Welcome to Day 6! Today, you'll learn how to analyze budget variances and generate insightful reports. We'll delve into understanding why costs deviate from the budget and how to control them effectively.
A budget variance is the difference between a budgeted amount and the actual amount spent. Analyzing these variances helps procurement managers understand whether they are staying within budget and identify areas needing attention. There are two main types of variances: Favorable Variance (actual cost is less than budgeted cost) and Unfavorable Variance (actual cost is more than budgeted cost).
Key variances include:
* Cost Variance (CV): Measures the difference between the actual cost and the budgeted cost. Formula: CV = Actual Cost - Budgeted Cost. If CV is positive, it's unfavorable (over budget); if negative, it's favorable (under budget).
* Schedule Variance (SV): Although typically associated with project management, we can apply it to procurement timelines. This measures the difference between planned delivery time (or expenditure time) and actual delivery time (or expenditure time). We won't focus too much on this one for this lesson but understand it's another type of variance.
Example:
Let's say you budgeted $1,000 for office supplies (budgeted cost) and actually spent $1,100 (actual cost). The cost variance would be: $1,100 - $1,000 = $100 (Unfavorable).
Variances can occur due to various reasons. Understanding the causes is crucial for taking corrective actions. Some common causes include:
Example:
If the price of steel increased unexpectedly (price change), a construction project may have an unfavorable cost variance on the steel purchase. Alternatively, if the construction project needed more steel than budgeted (quantity change), this also will contribute to a cost variance.
Variance reports present a summary of the variances, their causes, and potential solutions. These reports are essential tools for monitoring performance and making informed decisions.
Components of a Variance Report:
Example:
| Item | Budgeted Cost | Actual Cost | Variance | % Variance | Explanation | Corrective Action |
|---------------|---------------|-------------|----------|------------|---------------------------------------------|----------------------------------------------------------|
| Office Supplies | $1,000 | $1,100 | $100 | 10% | Price increase from supplier | Negotiate better prices; seek alternative suppliers. |
| Steel | $10,000 | $12,000 | $2,000 | 20% | Quantity purchased was greater than budgeted | Review future steel quantity estimations; explore more. |
Cost control measures are actions taken to reduce or eliminate unfavorable variances. These measures are preventative, detective and corrective. Some examples include:
Explore advanced insights, examples, and bonus exercises to deepen understanding.
Welcome back! Today, we're not just looking at the basics of budget variances; we're diving deeper into how to use them to proactively manage your procurement activities. We'll explore the nuances of variance analysis and equip you with the tools to become a strategic cost controller. Remember, understanding why costs deviate is the first step towards effective control and improvement.
While calculating variances is crucial, the true power lies in understanding why they occurred. This involves a thorough root cause analysis. Consider these techniques:
Use these analyses to create actionable plans. These plans should include:
Let's put your knowledge into practice!
Download this hypothetical variance report (available in your resources section). It details cost variances for a recent project. Identify the largest variances, the potential root causes for each, and recommend at least two corrective actions for each significant variance. Justify your recommendations.
You've noticed that the actual cost of office supplies consistently exceeds the budgeted amount. Use the "5 Whys" method to uncover the root cause. Then, create a short action plan outlining specific steps you could take to control future costs.
Variance analysis isn't just for procurement. Consider these practical applications:
Ready for a challenge?
Continue your journey by exploring these related topics:
Keep practicing, and you'll become a budget variance expert!
You budgeted $5,000 for IT equipment. The actual cost was $5,300. Calculate the Cost Variance and determine if it's favorable or unfavorable. What is the percentage variance?
Scenario: You budgeted $2,000 for a marketing campaign's promotional materials. The actual cost came to $2,400. The reason was that the design required a more complex print than anticipated. What is the variance? What is the cause of the variance?
Examine the example variance report provided in the lesson. Based on the report, what is the most significant unfavorable variance and what is a potential corrective action?
Imagine you are a Procurement Manager at a small company. You are preparing a budget for the upcoming quarter. Identify the main items you'll procure. Create a simple budget for these items. At the end of the quarter, calculate the variances for your budget. Write a short variance report showing your findings and possible corrective actions for the biggest discrepancies.
Prepare for the next lesson by gathering some basic pricing information from 3 different suppliers for an item of your choosing. We will be looking at supplier selection.
We're automatically tracking your progress. Sign up for free to keep your learning paths forever and unlock advanced features like detailed analytics and personalized recommendations.