Finance – Cost variance

Cost variance

Cost variance: Everything you need to know about cost variance (CV)

What is cost variance?

Cost variance (often abbreviated to CV) is a project measurement tool and equation which enables project managers and companies to assess cost performance on a project to date.

A projects cost variance at a specific point in time refers to the numerical difference between the earned value of a project so far, and the actual costs (AC) which have been incurred on that project.

In simple and applicable to all terms, cost variance is the process of evaluating the financial performance of a project by comparing the initial budget to what has actually been spent.Β 

Cost variance is one component of earned value management, which is the overarching project management technique which project-based companies to measure, understand and forecast project performance.

The key to earned value management is that it is used during the course of a project. Any company can compare their initial budget to what was spent at the end of the project, but the purpose of earned value is to understand how the project is performing during works. This way, the company can make course corrections and informed decisions about how to improve, rather than let the schedule and budget blow out of control.

Cost variance is one of the two major dimensions of earned value management, with the other being time or 'schedule'.

If a project is on schedule and on budget, then it is likely to end successfully. There are of course other considerations, if corners are being cut on the project to save time and money, then the safety and quality of the project may be compromised which will not result in a positive outcome.

But if safety and quality are good, and the project is on time and on budget, the project will be deemed successful.

A favourable cost variance occurs when...

On any project, we are looking for favourable cost variance, because that tells us we are not over budget. And to get a favourable cost variance, we simply need our calculated CV to be zero or a positive number.

If our cost variance equals zero, then our earned value equals our actual costs, which means we have generated the value we expected from the costs we expected i.e on budget.

If our cost variance is even more favourable and equals a positive number, then we are actually under budget.

To get a better look at what a favourable cost variance looks like, let's take this example.

Let's assume we are working on a $1,000,000 construction project which is scheduled to be completed in 12 months.

We are wanting to evaluate our cost variance at the 6 month mark, when we have completed 45% of the scheduled work and spent $420,000.

With these details, we can work out our cost variance, and find out whether we have a favourable cost variance.

First we need to calculate our earned value using our earned value formula:

Earned value = % of project complete x BAC = 45% x $1,000,000 = $450,000

So our current earned value on the project is $450,000.

To find our cost variance, we simply subtract our actual costs from this earned value number.

Cost variance = Earned value - actual costs = $450,000 - $420,000 = $+30,000

As we can see, our cost variance is $70,000, which is a positive number.

This gives us a favourable cost variance - and we are ~$70,000 under budget.

Cost variance and schedule variance

It's important not to get too carried away when using cost variance, because it is only one of the two major dimensions of project performance.

The power of earned value management comes from being able to get a more complete picture of project performance than looking at costs or time in a silo.

So we also need to factor in and consider our schedule variance (SV) too.

We can actually use the same information we assembled for cost variance above to work out our schedule variance.

Schedule variance = Earned value - Planned value = $450,000 - $500,000 = -$50,000

The result we want to see from our SV is similar to what we want to see to get a favourable cost variance: a positive number.

In this case, our number is negative, which means we are behind schedule.

So although we are under budget (positive), we are also behind schedule (negative).

In this case, the amount we are behind schedule is more than the amount we are under budget, so we are likely performing more poorly than expected from an efficiency perspective as well as an output perspective.

At least we can increase our spend in this case to try close the schedule gap, because our cost variance is favourable.

The worst case scenario is when we have an unfavourable CV and SV, because then we are over budget and behind schedule.

Other helpful CV resources

Hopefully this cost variance article has been helpful for explaining most of the ins and outs of cost variance, but there is of course more to know about cost variance as well as other earned value subjects and formulas.

The main part of cost variance that most project managers and other companies care about delving deeper into is the cost variance formula.

There's a lot more details and examples around the actual formula which can be helpful for people looking deeper into cost variance.

On top of that, there are a bunch of other earned value tools and measures which supplement and add to cost variance and schedule variance. These measures help project managers take what they know about current performance and current costs etc. and then project that onto the rest of the project. The power of any measurement is being able to take that data and apply it to current context and future scenarios, so that things can be improved.

Here is an earned value formula sheet you can use to reference more of these measures, and to build a more comprehensive approach to earned value management.

On top of manual resources, you can also look into using and trying some our software tools, which help to streamline cost variance data and reconciliation so that teams and project managers can save huge amounts of time on admin and improve the speed and quality of their data.

People in 70+ countries use this software to deliver their projects on time and on budget.

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About Lance Hodgson

Lance is VP of Marketing at Sitemate. His aim is to bring awareness to a brighter future for the Built World where industrial workers and companies work smarter.

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