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What is Cost Variance

StarAgilecalenderOctober 18, 2022book15 minseyes2072

What is cost variance and how to calculate it?

Projects running over or under budgets are always a concern and if you are a project manager of that project, then you are answerable to various stakeholders of that project. So make sure that you are not missing out on anything, you should be well versed with Cost Variance. Every PM will need to do the cost variance for their PMP certification as this is a crucial job in the project. If you are going to have a career in project management, then managing a budget is going to be your primary job. So with the right PMP training, you would be able to understand cost variance in a deeper way. In this article, we are going to cover this topic, its definition, its uses, tools for cost variances, and what are the formulas that are being used in the projects. So let us dig deep into cost variance definition and learn all about it.

What is Cost Variance in Project management?

It is also referred to as CV and it is the difference between the project costs that are estimated during the planning phase with the actual cost of the project that is going on. With the help of cost variance, we can find out how much the actual cost deviated from the budgeted cost for the project. With the help of this, the project managers are able to find out if the project is spending more or less than what was decided for the budget. The calculations are being done as part of one technique which is very common and called- earned value management (EVM). It is a kind of system in which we aim on checking if the cost management of any project is positive, negative, or zero.

With the help of this analysis, the project managers of the projects are able to decide where the project stands and what are necessary adjustments needed in the project to keep it on track. If the value of cost variance is extremely negative, ten changes are needed in the project, but if the cost variance value is zero or positive then the cost management is going in the right direction.

How to make sure that cost variance is zero or positive?

One of the ways to make sure that you are having correct cost variance for your project is by having an effective cost management system for your team and project. But what is cost management? Let us find out!

If you are looking for planning and control the budget for businesses, particularly the project, then cost management is needed. In cost management, all kinds of processes that include accounting and expenses are noted. This has a record of all the incoming money that includes cost estimates, budgets, resource planning, and much more. Generally, it is the duty of the project manager to take care of cost management in the project but it mostly depends on the need of the project. There are groups or teams that are dedicated to this part. Things that are part of cost management are:

Resource planning: This is one of the major parts of cost management as it includes time, labour, material, and equipment. The cost of these kinds of things is estimated while comparing with another similar project or keeping the current standards in view. Once the costs are calculated for each of them, the manager can calculate the associated cost with the project for resources needed.

Estimating cost: As mentioned above, the manager can use the information from another project to come to an estimation for the project or they can have mathematical formulas that will help them to calculate the cost as the project progresses. As they will have more information with time, the estimation will become more and more accurate. Here the managers decide the cost of each activity involved.

Cost Budgeting: In this step, the cost that is estimated before is combined with the project schedule and this will give us the total cost and the cost intervals for the project. This step is used to set the baseline in the project and also gives us an overview of when the costs are going to arise. In some small projects, it is seen that cost estimating and cost budgeting might overlap as the amount involved is small and it can be completed in a single process.

Cost Control: In the cost control step, the managers will see what is the variance of the project and if this is deviating from the cost baseline defined for the project, then they will take measures to bring it back to normal. The managers need to forecast the changes that might result in cost fluctuations. So they should be in the position to explain why the variance is present in cost management.

 

In this, you need to make sure that for every $ spend that you are doing on the project, you are earning the value back from it. The activities planned in the project have a value of their own. There are various formulas that are being used to calculate cost variance, schedule variance, and cost performance index. So as a project manager, you should learn these formulas to calculate the cost variance easily for the team. There are four types of cost variance formulas in EVM, let us learn about them in the section below.

 

Formulas to calculate cost variance in EVM

It is very important to understand them individually as they play an important role in cost management. If you are looking to have an aspiring career in project management, then you should focus on these too!

Cost Variance

The formula here is:

Cost Variance (CV) = Earned Value (EV) – Actual Cost (AC)

The earned value in the formula is the part of the budget that is allocated to that part of the given work which is needed to be completed in the given period of time or cumulatively over several periods and the Actual Cost is the cost that has been incurred in the project to complete the specific task in the project. This can have a single value that is for a period of time or cumulative as well.

This formula is adaptive in nature when different types of cost variances are needed to be calculated but the basic calculation of EC-AV is going to be the base of the formula.

