When Should a Manager Use Variance & Sensitivity Analysis?
Both variance and sensitivity analyses provide useful information to managers of small companies as they seek to increase company performance and reduce the company's risks. While both forms of analysis provide valuable information, one form helps managers assess future risk while the other helps improve over past performance in the company.
Variance Analysis Defined
Variance analysis looks at the performance of a project, company, division, department, etc., and compares actual performance with standard performance. Management establishes the standards against which performance will be measured, such as a dollar amount sales goal, number of hours worked in a specific period of time, or a certain number of consecutive days without any injuries in a work site. Company management establishes the standards used in measuring variance analysis, keeping those standards in line with the organization's mission and objectives.
Sensitivity Analysis Defined
Sensitivity analysis provides a method of assessing the amount of risk involved in a proposed project. Sensitivity analysis also involves calculating the impact of variations on different quantifiable components of a project, helping management identify potential pitfalls. Management may also use sensitivity analysis to identify components of a plan that, when changed even slightly, will most impact the outcome of a project.
Managers use variance analysis to measure and analyze what has already occurred in the company's activity, since variance analysis requires managers to use actual company performance. Management not only measures the difference between standard performance and actual performance, but management also analyzes the reasons for actual performance falling short or exceeding established standard performance. Understanding what has hindered or helped the company in its actual performance helps management decide what policies and procedures should be modified and how.
Making Future Decisions
Businesses engage in risk, since there is no guarantee a business will return a profit. Management strives to minimize risk as much as possible while still engaging in activities that earn the company profits. Managers engage in sensitivity analysis before executing a new project or other business activity. Sensitivity analysis helps managers assess what factors would cause a project to turn out a smaller profit, affecting the net profit value of the planned activity. Managers determine how to manage any involved risks in a new project or activity, if they decide to engage in the activity after using sensitivity analysis.