Welcome to a practical exploration of labour and efficiency variances. We will stir together some numbers and uncover how they can tell us about a business’s financial health, like checking the temperature to see if a cake is baked right.
The Simple Formulas
Labour Variance: First, let’s clear up how to calculate the difference in what you actually pay your team versus what you planned in your budget:
- Labour Rate Variance: ((Actual Hours Worked)x (Actual Rate per Hour) – (Standard Rate per Hour))
- Labour Efficiency Variance: ( (Standard Rate per Hour) x (Actual Hours) – (Standard Hours) )
A ‘standard’ refers to your benchmark or expectation when setting your budget.
Efficiency Variance: We’re not just looking at labour costs; we also care about how efficiently your team uses their time:
- Efficiency Variance: This checks whether you got your money’s worth from the hours paid. It focuses on whether more or fewer hours were used to complete a task than what was budgeted.
Now, let’s see how these play out in an easy-to-understand example.
A Real-World Slice
Picture a company that makes delicious pies. The labour cost budget is based on the idea that a baker can bake 10 pies in 5 hours for $25 per hour.
- If the baker’s hourly rate increases to $27 and they still bake 10 pies in 5 hours, that’s a labour rate variance. You’re paying more per hour than you expected.
- If the baker still makes $25 per hour but now bakes 10 pies in 6 hours, that’s a labour efficiency variance. It’s taking longer than planned to bake the pies.
- If both rates increased to $27 and it took 6 hours to bake the same 10 pies, you’d see a mix of both variances.
Putting It All into the Mixing Bowl
It’s important to know that labour variances do not occur in isolation – usually, they’re mixed together. A change in how much you pay per hour can have a ripple effect on how long something takes to make. Conversely, being more efficient might lead you to spend more on wages. So, you have to balance the two like balancing ingredients in a recipe.
What if your wage increase motivates your bakers to be more efficient, resulting in a lower cost per pie despite the higher wage rate? This is the insight you get when you look at these variances together.
Recipe for Improvement
Review Regularly: Keep a close eye on how your actual spending compares to your budget—think of it as frequently taste-testing your food as you cook.
Understand the Whys: When you notice a difference between your budget and actual spending, try to find out why. Knowing the reason can help you decide what to modify.
Balance Perfectly: Aim for a balance. Too few or too many ingredients in baking can spoil the result.
Adjust and Improve: Use what you learn to make better budget predictions and smooth your processes. Keep tweaking your ‘recipe’ until it’s just right.
Wrapping Up with a Bow
Labour and efficiency variances are the indicators that show you whether you’re getting your money’s worth from labour costs, much like how a recipe tells you what you need for the perfect cake. By understanding and acting on these insights, even those who are not accountants can help their businesses run more effectively and efficiently. The goal is to find the right mix that works for you and your team so your business can flourish and thrive.