What is the primary purpose of variance analysis in financial management?

Variance analysis is primarily focused on identifying deviations between planned (budgeted) and actual financial performance. This process involves comparing the budgeted figures to the actual results to determine areas where performance differs. By analyzing these variances, management can gain insights into the reasons for overperformance or underperformance. This information is critical as it assists in evaluating the effectiveness of business operations and financial planning.

Understanding these variances is essential for making informed decisions and adjustments. For instance, if expenses significantly exceed budgeted amounts, management can investigate the cause, whether it be increased costs or inefficiencies, and take corrective actions to improve financial performance moving forward. Thus, variance analysis serves as a vital tool for performance evaluation and helps in refining future budgeting processes.

The other options describe important aspects of financial management as well but do not encapsulate the primary focus of variance analysis. Preparing budgets relates to future planning but does not highlight the evaluative aspect of variance analysis. Calculating return on investment is specific to assessing profitability, while assessing liquidity focuses on short-term financial health. Each of those functions serves important roles, but variance analysis specifically measures and interprets actual performance against predetermined plans, making it integral to understanding and managing financial outcomes effectively.