What is cost variance in project management?
Staying within the project’s budget is a major concern for project managers. To ensure they don’t overstep their financial limitations and stay on track with their spending — they calculate the cost variance throughout the project’s lifecycle.
Cost variance is just one small part of project cost management, which helps us evaluate, distribute, and control project costs. So, in this guide, we’ll focus on explaining:
- Cost variance and its role in project management,
- The cost variance formula and methods we can use to calculate and measure it,
- The difference between cost variance and cost performance index,
- Types of cost variances that exist,
- The most common reasons cost variances occur, and
- How you might avoid them in your projects.
Along the way, we will support our explanations with different examples to shed more light on this important matter.
Let’s dive in.
What is cost variance?
According to the PMBOK® Guide (7th edition), cost variance is “the amount of budget deficit or surplus at a given point in time, expressed as the difference between the earned value and the actual cost.”
In simpler terms, cost variance is the difference between the allocated budget for work performed and the actual cost it incurred. Thus, it tells us if our project is over or under budget.
Cost variance is one of the key dimensions of earned value analysis (EVA). Earned value analysis is an analysis method we can use to evaluate a project’s performance and progress.
💡 Plaky Pro Tip
Earned value analysis and its key dimensions are a part of earned value management (EVM), a performance management methodology. To learn more about EVM, check out this guide:
How to calculate cost variance in project management
The cost variance formula helps us determine the difference between the budgeted cost of work performed (BCWP) and the actual cost of work performed (ACWP). These parameters are also known as earned value (EV) and actual cost (AC).
The PMBOK® Guide (7th edition) defines earned value as “the measure of work performed expressed in terms of the budget authorized for that work.”
In contrast, the definition of actual cost states that it is “the realized cost incurred for the work performed on an activity during a specific time period.”
Simply put, earned value is the monetary value of the accomplished work at a given point in time.
Actual cost, however, relates to the actual costs of the accomplished work. It is all the money we have spent on the work performed at a given point in time.
The difference between these 2 parameters shows if there is a cost variance. So, the formula for cost variance is:
CV = EV – AC
We can get the value of AC by simply adding up all the costs. To calculate EV, we can use this formula:
EV = % of work completed x total project budget
We can also calculate the cost variance percentage if it’s necessary for us to present information about our project in percentages. In that case, we can use this formula:
CV % = (EV – AC) / EV
What does cost variance tell us about a project?
Cost variance is a powerful measurement for project cost control as it shows us whether we’re on the right track regarding our expenses. Its core purpose is to show us if our project is doing well financially.
A big part of project cost control is figuring out how much the actual cost deviated from the cost baseline and what caused the variance.
Ideally, we want the cost variance of our project to be zero. However, that rarely happens as not every project always goes according to plan.
Instead, we can distinguish between a positive (favorable) and a negative (unfavorable) cost variance.
A favorable cost variance occurs when we spend less money than anticipated, or rather, than what we budgeted. It’s usually a good omen, though that depends on the context — it would be prudent to investigate why it has occurred to ensure we haven’t carried out less work than anticipated.
In contrast, an unfavorable cost variance means that we have gone over the budgeted amount. In other words, our project is in trouble.
We can apply the cost variance formula to different budget categories and types of project costs to determine where we stand financially. That way, we can pinpoint exactly where the positive or negative cost variance has occurred.
Cost variance examples
Understanding cost variance is a lot easier if you have an example to rely on. Down below, you will find 3 examples that should help you understand this cost performance measurement better.
Example #1: A negative cost variance
Let’s say you’re looking to build a garden fence to spruce up your backyard. Your budget is $4,000, and you have 5 days to build it.
Today is day 4. You’ve spent $3,300, but only did 75% of the work — you had to buy a new spade and some screws, and just the trip to the store cost you a few precious hours.
Clearly, everything didn’t go to plan, and you have to check the cost variance to see where your project stands. Let’s calculate it:
AC is $3,300 — the amount you have spent on the project so far.
EV is 75% of $4,000 = $3,000 — that’s the value of the amount of work that has been completed.
So, the CV is $3,000 – $3,300 = -$300. This means your project is over budget by $300.
Actual cost (AC) = $3,300
Earned value (EV) = $3,000
Cost variance (CV) = EV – AC = -$300
Example #2: A zero cost variance
It’s time to renovate your master bathroom, so you’ve hired a team to do it. The whole project should cost $8,000, including all the necessary materials. The team has 10 days to complete the project.
