03 Jul Respond To Classmate Discussion Post
Option 1 – Discuss a current business activity that you or your department does that could be improved by leveraging variance analysis. Discuss the perspective you could gain, and what a “favorable price” and a “favorable quantity” variance mean in this application.
My credit union is a co-operative financial institution and its main business activity is trading in money. We serve our members by accepting deposits (savings) and granting credit (loans) with a view to making a profit. Since revenue minus expenses equals profit, it stands to reason that leveraging variance analysis of the factors that affect either revenue or expenses will impact favorably or unfavorably on profit.
Revenue variancefor an accounting period is the difference between budgeted and actual revenue. A favorable revenue variance occurs when actual revenues exceed budgeted revenues, while the opposite is true for an unfavorable variance. Revenue variance results from the differences between budgeted and actual selling prices, volumes or a combination of the two.
Expense variancefor an accounting period is the difference between budgeted and actual expenses. A favorable expense variance occurs when actual expenses is lower than budgeted expenses, while the opposite is true for an unfavorable variance. Expense variance results from the differences between budgeted and actual cost of producing the service, which includes the cost of money and overheads.
How can leveraging variance analysis be applied to revenue and expenses to improve profits? In this application, revenue improves when either ‘price’ or ‘volume’ of loans is adjusted. In the case of lending, ‘price’ equals interest rate, and ‘volume’ equals number of loans.
Revenue will improve under the two conditions (assuming that there is no default in loan repayment).
- If interest rate increases i.e. ‘favorable price” and volume remains constant.
- If volume increases i.e. “favorable quantity” and interest remains constant.
It is assumed that if the cost of originating and managing the loan is constant, an increase in interest rate and or volume/quantity will increase profits.
Where interest rate on savings or cost of funds used to finance the loan (interest expense) can be reduced, (with all overhead costs remaining constant), the result will be even greater profits.
The concept of leveraging variance analysis can be applied to a single loan category (e.g. auto loans) or different loan categories (e.g. mortgage, business or personal loans).
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