The Importance of Variance Tracking
Variances eat your profits! They are a major reason for low
profitability and can represent more unplanned costs than your net profit. When
you plan a certain profit margin and you experience variances from the plan,
where do you think the money comes from to cover the costs? Your profits!
Variances are exceptions to goals, objectives, plans,
procedures, standard of performance, budgets, etc. Variances occur in the financial,
scheduling, construction, sales, closing, customer service, procedural and
quality areas, all of which affect your bottom line. You need to establish
quantifiable measurement and reporting systems to isolate the variances so they
can be analyzed and corrective actions can be taken to eliminate them.
This article will focus on construction cost variances,
which are a major cause of profit erosion. A construction cost variance is an
unplanned cost with no counter balancing revenue, such as, extra material, extra
labor, rework, damaged material, theft, estimating error, and sales
concessions. Change orders should not be considered a variance since they have
counter balancing revenues. If included as a variance, it is hard to get the
management team to really dig into the efforts to eradicate variances.
Purchasing—Good, detailed estimates and purchasing procedures allow for
better variance analysis and control. The construction cost budget should be
within 1% accuracy when you add both the over and under variances together. $100
over + $100 under = $200 of variances not $0.00 variance.
The construction budget should not include a contingency. Contingency
budgets hide your variances, and if you budget for contingencies the budget
tends to get spent. The contingency for variances should be considered in your
pricing procedure not in your budgets.
You should implement a true purchase order system where the
purchase order is a pre-printed invoice. You will pay only the purchase order
amount once authorized by your superintendent. If you are receiving invoices,
the invoice needs to match the purchase order unless a variance purchase order
was been authorized.
Order—Every variance should be authorized with a variance purchase order prior
to the added cost being incurred. Don’t write variance purchase orders after
the fact since it will violate your cost control system. The variance purchase
order identifies the unplanned cost. It should determine the root cause for the
variance through the use of variance codes as well as identify the action to be
taken to eliminate the variance in the future. Finally, the variance purchase
order should assign the responsibility for taking the corrective action. The
objective is to eradicate variances and to protect your profitability.
Meeting—You should have a monthly variance review meeting. Many times I see
these meetings run as rubber stamp approval meetings. Don’t accept variances as
a given. Yes, they happen, but they don’t have to. The purpose of the meeting
is to review the variances and establish a game plan to eradicate them. Each
variance can be rather small but when all the variances are aggregated and
sorted by reason code you will be able to identify the major sources for variances.
I like to graph the variances by reason code in a pie chart. It is easier to
understand and see the magnitude of the issues. The graphs can be created by
reason code, functional department, community, vendor, and/or superintendent.
Involve Your Team—Get
input from your internal and external team. 90% of the time, the people
involved with the process where variances are occurring have the solution on
how to eradicate them. You don’t need to have all the answers, you just need to
be able to isolate the problem, ask the right questions, and work with your
team to find the solutions.
Accountable—Once you discover the cause for the variance, hold your people
accountable to implementing procedures to eradicate the variances. The objective
is to assure that you and your team compel events to conform to the plan and
follow through with the implementation of variance solutions.
Improvement—Eradicating variances is not a onetime effort. As I stated at
the beginning of this article, you must maintain you vigilance because
variances happen. Incorporating strong variance analysis in the process will
continually reduce the volume of variances and improve your profitability.
Variance analysis and control is critical to improving your
profitability. For a 4% net profit builder, a reduction in variances of 1% on
sales will increase net profits by 25%. The efforts to eliminate variances within
your organization will be richly rewarded.
Best of luck to you!