Price variance

By:

Arti

Arti is a specialized AI Financial Assistant at Invezz, created to support the editorial team. He leverages both AI and the Invezz.com knowledge base, understands over 100,000... read more.

Reviewed by:

Prash Raval

Prash is a financial writer for Invezz covering FX, the stock market and investing. For over a decade he has traded spot FX full time while... read more.

Updated: Jun 18, 2024

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3 key takeaways

• Price variance measures the difference between actual and standard costs, highlighting cost control efficiency.
• It helps businesses identify deviations in purchasing and production costs, enabling better budgeting and financial management.
• Price variance analysis can uncover issues in supplier pricing, market conditions, and internal cost management.

What is price variance?

Price variance is a financial metric used in cost accounting to compare the actual cost of materials, labor, or overhead to the standard or expected cost. This variance indicates whether a business is spending more or less than anticipated on its inputs.

A positive price variance occurs when the actual cost is lower than the standard cost, indicating cost savings. Conversely, a negative price variance occurs when the actual cost exceeds the standard cost, indicating overspending.

How to calculate price variance

The formula for calculating price variance is:

Price Variance = (Actual Price – Standard Price) × Actual Quantity

Where:

• Actual Price: The price actually paid for the material, labor, or overhead.
• Standard Price: The predetermined or budgeted price expected to be paid.
• Actual Quantity: The amount of material, labor, or overhead used or purchased.

Importance of price variance

The price variance is important for several reasons:

• Cost Control: It helps businesses monitor and control costs by identifying areas where actual spending deviates from budgeted amounts.
• Budgeting: Variance analysis aids in refining budgets and improving financial forecasting by providing insights into actual cost behaviors.
• Performance Evaluation: It enables businesses to assess the performance of their purchasing and production processes, identifying inefficiencies or areas for improvement.
• Supplier Management: Price variance can highlight issues with supplier pricing, allowing businesses to negotiate better terms or seek alternative suppliers.

Example of price variance calculation

Suppose a company expects to pay $50 per unit for a raw material (standard price) but ends up paying $55 per unit (actual price) for a production run of 1,000 units (actual quantity). The price variance would be calculated as follows:

Price Variance = (Actual Price – Standard Price) × Actual Quantity Price Variance = ($55 – $50) × 1,000 Price Variance = $5 × 1,000 Price Variance = $5,000

In this example, the company has a negative price variance of $5,000, indicating that it spent $5,000 more than expected on the raw material.

Causes of price variance

Several factors can cause price variance, including:

• Market Conditions: Changes in market supply and demand can lead to fluctuations in prices for materials and labor.
• Supplier Pricing: Variations in supplier pricing due to changes in their costs, negotiations, or contractual terms.
• Quality Differences: Purchasing higher or lower-quality materials than initially planned can result in price variances.
• Economic Factors: Inflation, exchange rates, and economic policies can impact the cost of inputs.

Managing and mitigating price variance

Businesses can adopt various strategies to manage and mitigate price variance:

• Supplier Relationships: Developing strong relationships with suppliers can lead to more stable pricing and better negotiation terms.
• Market Research: Regularly monitoring market conditions and trends helps businesses anticipate price changes and adjust budgets accordingly.
• Quality Control: Ensuring consistent quality in purchased materials can help avoid unexpected price variations.
• Budget Flexibility: Building flexibility into budgets to accommodate potential price changes can reduce the impact of negative variances.

Price variance is a critical tool for businesses to manage costs, evaluate performance, and improve financial planning.

By understanding the causes and implications of price variance, companies can take proactive steps to control costs and enhance operational efficiency.

For further insights, explore related topics such as cost accounting, variance analysis, and financial performance management.