It is the end of day 5, and the team has completed 50% of the work. So far, you’ve spent $4,000 on the renovation.
In this case, the project is right on track. Here’s why:
AC is $4,000.
EV is 50% of $8,000 = $4,000.
So, the CV is $4,000 – $4,000 = 0. The project is financially doing well and is neither over nor under budget.
Actual cost (AC) = $4,000
Earned value (EV) = $4,000
Cost variance (CV) = EV – AC = $0
Example #3: A positive cost variance
You’re building an extension to your house to get another bedroom. The duration of this project is going to be 20 days, and you’ve allocated $50,000 for it, including all the tools, materials, and furniture.
You decide to check how the project is doing financially at the end of day 17. You want to see whether you’ll have to extend the project and/or invest more funds.
But you’re in for a surprise. You find out that you have spent only $40,000 because you opted to buy some of the furniture at the local thrift stores.
Better yet, you have completed 85% of work, which means you’re right on schedule.
So is your project in trouble?
It’s far from it actually:
AC is $40,000
EV is 85% of 50,000 = $42,500
So, the CV is $42,500 – $40,000 = $2,500. This means that you’re $2,500 under budget, so there is a positive cost variance.
Actual cost (AC) = $40,000
Earned value (EV) = $42,500
Cost variance (CV) = EV – AC = $2,500
CV vs CPI: How do they differ?
Cost variance tells us where we stand financially, or rather, if we have gone over our budget or not. Cost performance index (CPI), however, measures the cost efficiency of the completed work.
According to The Standard for Earned Value Management, CPI represents “a measure of the cost efficiency of budgeted resources expressed as the ratio of earned value to actual cost.”
CPI tells us whether we’ve been using our resources properly and gives us a numerical evaluation of our project’s performance.
Due to this, it can be an early red flag we ought to pay attention to — it’s a signal that some corrective measures might be in order.
The formula for CPI is easy to remember:
CPI = EV / AC
Here’s how to interpret CPI results:
- CPI is over 1 — the project is under budget, i.e., you’ve done more work than you expected with the allocated amount of money.
- CPI is 1 — the project is exactly on budget.
- CPI is below 1 — the project is over budget, i.e., you’ve spent more than you expected.
Much like in the case of a positive CV, a CPI greater than 1 isn’t always a good sign.
It could mean that the value you’ve made so far is greater than the incurred costs.
However, it could also mean that you incorrectly estimated your necessary resources — which could have been put to better use elsewhere.
💡 Plaky Pro Tip
If you want to know more about CPI and how to monitor cost performance, check out this post:
CPI’s role in forecasting
CPI is closely linked to 2 important forecasting parameters:
- Estimate at completion (EAC) and
- To-complete performance index (TCPI).
Estimate at completion (EAC)
EAC represents the predicted cost of the project at its completion, which we can calculate while the project is underway. This parameter takes into account the project’s progress and forecasts the final project cost.
We compare EAC to budget at completion (BAC) — the total estimated budget — to see how much they differ and if we need to take corrective action.
This parameter is also useful for determining variance at completion (VAC), which we will talk about more later on.
EAC can be calculated in 4 different ways, depending on what’s going on with our project:
EAC = AC + bottom-up ETC
EAC = AC + (BAC – EV)
EAC = BAC / CPI
EAC = AC + [(BAC – EV) / (CPI × SPI)]
💡 Plaky Pro Tip
We have a complete guide on how to calculate EAC using these formulas — and how to decide which formula to use. Check it out here:
To-complete performance index (TCPI)
TCPI, however, predicts the necessary cost efficiency we have to uphold to complete a project within budget.
In other words, it shows the cost performance index (CPI) we have to target to ensure the project meets BAC or EAC.
TCPI can be calculated using these formulas:
TCPI = (BAC – EV) / (BAC – AC)
TCPI = (BAC – EV) / (EAC – AC)
We use the second formula for what-if analysis when the original budget is no longer viable, e.g., when we’re already over budget.
Here’s how to interpret TCPI results:
- TCPI is over 1 — the budget is too tight, so the project will be harder to complete.
- TCPI is 1 — the project will require the same cost performance efficiency to be completed.
- TCPI is below 1 — there’s enough room in the budget, so the project will be easier to complete.
