What does cost variance mean?
Cost variance is the difference between earned value and actual cost, at the date you wish to measure. It is used to assess the project’s cost performance.
Cost variance for a project is represented as a financial amount. This number tells you the variance from your original budget, whether that is overspending or underspending against your forecast.
What is the cost variance formula?
The cost variance formula in project management is: CV = EV-AC
Here is how to work out cost variance using the simple formula. Start with the earned value figure. You will need to have this worked out first. Your software will be able to calculate it for you, and you probably already have monthly reports with it on. When you have the EV figure, take away the Actual Cost – the amount spent on the project so far. The answer will be a financial value.
In reality, software tools like Microsoft Project can calculate CV for you. If you work in an earned value management environment, you won’t have to ever do these calculations ‘by hand’. They can be generated at the click of a button from your project management tools. However, it helps to know how the numbers were generated so you understand what is driving the calculations. Remember: ‘garbage in, garbage out’. When you know what influences CV, you can be extra careful about making sure the data inputs are accurate.
Using cost variance analysis
Now you have a number, but alone, that won’t help you manage the project more effectively. You need to interpret the data and understand what it is telling you. Variance analysis is helpful in cost control because it gives you a starting point for your investigations. CV provides accurate, real-time information about cost performance, allowing you to make the right management decisions for the next step.
If the result is a positive number, you are coming in under budget. This is a favorable variance. To give you an example, a CV of $120,000 would show that the project had spent significantly less than what was expected. While that might sound like a good thing, it probably isn’t! Look into what is driving this number: project delays or poor estimating might be causing problems. If the CV is more like $10,000, that might fall within your agreed tolerance and be considered reasonable for the size of budget you are working with.
If the result is a negative number, you are overspending and have spent more than what was expected at this point in the project. This is an unfavorable cost variance and could point to a cost overrun. For example, if the project intended to procure equipment for the cost of $50,000 but actually ended up paying $75,000 that would contribute to a negative CV on the project. Negative cost variance may also be caused by front-loading cost, so it’s always important to have a view of the whole situation and the narrative surrounding the numbers. Then you can be confident in what the data is telling you.
Read next: What causes variance on projects?
In an ideal world, the EV and the AC would be identical because that would mean you were spending as much value as was being earned. However, in real life it’s likely they will be a little different because of how equipment and time is booked and paid for. The challenge for you as the project manager is to reconcile the variance with what is acceptable. For example, there should be tolerances set on the project so you know what is a reasonable amount of drift.
How to reduce (CV)
What do you do if the cost variance of your project points to overspending? Earned value analysis identifies trends, so hopefully you will start to see an increase in costs through regular reporting. For example, variance reporting can be done in Oracle Primavera P6. That will give you an early warning so that the team can take the appropriate action. But what can you do? Here are a couple of suggestions from our team.
Make sure change is being managed appropriately. Is some of the cost increase due to uncontrolled changes? It’s possible that a few additions to scope have sneaked in without going through the proper process. If that has happened, it’s likely that the baseline and the cost forecast are no longer aligned.
Address the changes, update the baselines as appropriate and remind everyone about the proper process for raising and introducing changes so it doesn’t happen again.
Make sure risk is being managed appropriately. Is some of the cost increase due to risk management activities? If the risk management work has not been costed effectively, those actions could be eating into your budget.
Check that risk management work is fully costed and incorporated into your project as appropriate. Going forward, new risks should have a budget associated with them if one is needed to manage them.
Make sure resource estimates are accurate. In our experience, many cost increases are due to work needing more time – and that means more people hours to pay for. Could this be the case for your project?
Look at where estimates have proven to be inaccurate in the past. What could have been done to revise them? Think about the data you have available now – perhaps the experience on the project so far will enable the team to more accurately forecast their effort. If it looks like the cost variance is trending upwards, and time spent seems to be the problem, it is probably worth looking at an exercise to review project timelines. Rebaseline with realistic estimates and manage expectations from there.
Cost variance is simple to use, easy to calculate and hugely valuable as a measure of project performance. Now you know how to work out CV, how to use what it tells you and how to address common problems that cause variance. Used with other cost control measures like schedule variance, the project team has a powerful way to manage performance.