 

Cost Variance Percentage

The cost variance percentage is the percentage of cost variance as compared to the Earned value of the project as explained above. The formula is:

Cost Variance Percentage (CV) % = Cost Variance (CV) / Earned Value (EV)

This formula gives us the percentage of how much the project is over or under the pre-defied budget for the specific tasks for a period of time or the cumulative period.

 

Cost Performance Index

It is one of the metrics that are used in the project to identify how well the allocated resources are working and being used in the project. It is the ratio of earned value and actual cost as defined below:

Cost Performance Index (CPI) = Earned Value (EV) / Actual Cost (AC)

 

When you solve this, the ratio will give one of two results stated below:

If the ratio is less than or equal to 1 then it signifies that resources allocated in the project are not used effectively. But if the ratio is greater or equal to 1, then the resources are working efficiently.

Well, these are just the basic formula that is being used in project management for cost. If you wish to learn more about it, then you should go for the PMP training and learn all about what is cost variance.

 

What do you understand by a Negative, positive, or Zero CV?

We have learned that cost variance can be negative, positive, or zero. Here we will put more emphasis on these values and understand the meaning of these and the reasons why we are getting these values. A negative value for cost variance indicates that when your project is overspent and you are over your budget. The positive value will indicate that you are underspending. The zero value here will indicate that the amount you are spending is accurately matching with what was planned in the planning phase. Zero cost variance is ideal for the project. There are many reasons that can cause the cost variance to come negative or positive but there are two reasons. One reason is overestimations or underestimations about the specific outcome. Another reason is the reasons that are out of your control and they are more like market transitions. Some of the issues that can cause unexpected cost variance are mentioned below:

Direct Labor cost: There are many factors that influence the direct labour cost in any organization and these factors are challenges in production or some transition in employment. There are many internal factors that play role in this.

Direct Product Costs: These types of costs depend on e direct product costs that are influenced by unexpected product damage, some delay in handling, or there could be a shortage of items along with increased shipping rates for the whole market, etc.

Overhead Costs: There are some other costs that are part of this variation. Some costs like insurance, rent, salaries, or taxes show very rare change, but if you are not managing them properly, then these factors can take turns during the course of the whole project. So you might not have time to work on these factors later.

 

Why calculating cost variance is important?

We have seen various values that indicate crucial parts of the projects. So this helps in keeping track of the financial progression of the project. Using this, you can have great monitoring over the potential risks and how well you can analyze them when they are related to your project. You can make those comparisons between the actual cost of the project and the budget and with this, you will have an opportunity that will help you make improvements in the projects that will keep you more aligned with the goals of the project. Also, with the use of this data, you can be more precise next time in your project planning phase. You will be able to have accurate estimations for your budgets.

Ways to keep your budget on track

If you are now looking for ways that can help you to keep your budget on point, then you follow some of the points mentioned below:

Review and revise

One of the best ways to track the progress of your project along with the budget is to review it at least weekly. This will help you be on top of things and if you see any fluctuation in these, it will be much easier for you to make changes and keep the project back on track. This tip might sound mundane, but it will amaze you with its effects.

Document everything

If you document the things that are planned beforehand and keep track of changes that have happened during the week, you are more likely to see the changes. You can review that information and even use them to draw a budget for the next time.

Include the team members

If you are going to include your team members while reviewing the budget regularly, you are going to get all the insights needed for your review. The team is actually working on the surface and you can get information from them about resource allocation, equipment, software, and much more. These things affect the project budget directly.

 

Well, these are some of the tips that you can use for keeping your cost variance in check

 

Conclusion

We have found all about cost variance, and how to use different formulas to make sure that we are not over or under-spending the budget that was decided for the project. Cost variance is one of the major tools that is needed in project management and this tool should be read properly when you are going to work as a manager. There are various tools that will not only help you in keeping track of the budget but they will help you out with better planning for the project budget. Using these tools, you can have an accurate estimate.

So, if you are looking for a career in this field, then going for PMP training is the best way. You should make sure that you are getting all the information from the best website. StarAgile is one of the best platforms where you can learn all about PMP training and certifications as well. These certifications are going to be your feather in the hat. So start your journey now and have a wonderful career ahead of you.

 

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