3 Ways to measure cost variance
We can discern between 3 different ways of measuring a project’s cost variance. These are:
- Cumulative cost variance,
- Point-in-time (or period-by-period) cost variance, and
- Variance at completion.
Cumulative vs. point-in-time cost variance
Cumulative cost variance takes into account multiple timeframes, which comprise a range of EVs and ACs.
In other words, we can calculate the cumulative CV by finding the difference between the cumulative earned value and the cumulative actual cost of a project.
Most of the time, the values we use to calculate cumulative CV are for consecutive timeframes. We essentially want to know how much we’ve gone over budget (if at all) up to a certain point in time.
In contrast, point-in-time (or period-by-period) cost variance refers to measuring the cost variance in a single timeframe. It entails finding the difference between the earned value and the actual cost of a single project phase or time period — without taking into account previous or future variances.
To calculate these cost variances, we use the same basic formula for CV:
CV = EV – AC
The main difference, however, is in the time period(s) we focus on.
Cumulative and point-in-time cost variance example
You’re working on a project with a budget of $5,000 and have 5 weeks to finish it. Over the course of 3 weeks, you manage to do 65% of the project, and you spend $3,500.
Here’s a breakdown of the work performance and project costs for each week:
|Time period||% of work done||Costs|
You can easily use this data to figure out a point-in-time cost variance for each week and a cumulative cost variance for those 3 weeks. Here’s how:
Cumulative cost variance
EV is 65% of $5,000 = $3,250
AC is $3,500
CV is $3,250 – $3,500 = -$250
Actual cost (AC) = $3,500
Earned value (EV) = $3,250
Cost variance (CV) = EV – AC = -$250
Obviously, there’s a negative cost variance here. But let’s check the point-in-time cost variances for every week:
Point-in-time cost variance
Here’s the EV and AC data for each week:
|Time period||EV||AC||CV = EV – AC|
As you can tell in the example, the project has been consistently missing the mark as far as the budget goes.
Since there are only 2 weeks left until the deadline, you as a project manager would have to take corrective action now. You’d need to figure out how to stretch the remainder of the budget, or where to find additional funds.
Keeping track of all these parameters would be a lot easier in project management software like Plaky. Here’s how you could display project information on a single board:
Variance at completion (VAC)
Unlike the 2 other types of cost variance, variance at completion focuses on the end of the project. It is another forecasting parameter that we can use to predict whether our project will end successfully or not.
Variance at completion is the difference between BAC (budget at completion) and the most recent EAC (estimate at completion). Its core purpose is to project if there will be a budget deficit or surplus at the project’s end.
To calculate it, we use a simple formula:
VAC = BAC – EAC
Much like CV, VAC can also be positive, negative or zero. Here’s how to interpret the results:
- Positive VAC — the project will end under budget.
- Zero VAC — the project will use up all of the planned budget.
- Negative VAC — the project will go over the planned budget.
Variance at completion example
Your project is already underway, and the original budget is $500,000.
After many twists and turns, you grow apprehensive of your spending and want to calculate the EAC.
After applying the formula, you figure out that the EAC is $505,000.
In that case, the VAC is $500,000 – $505,000 = -$5,000. So, it’s expected that you will be $5,000 over the planned cost at the end of the project.
Budget at completion (BAC) = $500,000
Estimate at completion (EAC) = $505,000
Variance at completion (VAC) = -$5,000
What causes cost variance in project management?
Cost variances can occur in any project, and they are sometimes inevitable or even impossible to prevent.
Here are some of the most common causes of positive or negative cost variances in project management.
Cause #1: Changes in economic conditions
Staying within the project budget largely depends on your estimates being accurate. However, you cannot always predict economic conditions, the rates and prices you will have to adhere to — or the exact circumstances linked to their changes.
For instance, contractors may change their labor rates or the prices of tools, materials, and other project resources may go up due to unforeseen circumstances. If you don’t have a way of lowering the prices (such as going for another vendor), those price hikes might lead to a negative cost variance.
Whatever the reasons behind the changes may be, they will inevitably prevent you from accurately reporting on the project’s progress. Therefore, if you notice that the changes are constant, and not a one-time thing, make sure to reevaluate your budget and set new estimates.
Cause #2: Scope modifications
The project scope details everything we have to do to complete the project, but it is not immune to change. If the project’s requirements change, the scope may also suffer some modifications.
