Budget Variance Analysis

 

Raw Materials

Raw materials are the commodities or items that are transformed into the finished product. Prices of certain raw materials may change over the course of the year, either by increasing or decreasing. Such price fluctuations can be managed by purchasing via long term contracts or other means to fix a price over a longer term. An increase in raw materials prices may be recovered by increasing the price of the finished goods, if the market will tolerate a price increase. Otherwise, gross profit will decline.

Issues to consider:

  • Is management obtaining competitive bids for raw material inputs?
  • Are volume discounts and early payment discounts actively considered?
  • Has technology changed the specification of the raw materials?
  • Are hedging strategies considered to minimize price fluctuations and price increases?

 

Labour Wages

Labour wages forms part of “Cost of Goods Sold” if it is identified separately. This is usually an easy item to forecast, since the quantum of labour payments is directly related to the expected level of output, i.e., as output increases, cost of labour will also increase. There can be a variance if any negotiated wage increase is greater than the budgeted amount. Significant overtime payments could also affect this item.

Issues to consider:

  • Has labour productivity increased (output per unit of labour)?
  • Can overtime expense be reduced by increasing the number of workers?
  • Can labour cost be reduced by outsourcing some functions?

 

Transport

This is a management controllable item if shipment of goods to customers is done in-house. Frequently, however, this function is out-sourced. Transport rates may change during a given period if there are significant changes to underlying costs of the contractor, such as fuel and labour. A significant increase (or decrease) may be due to change in the volume of production. Thus, it should vary closely with the change in turnover.

Issues to consider:

  • If transport is out-sourced, is the contractor's performance reviewed from time-to-time?
  • If transport is provided internally, are there regular reviews of costs such as petrol, insurance and spares?
  • Is driver performance monitored and those with poor driving records removed or re-deployed?

 

Electricity

Electricity is used by every business and in manufacturing companies is often a major expense. To some extent electricity consumption is management controllable. If this expense exceeds the variance limit or shows a worrying increase over time, it should be examined by management.

Issues to consider:

  • Has load management equipment been installed, and is it working properly?
  • Has the company negotiated a power purchase agreement with Eskom (or other power distributor as the case may be), and if so, has this agreement been reviewed recently?
  • Can any activities be moved to non-peak hours where rates are lower?

 

Water

Water is usually purchased from another publicly owned utility, and rates are usually different for different classes of users, such as agriculture, manufacturing and residential. Bulk rates may be negotiable.

Issues to consider

  • Can water be processed and re-used, where it is not used for human consumption?
  • Can water be obtained from a borehole, and would this be more cost efficient than water obtained from a municipal utility?
  • Is there a regular check for water leaks, both on the premises and underground?

 

Rates

Municipal levies such as rates are usually dependent upon the valuation of the property, which is related to its use and classification. There should rarely be a variance in rates, as their base of assessment is transparent and changes only infrequently.

 

                 

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