Webster Bank: reading waterfall charts

Hello, and welcome to Henry Stewart Talks. I am Professor Michael McDonald, and today I'd like to talk to you about a case study involving a company called Webster Bank, which is a regional bank in the Northeast United States, and use them as an example of how we can go about reading what are called waterfall charts. These waterfall charts let us examine a financial metric called a variance.

What is a variance? Well, variance analysis really essentially helps firms to understand where they are at present in relation to where they have been, or where they plan to be. A variance is simply a difference between actual financial results and either planned results, or past results.

There are three types of variances, and these are often called accounting variances. But the reality is they're frequently used by the finance function at most major corporate organizations. It's important to be familiar with them even if you're not an accountant. But these three variances are plan variances, commitment variances, and growth variances. The plan variance measures in essence something like the planned operating margin versus the prior periods operating margin. Or it might be as an example of the planned net income versus the prior period net income. Or planned revenues minus prior periods' revenues. Whenever a specific metric or accounting item we're looking at, we're in essence measuring plan versus prior period to get plan variance. If our planned operating margin is 120 million, and our prior period operating margin is 100 million, then our plan variance is 20 million. Next we have the commitment variance, and this simply measures our actual results minus our planned results. It's in essence that commitment that we have made to shareholders or stakeholders in terms of where we expect it to be. Again, if we have an actual operating margin of say, 110 million and our planned operating margin was 120 million, then we have a commitment variance of -10 million. Now, there's a lot of discussion that goes on as to whether negative variances are better or worse than the positive variances, or whether we should treat them symmetrically. That differs between different companies. Certainly, if we see a positive variance in something like a commitment variance, so if our actual operating margins, our net income, for instance, were higher than we'd planned, well all else equal, that's good. It's certainly better that it's positive than that it's negative. On the other hand, if we're trying to accurately estimate any accounting metric; revenue, net income, operating margin, anything of the sort, well then, we might say okay, whether we're positive or negative on our variance, any deviation from actual represents a planning failure. It represents a forecasting failure. We can look at either positive or negative variances as being bad. Third, we have growth variances. These are just going to measure our actual results minus our prior period results. For instance, we might have as an example, 110 million, an actual operating margin versus our prior operating margin was 100 million, giving us a growth variance of positive 10 million.