What Is Actual Cost in Project Management?
Knowing how to manage actual cost in project management is the key to using various project management metrics.
This includes cost management indicators, such as cost variance and the cost performance index (CPI). Here’s all you need to know about it.
What Is Actual Cost in Project Management?
Unlike some other earned value management (EVM) terminology, understanding actual cost is pretty simple.
Actual cost is the sum of the expenses that have been incurred for project activities during a specific time period. Depending on whether you’re analyzing your project budget during execution or after completion, this can be your full costs or a smaller slice.
While actual cost isn’t too interesting of a concept by itself, it’s significant for its application in cost control EVM formulas.
How Is It Used in EVM? Actual Cost Calculations
EVM is a methodology that analyzes three facets of project management: cost, schedule, and scope. Actual cost values are used in two main earned value calculations: cost variance and cost performance index (CPI).
Cost Variance
Cost variance (CV) monitors the difference between projected project expenses and actual project expenses. The formula usually uses this terminology:
earned value – actual cost = cost performance index
The result is the difference in money budgeted vs money spent in monetary terms. A positive cost variance means that you’re ahead of your budget, while a negative one means that you’re overspending.
Cost Performance Index
The cost performance index (CPI) is a variation of the cost variance formula. By this, it’s meant that it monitors the same aspect of project management — whether you have budget overruns or you’re on track — but uses a different method.
earned value / actual cost = cost performance index
The result is an index that points to your cost efficiency. For example, a CPI of 1.25 would mean that a project is 125% efficient, while a CPI of 0.75 means that you’re 75% efficient.
Other EV Formulas
Here’s a brief overview of other EVM formulas and terminology:
- Earned value (EV): the amount of value achieved while investing resources; in other words, the amount of work completed on a project.
- Schedule variance (SV): compares the difference in the projected vs real project schedule by substracting earned value (work completed) with planned value (worked planned to be completed).
- Schedule performance index (SPI): A similar metric to schedule variance as it examines project schedules but results in an index (similarly to CPI). The formula divides earned value with planned value.
- Budget at completion (BAC): Defined as the sum of all authorized budgets allocated to a project. Used to calculate variance at project completion, or the difference between the projected final cost of the project and the actual final cost of the project.
- Estimate at completion (EAC): A forecasted value that represents the final cost of the project when all work is completed. Used to calculate variance at completion.
Different Types of Project Costs
So, what are the most important factors of project cost management? Usually, these are labor, materials, and machinery.
In a professional services context, labor costs are usually prevalent, as employees track their billable hours to deliver services.
Usually, an agency project will comprise direct and indirect costs. The difference is:
- Direct cost is directly involved with the production of goods and services or revenue-generating activities — in the case of professional services, these are employee salaries
- Indirect costs or overhead are tied to activities that don’t produce revenue; overhead can be fixed (such as facility costs or salaries of administrative staff) or variable (such as employee benefits or equipment maintenance)
Monitoring Actual Cost
All of these different types of costs affect your agency’s financial health and profitability, so project managers need to know how to manage it successfully.
By using a cost management system such as Productive, you can track billable hours, monitor budgets in real time, calculate your overhead, and track external expenses.
Tracking Billable Hours
On T&M projects, you’ll need to keep track of exactly what is being done and when. Creating a WBS (work-breakdown structure) that defines your tasks and milestones ahead of the project is one part of it — the other is ensuring that everything is being completed on time as the project progresses.
Actual costs are usually calculated by multiplying time tracked with employee billable rates (or the rate at which you’re selling your services to clients). Productive does this automatically and updates your budget burn in real time.
In the example above, you see that 5 billable hours have been tracked out of a 100 estimated hours. On a price of $100 per hour, this means that $500 have been spent, or 5% of the budget.
You can also switch to the profitability chart to see how you’re faring in revenue and profit margins.
Track External Expenses
With Productive, you can also easily account for additional expenses in your projects. You can:
- Set up an approval process to verify expenses
- Track payments and reimbursements
- Integrated expenses into your reports
- Oversee expenses on your home dashboard with a widget
Productive also includes a built-in Xero integration, so you can sync your expenses and transfer them over to Xero.
Learn more about using Purchase Orders in Productive.
Calculating Overhead
Finally, Productive takes into account your facility cost, time off bookings, and expenses tracked on internal projects.
Not only that, but it spreads these overhead costs across your employees, so that when people track their time, the overhead amount will be deducted from their billable rate. Basically, this means that Productive tracks your overhead per hour.
So, you can now deduct not only cost rates (salaries) but also your overhead from your billable rates to understand your true profit per client.
If I wanted an accurate report on overhead spread across clients, I would’ve spent hours working on it, but with Productive, we can generate that report automatically.
Learn more about getting reliable and accurate data with Productive.
With Productive, you can also:
- Recognize revenue across time or at a single point for fixed-price projects
- Use your time tracking data to create invoices and track payments (with native Xero and QuickBooks integrations)
- Forecast financial data based on your employee scheduling for informed decision-making
And much more.
Manage Costs and Expenses With Productive
Switch from multiple tools and spreadsheets to an all-in-one agency management software solution.
Tips for Preventing Project Cost Overrun
Finally, here are some tips for managing cost overruns:
- Create a detailed project plan with realistic cost estimates, including contingency funds for unexpected expenses
- Implement frequent cost reviews and monitoring systems to track progress and identify issues early
- Compare your estimated performance metrics with your baseline when reaching project milestones and implement improvements when necessary
- Maintain open communication between stakeholders and project teams to ensure all parties are aware of budget constraints and aligned on goals
Conclusion: Optimizing Your Financial Management
While the concept of real costs isn’t too complicated, managing them efficiently is crucial to successful projects. Not only that, but it helps safeguard your business’s financial performance by supporting profitability and steady cash flow.
Modern software supports project performance in many ways. It helps consolidate your data, automates various parts of the workflows, and delivers more reliable data than when manual calculations are used.
If you’re interested in an all-in-one agency management solution, you can book a demo with Productive today to learn more.
To keep reading about all things finance, you can head over to our guide on customer profitability management.
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