These changes may include adding or eliminating certain project activities that incur some set costs. Alternatively, the changes may relate to specific items, whose addition or removal may lead to negative or positive cost variances.
💡 Plaky Pro Tip
Do you know what scope creep is and how it can affect your projects? Learn all about it in this post:
Cause #3: Bad estimates
Inaccurate estimates can be made by both novice and seasoned project managers. There are a few reasons for wrong project cost estimates, including:
- Relying heavily on the costing data of previous projects,
- Assigning cost estimation to inexperienced team members,
- Assigning the task to multiple people,
- Underutilizing lessons learned, and
- Ignoring or underestimating the project schedule.
A bad estimate could signify that a cost variance (often a negative one) is just around the corner. So, it’s important to monitor and manage the estimates throughout the project’s lifecycle.
Cause #4: Accounting mistakes
To err is human, so it’s unreasonable to expect to complete projects without making any mistakes along the way. Unfortunately, accounting mistakes can spell trouble for a project as they can lead to cost variances.
Sometimes, the mistake may be as simple as bad math. Other times, though, their cause may be your reliance on outdated data while creating estimates.
5 Tips to keep your project’s financial performance in check
The road to a high-quality project deliverable is full of obstacles like negative cost variances, schedule delays, and similar. And yet, it is a project manager’s job to handle the 3 project constraints — scope, time, and cost — to the best of their ability.
Unfortunately, problems like cost variances can happen to the best of us. Generally speaking, keeping a project on budget can be a difficult endeavor as you can only anticipate so many changes.
Unforeseeable circumstances can get the best of you, and if you haven’t already paid enough attention to the project’s financial performance — they can be your undoing.
Every project manager likely already has an idea of how to avoid negative cost variances and a bad financial performance. We’ve come up with 5 tips to help you keep your project budget and expenses in check:
- Set realistic and accurate goals and estimates,
- Plan out your costs with WBS,
- Keep track of your project’s KPIs,
- Investigate cost variances regularly, and
- Continue to forecast throughout the project’s life cycle.
Let’s discuss these tips in more detail.
Tip #1: Set realistic and accurate goals and estimates
Though it seems like a no-brainer, it’s not uncommon to make wrong project goals and estimates by purely following your wishes — and failing to consider the real situation. Remember that the budget, scope, and project timeline must be accurate and feasible.
One way of acquiring accurate data to make realistic cost estimates is to examine the budgets and expenses of previous projects.
This historical data should help you anticipate the scope and timelines as well, provided the projects are similar and the data is relatively new.
However, keep in mind that you don’t have to do it all alone. In fact, it’s recommended to include some of the project stakeholders, such as your team, in the estimation process.
Their past experience should help them foresee all the minute expenses that may have to be added to the project.
In turn, you will be able to make a more detailed cost breakdown and potentially prevent both negative and overly positive cost variances that can occur due to accidental miscalculations.
💡 Plaky Pro Tip
Learning from your past experiences is vital for becoming a better project manager and leading successful projects. There are two tools to rely on in that case — the post-implementation project review and lessons learned. Check out our guides on both of these down below:
Tip #2: Plan out your costs with WBS
A work breakdown structure (WBS) is just what it says it is — it is a breakdown of everything you need to do for the project to complete it.
As this breakdown includes 100% of the work tied to the project in question, it can also serve you as a guide for a cost breakdown.
Instead of playing the guessing game with expenses, you can use the WBS to identify costs line by line.
The more detailed you are, the better. That way, you will lower the chance of omitting an important expense that could later on lead to a cost variance.
An expert we reached out to, Carla Jenkins, a PMP-certified Cloud Project Manager at Phenomena Corporation, suggests going the extra mile when preparing your budget and outlining the potential costs:
“I draft three different budgets using the 3-point method based on most likely, best case and worst case scenarios. Having these three different budget baselines helps me gauge if I need to ask for help securing more people and resources.”
Tip #3: Keep track of the project’s KPIs
Your intuition and experience can only take you so far. If you want to stay on budget and avoid cost variances, tracking certain metrics is incredibly helpful.
Some of the most useful project management KPIs you can track to keep your budget in check include:
- Earned value (EV),
- Actual cost (AC),
- Cost variance (CV), and
- Cost Performance Index (CPI).
You can always choose to track more than these 4 KPIs.
