When is a Variance Analysis Needed?

If we know that a variance is the result of an uncontrollable price increase for a supply item that we must have, do we need to investigate and make a report regarding the variance? Why or why not?

I’m not sure if this question is fully packed. What matters in looking at the variance is not just that a variance occurred, but also the size of the variance. We can look at a variance as just an absolute dollar amount or as a percentage of budget. If he variance of the line item surpasses either of those thresholds in terms of the company’s policy , then I would say of course a variance report should be prepared. This variance report would be able to unpack the other issue with the question. It says we know that a variance is the result in the price increase – but do we know that this is the sole driver of the variance, or do we know that the price went up so we spent more? A variance analysis can find other underlying trends that just knowing that there is a correlation between the variance and the price of the supplies. This can let us look at perhaps other vendors of the needed item or perhaps a renegotiation of the terms with our current supplier.

The Importance of Credit Policies

Having a credit policy ensures that your organization has the cash flow to operate. If you give everyone service and are relaxed on how soon (if ever) to actually cash in on those receivables, you may have some assets on your books in A/R that will never be realized as cash.  If you never get the cash, you are going to go under soon.

One thing to note is that in public service you might have to essentially give away services at some point. The book talks about hospitals doing charity care, but it can operate in the same manner in different organizations. You should have a development department to make up for the shortfall in funds from services. Having a firm, defined credit policy about who gets credit and who does not will help the planners in your organization make plans on budgets and cash flow.

In my experience, there is an interesting other side to this. Our biggest funder is the state of Illinois, with almost 70% of our operating budget coming in from them. If a funder is a big enough part of the budget, you lose leverage over your policies. Even in good times, we have to plan cash flow on not being paid for service we do right away. Service today might be paid in January.  That makes our planners have to be reactive to the state’s whims.

Kinds of Long-Term Financing

Long-term debt is characterized by being debt that will last in duration for more than a year. There are several sources of long-term debt for an organization to use.

The first of these is a long-term note. With a long-term note, the organization just borrows money from a lender with a promise to pay at a certain interest rate and payments at certain times. This form is considered an unsecured debt. The organization can lock in a better interest rate by pledging collateral against the loan. This is an asset the organization promises to forfeit if they default on payments of the note.

A second kind of long-term debt is a mortgage. A mortgage is like a collateralized long term note, but the mortgage is secured by a specific asset, usually real estate. Usually a mortgage exists to purchase the building or land. There are multiple structures to how the repayment schedule of a mortgage is set up, but it is usually a set payment every month.

A third kind of long-term debt is bonds. With bonds, the organization is borrowing a lot of money, but the borrowing is not coming from one institution as it might be when borrowed as a long-term note or mortgage. A bond is usually set up as promise to pay the holder of the bond a set amount of interest payment (normally twice a year) for the length of the bond, and then payment of the par value of the bond when the time period comes due.

The final kind of long-term debt is a capital lease. With a capital lease, the organization is not taking ownership of the capital item, instead is paying a third party that maintains ownership, and to which the capital item will revert to when the term of the lease expires.

The Most Powerful Force in the Universe

               Somewhere Einstein is quoted as saying that the greatest force in the world is compound interest. I’m not sure if he said it, but it is a deep truth, and people like to tie Einstein’s name to things to make it seem real and important, even if they only know him as the eccentric genius of the later years where he traded on the reputation he made in a couple of papers in his youth – but I digress. 

                Compounding is where you take a sum of money and apply interest to the amount of money that is also earning interest. So for example, in a simple interest scenario, if you have $1000 bucks at ten percent interest for ten years, you get ten periods where you get 100 bucks, and you double your money in real terms over those ten years. But with compounding, you take a thousand bucks, and at the end of year one, you get a hundred bucks, so that at the start of year two, you are actually earning interest on the original thousand plus the new hundred bucks. This means that with compounding only one time a year, at the end of the ten years, you will end up with $2,593.74, more than doubling the original investment. Discounting is basically the opposite of compounding. If you need a certain amount of money in the future, you need a smaller amount than the amount you need because the magic of compounding .

Break-Even Analysis: Two Answers

What can your manager do if a break-even analysis indicates that a venture will lose money?

The simplistic answer is that if a manager is looking at a break even analysis and the analysis shows that the venture will lose money is to not do the venture. 

Realistically though, the answer is more complicated than that. The simplistic answer assumes that all the variables in the equation are fixed – static without the possibility of changing. There are three variables in the equation for the break-even analysis. There are the fixed costs, the price you are selling your good or service, and the variable costs included in your service or product. All of these can be examined and perhaps tweaked so that the anticipated quantity is above the break-even quantity – can you charge more or pay less for inputs or not rent as big a space. 

One thing to be careful with is that these things are not strictly linear. If you pay less for inputs like labor, you might not be able to recruit the kind of people you want; if you try to up the price, you might dampen demand. (At that point, price and quantity demanded is dependent on the elasticity of demand of the good, and you’re calling in the economists to see if your estimated new price will support a break even quantity you expect.)

Quick Thoughts: The Jossey Bass Handbook of Nonprofits

This book, in its third edition, was the assigned text for both my classes in my MBA program for introduction to nonprofits and  board management.

For the intro class, I was assigned to read the whole thing in eight weeks, which I did. During that class, we covered up to four chapters a week for an eight week class, so there was not a lot of retention going on except for the areas I had flagged for use in my discussions and papers.

I had to read fewer chapters for the next class, and I think that was where the book shined. Reading some of the chapter in a more in-depth manner suited both me and the text. I say this because for the most part the book’s chapters are a fairly deep introduction to the subject they cover, and in spite of worrying that the book and the class wouldn’t be applicable to me since I have worked in nonprofits for five years, I learned a lot. The structure of the book is that it has chapters written by subject matter experts, so there is some inconsistency in the voice of the text, but that is eclipsed by the expertise that it brought to bear on the individual subjects covered. And there are a lot of subjects covered. It is a thick, long book with a lot of type on each page, so it is not a quick read, but it is well worth it as it is broad and fairly deep. I pulled my copy because I think I can pass it off to one of my subordinates in hopes that it might teach and inspire her about the entire context of the work we do.