Chuck Shinn: Rx from the Profit Doctor

The Importance of Variance Tracking

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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.

Estimating and 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.

Variance Purchase 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.

Variance Review 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.

Hold People 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.

Continuous 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!

 
 

Comments (1 Total)

  • Posted by: Anonymous | Time: 1:57 PM Wednesday, September 25, 2013

    The problem with variances is that they are always going to be variances. Most projects will have multiple change orders, upgrades, downgrades, and just plan old "we missed it". The author of this article hits the solution right on the head. Keep all team members informed and everything needs to be in writing. John Clark CEO www.ubuildnet.com

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About the Blogger

Chuck Shinn

thumbnail image Charles C. Shinn, Jr., Phd, often referred to as the Profit Doctor, created the Shinn Group of Companies, The Lee Evans Group, and Builder Partnerships to help increase the professionalism and management standards of the homebuilding industry. His constant focus is to help builders and manufacturers to improve performance of their companies, improve relationships and ultimately maximize their total profits. Chuck inspires hundreds of builders each year through his frequent speaking engagements and educational seminars. Chuck Shinn holds a BA in Economics, and an MBA and PhD in Business Administration from the College of Business Administration at American University in Washington, DC.