For instance, we believe it would be prudent to add the planned hours vs. time spent KPI to this list. Tracking the time you spend on each project task and comparing it to your estimates will show you the real picture of the project’s progress.
All this, however, is challenging to do “by hand” — that is, by keeping a score in different documents.
Instead, you can just use customizable organizational software like Plaky to keep the relevant KPIs of your projects in one place for effortless tracking and comparison.
Here’s what that might look like in Plaky.
Plaky is also fantastic for improving team productivity as you can even use it for project time management. It can be integrated with Clockify — the most popular free time tracker for teams — so you can easily track time on different tasks with just one click.
While monitoring KPIs, it’s also essential to review them on a regular basis with your project team and stakeholders. Everyone should have a clear idea of the progress and all the roadblocks they might have run into.
Once they do, it’ll be easier to navigate changes and different issues.
In the end, nurturing transparency about project costs and all other aspects of it could help you address any money concerns more successfully.
Tip #4: Investigate cost variances regularly
Cost variances can be a result of various issues and changing circumstances. Their effect on the whole project can be monumental, so it’s necessary to keep tabs on them on a regular basis.
Since a cost variance can stem from all kinds of costs, we can investigate each type of cost separately to determine where and why the variance occurred.
For instance, if we’re consistently missing the mark in terms of labor costs, it would be prudent to examine why the variance keeps happening and use corrective measures to reduce it.
A major part of project cost control includes establishing variance control thresholds. These are set amounts of variation that don’t require resolving or any corrective action.
However, when deciding whether to investigate a cost variance, we also have to consider:
- How consistent it is — does it keep appearing or is it a one-off thing?
- If we can control it — if the variance is beyond our control, the best thing we can do is forget about it.
Corrective action should always involve the proper identification of the causes. Pointing fingers at the managers is not the way to go about it, as some variances will be out of their control too.
Tip #5: Continue to forecast throughout the project’s lifecycle
The final tip we have for you is to continue forecasting your project’s cost performance until it is completed.
Given how project changes can greatly impact the costs, it’s important to not only keep a close eye on the budget but also keep re-forecasting frequently.
With consistent re-forecasting, you will be on top of things when it comes to all costs that matter within the project’s lifecycle. What’s more, you will be better at anticipating the project’s progress.
The expert we reached out to, Carla Jenkins, says that she re-forecasts “on a routine basis”.
“At the end of my week, I re-forecast my budget. I do it every week so that I do not miss any trends or developments.”
Re-forecasting her budget on a weekly basis allows Carla Jenkins to be proactive about cost control:
“I also want to see if we’re at least on budget or under budget. If we’re over budget, let’s see where we can cut costs by either streamlining resources or seeing where we can cut.”
That said, there’s no point in forecasting if you don’t know what to do about the changing circumstances of your project’s cost performance. So, make sure you have a plan B, C, and even D in place in case your project costs become more of a headache.
Essentially, you need contingency plans to keep the project on the right track even if conditions (such as costs) change.
That way, you can balance out your project’s cost performance and minimize any potential cost variances that may occur.
Conclusion: Keep tabs on cost variance to ensure project success
As you can see, cost variance plays a significant role in project management — it clearly shows us whether our project’s financial performance matches our expectations.
Thus, it is a key performance indicator project managers shouldn’t ignore.
In fact, failing to keep track of both positive and negative cost variances could keep you in the dark regarding your project’s financial health.
This guide should serve as a quick reference on the importance of cost variance and how to calculate it. Better yet, you can use the tips we’ve provided to improve your budget management — and coincidentally prevent or at least minimize cost variances in your projects.
- Project Management Institute. (2019). The Standard for Earned Value Management. Project Management Institute. https://www.goodreads.com/en/book/show/45899516
- Project Management Institute. (2021). A Guide to the Project Management Body of Knowledge (PMBOK® Guide)–Seventh Edition. Project Management Institute. https://www.goodreads.com/book/show/58474625-a-guide-to-the-project-management-body-of-knowledge-pmbok-guide-sev
- Juma, A. (2022, October 19). Guide to Earned Value Analysis: Definition, Uses and Formula. Indeed. Retrieved January 25, 2023, from https://www.indeed.com/career-advice/career-development/earned-value-analysis
- Rudder, A. (2022, November 17). What is the Project Management Triangle? Forbes. Retrieved January 25, 2023, from https://www.forbes.com/advisor/business/project-management-triangle/