Variance Analysis

Variance Analysis Hospital organizations are becoming more and more familiar with using a variance analytical tool to compare actual costs and charges. “This type of analysis is becoming even more common as healthcare executives work to improve efficiency, to set priorities for organizational improvement as part of strategic planning, and to explain costs and charges to interested groups such as purchasers and payers” (Forthman & Dove, 1995, para. 1). A department manager is responsible for creating an operating budget and overseeing the day-today operations of their department. Budgets are important to an organization; this is a way to help manage and forecast future finances. An unfavorable variance helps identify potential financial problems. The deviation from what was budgeted brings awareness to the Chief Executive Officer, that things are not looking good; therefore, it is critical to analyze unfavorable variances, investigate the cause and make necessary changes. It is the responsibility of the department manager to ensure that monthly costs are in line with the projected budget. In the event, there is a variance one must provide a detailed variance report to explain discrepancies. By doing this, one must ask provoking questions as to what, when, where, and why. “Variance analysis is an important analytical tool for managed care firms seeking to monitor and control their costs” (Cleverley, Song, & Cleverley, 2011, p. 392). In addition, a variance analysis tool is key to identifying and addressing variance issues, including the relationships between budget goals, and actual results of performance. 2 As a healthcare organization Chief Executive Officer (CEO) and or a Chief Financial Officer (CFO), it is their responsibility to ensure the overall cost-efficiency performance in the organization is controlled. The CFO reports the financial status of the hospital to the CEO and the board of directors. Therefore, it is important to consider different factors when deciding which variances to investigate. Every variance should stimulate questions; however, not all variances need to be investigated. Determining which variances to investigate should be decided based on significant differences or large, unexpected variances. When there is a negative discrepancy one must identify the mistake and provide a detailed statement to the CEO of the organization. Factors to consider may include reliability and accuracy of the figures, materiality, possible interdependencies of variances, the inherent variability of the cost of revenue, adverse or favorable, trends in variances, controllability/probability of correction, and costs and benefits of correction (aCOWtancy). A mistake leading to a variance when there were no actual problems can result in loss of productivity and work hours. The relationship between budgeted goals and actual results of performance can be good news (favorable) or bad news (unfavorable). A budgeted goal is what is projected, and actual results are what are spent. Projected budgets are based off the previous year’s actual numbers, which are then compared to what actual was spent to determine the variances. “In theory, the positive variances are good news because they mean spending less than budgeted. The negative variance means spending more than the budget” (Berry, 2021, para. 1). Positive variances are not always good, for example if there was a budget for $3,000 for supplies and the actual variance showed a positive $3,000 it would mean the money was not spent (Berry, 2021). This could be a direct result of a failure to implement funds budgeted and allocated for supplies. “An unfavorable variance could be the result of lower revenue, higher expenses, or a combination of 3 both” (Kenton, 2020, para. 4). Differences in budgeted and actual can be caused by a combination of factors. In the example given, the salaries were higher than budgeted for. This could be a direct result of a crisis or state emergency. For example, the COVID-19 pandemic has increased hours worked for medical and non-medical staff. At the time, the budget was put in place there was no pandemic in sight. Due to the overwhelming response from healthcare personnel to address the patients coming to the hospital for treatment, the hospital had to increase hours for higher patient needs. The factor used to explain this variance would be an adverse variance; this can also be controllability/probability of correction, due to the higher salaries is out of the manager’s control. However, the supply use was lower than what was budgeted. This could be a direct result of inherent variability of the cost or revenue. In the event the purchase price of the supplies was at a higher price when budgeted, the cost when purchased may have been reduced, which will result in a lower supply use cost. “An unfavorable variance can occur due to changing economic conditions, such as lower economic growth, lower consumer spending, or a recession, which leads to higher unemployment” (Kenton, 2020, para. 1). It is often hard to tell what caused differences in costs, if spending did not meet the budget; a lower volume unit perhaps may cause the variance. Lastly, the Chief Executive Officer and the Chief Financial Officer of a healthcare organization works hand in hand ensuring all departments across the organization are working to meet the projected budget for their departments. However, investigating variances is not uncommon. Many hospital organizations are using a variance analysis tool to compare actual costs and charges. When deciding which variance to investigate, factors to consider may include reliability and accuracy of the figures, materiality, possible interdependencies of variances, the 4 inherent variability of the cost of revenue, adverse or favorable, trends in variances, controllability/probability of correction, and costs and benefits of correction. Variances are based off what was the projected budget verses what the actual cost are. In the event these numbers do not match, the CEO or the CFO can request a variance analysis from the department manager. The relationship between variances can be favorable or unfavorable. “An unfavorable variance could be the result of lower revenue, higher expenses, or a combination of both” (Kenton, 2020, para. 1). It is critical to analyze an unfavorable variance, investigate the cause and make necessary changes Therefore, utilizing a variance analysis tool is key to identifying and addressing variance issues, including the relationships between budget goals, and actual results of performance.