Definition: A percent variance is the change in an account during a period of from one period to the next expressed as a ratio. In other words, it shows the increase or decrease in an account over time as a percentage of the total account value.
What Does Percent Variance Mean?
This concept is useful in all types of financial planning and decision making because it helps management, investors, and creditors track company performance trends and evaluate performance. Management typically uses it to review budgeted and actual numbers to see how close they company was to reaching its budgeted goals. On the other hand, investors and creditors tend to use this concept for financial statement analysis to track performance year over year.
The standard percent variance formula is calculated like this:
(Current Year Amount – Prior Year Amount) / Prior Year Amount
If management were using this for budget analysis they would change the equation to something like this:
(Budgeted Amount – Actual Amount) / Actual Amount
Let’s look at an example.
Top Ten Food Supplies issues their comparative financial statements on an annual basis. The external auditors analyze the company’s financial statements on a high level basis to determine which accounts need to be further reviewed. TTFS has annual revenues of $100 million per year. Given the size of the company, the external auditors determine it is most appropriate to analyze accounts, which have a percent variance greater than 20%. All variances greater than 20% are analyzed to determine the reason for the change.
The cash account changed from $500,000 at the end of the prior year to $300,000 at the end the current year. The variance in cash is calculated like this:
($300,000 – $500,000) / $500,000 = 40%
As you can see, the percentage variance is greater than 20 percent. Auditors should analyze this account further to see if there are any errors in it.
Keep in mind that large percentage variances show areas where the company has changed drastically from one period to the next, but these ratios must also be examined along side the actual variance in the account. For instance, a $1M change in inventory might only translate into a 5 percent change if the total inventory account has $20M in it.
Although this example was about auditing, management does frequently use this approach to measure the discrepancy between actual figures and budgeted figures when reviewing budgets and cost performance for the period.