Cost Variance Explained

Cost Variance is a simple concept and can be used to avoid cost overruns while managing a project. In this article, I will explain what cost variance is and why it can be useful.

What is cost variance?

Cost variance is the difference between the Budgeted Cost of Work Performed (BCWP) and the Actual Cost of Work Performed (ACWP).

Budgeted cost of work performed is also referred to as earned value. 

 Cost variance= Earned value - Actual Cost.

To keep it simple and short, I will call budgeted cost of work performed (BCWP) as Earned Value and Actual cost of Work Performed (ACWP) as Actual Cost. 

Example:

Let’s say, your old car has a few problems and you want to repair it. You take the car to a mechanic and after the initial inspection, he gives an estimated repair cost of $5000.

After a few days, you visit the mechanic and the mechanic tells you he had to replace the battery instead of charging it.

As per your calculation, you found out that instead of $1000 for battery repairs you got charged $1200. This is an increase of $200 compared to your original estimate.

Here, $1000 is the earned value and $1200 is the Actual cost. 

 Cost variance = $1000 – $1200 = -$200

You can express cost variance in terms of percentage,

Cost variance (%) = ( Earned value – Actual cost ) / Earned Value

% Cost variance in our example would be,

Cost Variance(%)= ($1000-$1200)/$1000

Cost variance(%)= -20%

So, the actual cost increases by 20%.

• If the project is over budget then the cost variance is negative.
• If the project is under budget then the cost variance is positive.

When you look at the graph below, you can visualize cost variance.

 

Why is cost variance useful?

Cost variance can be used in multiple ways, from reporting to cost projections, it depends on the user. Let’s look at some of the ways in which cost variance can be useful.

1. Comparison:-

After you are completed with the project, comparing the budget with the actuals can be of huge importance.

If the actual cost is higher than the budgeted cost by a large margin. You have a problem with the budgeting system and need to rectify it.

2. Projection of final cost:- 

For the projection of final variance in cost, you can use historical data.

Historical data can be data from a similar project or the project you are currently working on.

If you have Budgeted cost or Earned value along with the actual cost, you can project the cost of the project after its completion.

Let’s try to understand this by using the above graph,

We have to consider the graph with linear nature to better understand the scenario. If the actual cost goes on increasing at the same rate, it will cross the budgeted cost.

Conclusion:

Cost variance is used to determine project health and helps you in avoiding cost overruns when you have multiple large scale projects to manage.