Throughout the life of a project, project managers check in on progress and compare it to the project plan—comparing their predictions to reality. If they don’t do this regularly, odds are the budget will suffer and their project will fail entirely. Luckily, these deviances from the plan, such as cost variance, don’t have to sink a project.
In fact, they can actually strengthen it. The key is spotting them and making adjustments to stay on the right path. One of the best ways to avoid cost overrun is by calculating cost variance.
Understanding Project Costs
All projects cost money, regardless of their size, scope or deliverables. We’ve all heard “there’s no such thing as a free lunch”. The same goes for projects – there’s no such thing as a project without costs. These costs come in many different forms, from the cost of materials to simply the cost of doing business (rent, salaries, etc.). It’s the project manager’s job to take all of these costs into account and create a flexible budget.
Different Types of Project Costs
In order to fully understand project cost variance, it’s helpful to be familiar with the main types of project costs. Take a look at the four you’re most likely to see. Most projects have all four, and each can contribute to overall cost variance:
- Direct Costs: Think of direct costs as costs that go straight to the project in order to achieve deliverables. A helpful example of a direct cost is the cost of the material needed to build something. The cost of these materials is going toward creating an end product.
- Indirect Costs: Indirect costs, on the other hand, go toward funding “behind the scenes” expenses that are incurred throughout the life of a project. They’re also known as overhead costs. For example, the cost of renting an office space is a common expense fixed overhead. This expense must be paid in order to complete the project, but it also goes toward supporting other projects.
- Fixed Costs: Fixed costs are expenses with set prices that aren’t subject to any kind of change. These are dependable costs that will not fluctuate and potentially throw off a budget. Both direct and indirect costs can also be fixed costs (or variable costs). A fixed cost, for example, might look like the flat fee a contractor charges for their services.
- Variable Costs: Variable costs, on the other hand, are not as predictable. For example, the cost of equipment rental may go up or down depending on the vendor, the demand or how long the equipment is needed.
What Is Cost Variance in Project Management?
Cost variance (also referred to as CV) is the difference between project costs estimated during the planning phase and the actual costs. In other words, it is how much actual costs vary from budgeted costs. Calculating cost variance is how project managers track expenses to see if a project is under or over budget.
These calculations are part of a technique called earned value management (EVM). In an EVM system, the goal of cost management is to establish whether a variance is positive, negative or zero.
When project managers have this earned value analysis information, they can make the necessary adjustments to stay on track. If a variance is extremely high (negative), changes need to be made. If there is an extremely low cost variance (positive) or zero variance, they can take it as a sign to keep doing what they’re doing.
The Four Types of Cost Variance Formulas in EVM
There are four variations of the cost variance formula used in earned value management (EVM). Each of these variance equations solves for different values, so it’s very important to understand all of them and what exactly they show.
Cost Variance (CV) = Earned Value (EV) – Actual Cost (AC)
Cost variance is exactly how much a project is over or under budget. A cost variance equation subtracts actual cost from earned value to solve for this number.
Cost Variance Percentage
Cost Variance Percentage (CV%) = Cost Variance (CV) / Earned Value (EV)
A cost variance percentage is the percentage over or under budget for a project is. This is calculated by dividing cost variance from earned value.
Cost Performance Index
Cost Performance Index (CPI) = Earned Value (EV) / Actual Cost (AC)
A cost performance index (CPI) is a metric used to judge how well resources are being used in a project. When solving for a CPI, the value will be one of two things:
- Less than or equal to 1 (resources are not being used efficiently)
- Greater than or equal to 1 (resources are being used efficiently)
In order to solve for CPI, you must divide earned value by actual costs.
Complete Cost Performance Index
To Complete Cost Performance Index (TCPI) = (Total Budget – EV) / (Total Budget – AC)
Solving for a complete cost performance index (TCPI) is extremely helpful, especially if you’re experiencing a high (negative) project variance. A TCPI is an index that shows you how resources must be used for the rest of a project in order to come in under or on budget.
To find your TCPI, begin by subtracting your earned value from your total budget. Then, subtract your actual cost from the total budget. Last, divide the first quotient by the second quotient.
Using Tools to Automatically Calculate Project Variance
Throughout the life of a project, you’ll want to have each of these cost variance formulas at your disposal. Thankfully, there are cost management tools that make keeping your eye on variances effortless so that you don’t have to manually crunch the numbers.
ProjectManager fills formulas with the correct values automatically and prevents any human error that can lead to major budgeting mistakes. Factors like total budget, actual costs, earned values and more are updated in real-time so that you’re always seeing the most current data.
Create and manage project budgets, as well as see how actual costs compare to planned costs on the project dashboard. The ProjectManager project dashboard updates automatically, so you’re always looking at the most current figures and making the smartest budgeting decisions. This makes all the difference between spotting cost variances and missing crucial details. Keep your eye on cost baselines, as well as spending and where projects are at in terms of budget.
Need to share this information with stakeholders? Create a budget report in only a few clicks to keep the team up to speed and making the best decisions together. Having this information at your fingertips and being able to share it is the difference between projects staying on budget and going over budget, which can result in cost overrun and total failure.
Calculating cost variance requires project management software robust enough to calculate and organize your data in real time. ProjectManager is a cloud-based project management software that keeps your project’s costs within budget. Try it today with this free 30-day trial.