so sales were above plan.
3. There were pleasant surprises as well for software and training.

Given what’s happened, with the sales results, the plan-as-you-go planning process indicates in this example that systems sales are going badly, but there are other sales that can make up the problem.

Do you change the plan? That’s where the management comes in. Get the people together and talk about it. Why are systems sales so much less than plan? Were the assumptions wrong? Was the plan too optimistic? Has something happened — new competition, for example, or new technology, or something else — to change the situation as it was planned.

What about the people? Here’s where you have to manage expectations and follow up. Do you have metrics on sales presentations, leads, close rates? Have the people been performing, but just not getting the sales? Was your pipeline assumption wrong? What’s going on here.

For this example, at least, we adjusted the sales forecast to absorb some changed assumptions. Here’s the new sales forecast, after adjustments.

The illustration shows the revised plan in the April and May columns, even before they happen, to reflect the changes shown in the January-March period. Why are you going to work with an obsolete plan when the situation has changed.

Does this blow the plan-vs-actual comparisons for future months? Not if you make the changes correctly, with everybody on the team being aware of them. You just keep moving your plan away from the horizon.

In the end, it’s not a game. So what if you change the scoring in the middle. The point is managing the company better. Since the company knew systems sales would be down, they planned on it and made a revised forecast in the actuals area. The same revision affects projected profits, balance sheet, and — most important — cash.

So that was an example with a sales forecast, checking plan vs. actual. Now let’s look at an example of plan vs. actual on the income statement, which of course includes not just sales and cost of sales, but also expenses, and profits.

So variance is good or bad depending on context. More sales than planned is a positive variance, and more expenses or costs than planned is a negative variance. More profits is positive, less profits negative. Higher gross margin is positive. Lower expenses or costs is positive.

This table shows the gross margin and sales and marketing expense area of the original plan. This is a portion of the full table.

So that was plan, and this is actual. Following up on our hypothetical, this is was actually happened.

Of course the first thing you notice, I expect, is that it’s hard to see the significance of this table by itself. You need to compare it to the planned results, and consider the differences. That’s an instant illustration of why plan vs. actual is important.

Unfortunately, many businesses also forget to compare the original plan to the actual results. Especially if business is going well — the operation shows a profit, and cash flow is satisfactory — comparisons with the original budget are made poorly or not at all.

So we’ve seen some simple examples, in sample financial statements, of how things can go differently than planned. The real management here isn’t just the calculations, but rather the management of the differences.

You have to look beyond the numbers, talk to the people, bring these things up in the meetings so the plan stays alive as planning, nad becomes management. It isn’t always obvious.

Variance analysis ranges from simple and straightforward to sophisticated and complex. Some cost-accounting systems separate variances into many types and categories. Sometimes a single result can be broken down into many different variances, both positive and negative.

The most sophisticated systems separate unit and price factors on materials, hours worked, cost-per-hour on direct labor, and fixed and variable overhead variances. Though difficult, this kind of analysis can be invaluable in a complex business.

Look for Specifics. Talk to the People

In this case there’s a $5,000 positive variance in ads for January, and a $7,000 positive variance in literature (meaning collaterals, like brochures, sales pamphlets and folders). Is that a good thing, because less money was spent? Or is it a bad thing, because things that were supposed to be done weren’t done. That takes discussion, and then management.

The literature variance looks easy. Spending was low in February, but higher by a similar amount in March. It looks like the project was behind schedule, which might be bad, but not that much. And it might have been as simple as a vendor billing late, and accounting not adjusting. These are the kind of questions you ask.

• Why did one project cost more or less than planned?
• Were objectives met?
• Is a positive variance a cost saving or a failure to implement?
• Is a negative variance a change in plans, a management failure, or an unrealistic budget?

A variance table can provide management with significant information. Without this data, some of these important questions might go unasked.

More on Variance

Variance analysis on sales can be very complex. There can be significant differences between higher or lower sales because of different unit volumes, or because of different average prices. In the sales variance example in this chapter, the units variance shows that the sales of systems were disappointing. In the expenses variance, however, we can see that advertising and mailing costs were below plan. Could there be a correlation between the saved expenses in mailing, and the lower-than-planned sales? Yes, of course there could.

The mailing cost was much less than planned, but as a result the planned sales never came. The positive expense variance is thus not good for the company. Sales and Marketing expenses were also above plan in March, causing another negative variance.

The Sales Forecast Variance (see page 20.4) in Systems comparison between units variance and sales variance yields no surprises. The lower-than-expected unit sales also had lower-than-expected sales values. Compare that to Service, in which lower units yielded higher sales (indicating much higher prices than planned). Is this an indication of a new profit opportunity, or a new trend? This clearly depends on the specifics of your business.

It is often hard to tell what caused differences in costs. If spending schedules aren’t met, variance might be caused simply by lower unit volume. Management probably wants to know the results per unit, and the actual price, and the detailed feedback on the marketing programs.

Summary

The quality of a business plan is measured not by the quality of its ideas, analysis, or presentation, but only by the implementation it causes. It is true, of course, that some business plans are developed only as selling documents to generate financial resources. For these plans, their worth is measured by their effectiveness in selling a business opportunity to a prospective investor. For plans created to help run a business, their worth is measured by how much they help run a business — in other words, their implementation.

Variance analysis is vital to good management. You have to track and follow up on budgets, mainly through variance analysis, or the budgets are useless.

Although variance analysis can be very complex, the main guide is common sense. In general, going under budget is a positive variance, and over budget is a negative variance. But the real test of management should be whether or not the result was good for business.