Here’s a good test of your financial reporting if you’re in a manufacturing environment. You may publish variances in your reporting package related to manufacturing. In particular, one variance that is reported is the absorption variance.

But, does anybody really understand that variance? If you ask the president or CEO if it made sense to him/her, what would the answer be?

If the variance doesn’t seem to make sense then that could be a sign that something is not in alignment.

It should make sense when the volume of activity relates well to the production absorption variance. In other words, when production is up during the month, you expect to see a positive absorption variance. When production is down during the month versus your expectation, you expect to see a negative variance.

But, that’s not often the case. Your production might be way up, but what happens when you show a negative variance.

You can think of a couple different things that could trigger this swing:

1. You have a short production cycle, such as batches that are completed during the month, in other words batches that may just take a shift a day or a few days to produce. Except for batches right towards the end of the month, you’re not likely to have any batches carry over from one month to the next. In this case, a funny absorption variance could be a signal that batches are not getting closed out on a timely basis. Take a good look at your process and see how soon batches are getting closed out in accounting prior to completion. If they are taking a long time, find out what is the particular delay. What can you do about it to speed that up?

2. When you have long production batches that might stretch over a couple month’s period of time. Here the accounting is more complex. One cause then of funny production absorption variances can be waiting until the entire batch is completed until you book absorption variance. Your absorption variance then is subject to the mercy of when batches are completed. If you have a lot of batches getting completed right during a particular month, you could have huge positive absorption variances. You also could be subject to the same factors like in example one, delays in reporting of production batches, although it’s likely that this will be less of an impact. If you’re faced with a number of batches that are in process that take a couple months or more to produce, you may need to develop some process to estimate the percentage of completion of particular batches in process by each month. From that, you can get an estimate in terms of how much absorption activity has gone in during the particular month. You can eliminate some of the month to month fluctuation just do to timing of when batches are completed.

So, if your absorption variances from manufacturing don’t make any sense at all, take a hard look at your process from closing batches or accruing worked on on batches that take multiple months to produce. Very likely, the absorption variance can be a significant number in the profit and loss. If could make or break your particular month. You want it to be a real number, not something subject to artificial accounting swings, which mean that you then never have any idea how you’re really doing in one month compared to the next.