How to Calculate Variance for Business Owners

In statistics, variance measures how much data points vary from one another. It accounts for outliers (very high or low data points) and calculates the average value. It's important to note that variance is not the same as the standard deviation of a data set.

Variance is a statistical measure of how far each data point is from your average. It can help you determine market stability if you are an investor. This important tool has many uses for small businesses seeking to run their operations more efficiently and improve their forecasting.

When you plot out variances on a chart, many values will cluster in a particular area. Other data points and variances will show up far away from the median value (outliers). Analyzing variances allows leaders to make more insightful decisions for the company.

Why is variance important for business?

Variances can help businesses run their companies more efficiently. They allow you to plan ahead and make careful decisions about all aspects of your organization. If you want to better control a project’s expenses, monitor actual time and cost against your project plan. Additionally, variance analysis will help your leadership team spot issues, trends, threats, and opportunities in the near and far future.

Here are some key factors to keep in mind as you learn more about how to calculate variances for businesses:

• Variances tell you the spread of data points from the mean.
• It measures the dispersion of the entire data set.
• Investors pay attention to variance to determine the profitability of your company.
• Variances compare each asset against the whole data set.
• Standard deviation is the square root of the variance.

So, are you ready to put variance calculations to work for you?

Use variance to determine how effectively you're managing your business expenses. Variances also have an important role in the budgeting process and can tell you where to focus your attention when it comes to increasing profitability.

Take a look at the following examples of how you can use variance in specific aspects of your business. These will help you brainstorm how to apply variances to your startup or established business.

Business expenses

From office supplies and other variable expenses to fixed costs such as utilities, your expenses affect your ultimate profitability. By budgeting for expenses, you can ensure you have enough money to cover your costs.

Variance analysis can also help you focus on areas where you can save money or improve your return on investment. For example, you may notice that you're spending more money on fixing your printers than it would cost to outsource the entire operation.

In this case, you can make an effective business decision that will fatten the bottom line and save your internal team time and energy.

Budget

Accurate budgets can make or break businesses. In order to budget accurately, you need to know how close your last forecast came to the actual cost or revenue stream.

Here is a simplified example:

Budget variance % = Actual amount divided by the budgeted amount. (Multiply by 100 to get a percentage.)

So, if the budgeted amount is $15,000 and the actual amount is $20,000, you would divide ($20,000 minus $15,000) by $15,000: $5,000/$15,000 is 25% (over budget).

Profits

Major causes of profit variance include:

• Variance in sales price
• Changes in the cost of goods sold
• Changes in the volume sold

Gross profit analysis gives you valuable insight into variances that are increasing or decreasing your bottom line. By analyzing how your data varies from your target or mean, you can improve your operations, invest in tools that will help you streamline processes, and, ideally, positively impact your company’s performance as a whole.

Investments

Variance is used to evaluate risks. Savvy investors will want to understand your variances and how you plan to improve your performance before giving you money for your startup. You can also use variances to evaluate the effectiveness of your startup marketing strategy.

For example, let's say your return on investment for three years equals 10%, 20%, and -15%, respectively. This leads to a 5% return on investment. For each year, that's a difference of 5%, 15%, and −20%.

A savvy investor will note the downward trend of performance as well as the low ROI and likely pass on this opportunity.

As established earlier, it’s important to know how variance is calculated. Here is a simplified version of the variance formula:

s^2= [Y [X - x^2] divided by (n - 1)

where,

s^2 = sample variance Y = sum of… Χ = each value x = sample mean n = number of values in the sample

When you measure variance, you're calculating the mean or average of your data points. By squaring the differences and dividing the squares by the total number of data points, you can get a good idea of how well (or not) you are meeting measured goals.

Here’s how you calculate business variances:

1. Determine the mean of your data.
2. Find the difference of each value from the mean.
3. Square each difference.
4. Calculate the squared values.
5. Divide this sum of squares by n – 1 (sample) or N (population).

For the easiest route, find an online variance calculator or Excel workbook set up to do the heavy calculating for you.

Example of calculating variance

Usually, companies use software to calculate business variances. However, it can be useful to do so manually until you fully understand the process. This example will use six numbers representing the sale of a particular product.

Sales over a six-month period: 41, 46, 69, 60, 52, 32 (This is your data set.)

Step 1: What’s the mean (average)?

Add the sales number and divide by six (number of data points).

Mean = (41 + 46 + 69 + 60 + 52 + 32) ÷ 6 = 50

Step 2: What’s the deviation for each sales number?

Remember, 50 is the mean. So, subtract 50 from each sales number.

41 – 50 = -9 46 – 50 = -4 69 – 50 = 19 60 – 50 = 10 52 – 50 = 2 32 – 50 = -18

Step 3: Square each deviation

Multiply each deviation from the mean to get all positive numbers:

(-9)2 = -9 × -9 = 81 (-4)2 = -4 × -4 = 16 192 = 19 × 19 = 361 102 = 10 × 10 = 100 22 = 2 × 2 = 4 (-18) 2 = -18 × -18 = 324

Step 4: What is the sum of squares?

Add up the squared deviations to get the sum of the squares.

81 + 16 + 361 + 100 + 4 + 324 = 886

Step 5: Divide by n – 1 or N

In this case (a sample), we’ll divide this result by n – 1, where n is the number of data points (6).

886 ÷ (6-1) = 886 ÷ 5 = 177.2

The next step is brainstorming ways to achieve more consistently positive results to move your sales efforts forward.

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Learning how to calculate variances for business starts with a full understanding of each step. It’s also important to understand the role variances play in running your company. By focusing on critical variances, you can identify bottlenecks and wasteful spending and streamline cumbersome processes.

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