Cost Variance in Project Management: How to Calculate It

Cost variance in project management helps project managers keep their cost baseline under control.

This is why cost variance analysis is one of the core project management metrics. In this article, we’ll discuss how you can calculate your cost variance, what you can use it for, different types of project costs, and how you can minimize them. 

Cost variance is a metric that depicts the difference between your expected project cost and your actual cost at a certain point in time. A positive cost variance means that your project budget is on track, while a negative variance signifies budget overrun.

The basic formula for cost variance is:

Projected cost is also sometimes called earned value in project management (EV), since it reflects on your work completed.

To give a practical example, let’s say your original budget is $10,000. Let’s say you’ve completed 50% of the project; your projected cost or earned value would amount to $5,000.

However, you’ve actually spent only $4,000. This means that your cost variance is $1,000, meaning that you’re not only within your budget but that you’ve spent less than expected.

For the cost variance percentage, use the following formula:

Using the example above, $1,000 / $5,000 is 20%, meaning that your budget is 20% over the expected amount.

 If you don’t want to do manual calculations, you can use project management software like Productive for real-time data access. Head over to our section on tracking cost variance with Productive to learn more.

There are also a couple of different ways to measure your budget spend and get insights from multiple perspectives, including:

A full understanding of cost variance requires using all three methods. Point-in-time and cumulative cost variance help project managers take proactive measures to correct unfavorable cost variance, while variance at completion is necessary for delivering budget reports and promoting cost efficient workflows.

Cost variance analysis helps project managers identify exactly the point at which budgets begin to diverge from expectations. This allows them to pinpoint specific roadblocks and address them before the project gets derailed. This makes the concept of cost variance an essential part of project financial management.

Additionally, building a better understanding of how to control actual cost in project management supports future projects; it helps set better estimates and measures for monitoring your budgeting in stages.

Cost variance also supports accountability and transparency between project stakeholders. Project managers who have a handle over their finances during various time periods can present this data to clients, which helps manage expectations, control scope creep, and increase client satisfaction overall.

Learn how to optimize your project cost control and collaboration with Productive.

There are two main types of project costs: direct and indirect costs. Direct cost is usually involved closely with the production of goods and services — in the case of professional services, this usually includes employee salaries. Indirect costs, also known as overhead, are tied to activities that don’t produce revenue.

Overhead can also be classified into two types:

1. Fixed overhead, which includes costs that remain constant and don’t change with business activity levels. For example:

2. Variable overhead costs, or expenses which fluctuate depending on the volume of goods used or services provided, and include:

Project managers will need to understand and consider all of these cost elements to optimize their management.

Now that you know what you need to calculate and how to do it, here are three tips to prevent and mitigate cost overrun in project management:

Without realistic estimates, it’s impossible to prevent cost overruns. Businesses might commit to delivering more than they’re capable of for various reasons: fear of losing a client, inexperience, and lack of historical data.

While the first reason requires a mindset change, the other two can be more easily addressed. Businesses should consider implementing a more thorough project planning and risk management process to improve estimation.

Implementing project management tools that help gather past project data can help pinpoint historical roadblocks and address them so they don’t impact future projects. Regularly revisiting and updating these estimates throughout the project lifecycle also allows businesses to adapt to changes promptly, another thing for which software is invaluable.

Even if your costs have exceeded their initial estimates, that doesn’t necessarily mean that either the project or your business operations will be negatively impacted. You might still be able to retain a positive profit margin. This is why it’s so important to have budgeting and profitability information in one place; in these cases, going over budget can be a good idea in order to satisfy client requests and deliver a better service.

Finally, efficient resource allocation ties into both your estimating and profitability. This involves assigning the right people to the right tasks and ensuring that their skills are fully utilized without overburdening them. This is done by calculating employee utilization, or the percentage of billable hours worked vs total hours worked.

Low utilization means that project teams are missing out on billable work and, consequently, revenue. It can signify issues with your workflows, such as miscommunication, lack of organization on tasks, client issues, etc. On the other hand, if your utilization is too high, this can mean that your project team is on the track to burnout. Unexpected employee attrition can have a significant impact on your project success, not to mention the costs of finding and onboarding new staff.

This is why utilization and capacity planning are so important to effective cost management.

With Productive, you don’t have to manually gather your estimated vs actual cost to monitor your budget burn. Instead, Productive takes into account your employee billable rates and logged hours to update your budgets in real time.

In the example below, you’ll see that 5 billable hours tracked x billable rate of $100/h = $500 budget used.

You can also set automatic warnings on your budget; for example, when 50% of billable hours have been tracked. You’ll get an email notification letting you know that it’s time to check your estimated vs actual costs.

To monitor the overall trend of your budget over the project duration, you can use the cumulative view. For a point-in-time analysis, switch to the per-period view and get a snapshot of a selected period of time.

To see whether you’re on top or over your budget, you can check the Budget tab under the chart. With a negative cost variance, your Budget remaining will be under 0% (and have a red line to indicate overflow), while a positive cost variance will be over 0% (with a green line indicating how much you have left to spend).

To make your data more accurate, you can also enable overhead costs and expenses. Productive calculates your true profit per hour by deducting employee cost rates (salaries) and overhead cost per hour (facility cost + internal cost such as time off) from billable rates.

With expenses, you can manage various additional costs and even set up an approval process to verify them beforehand.

Going back to our Budgeting overlay, you can also switch to the Profitability overlay to monitor profit margins and even predict these metrics. How does this work? By scheduling your project team with Productive’s Resource Planning ahead of time, you can get your estimate at completion (budget at completion or the total cost of a project once it’s finished) to take corrective actions on time and improve financial performance.

Productive’s additional features include:

You can check out Productive with a 14-day free trial.

Variance analysis can be applied to other metrics, including:

A related metric is also the cost performance index in project management, which evaluates project efficiency.

In short, a project manager needs to understand and manage cost variance regularly to get control over the project’s financial health and ensure a positive outcome.

By calculating different variances—point-in-time, cumulative cost variance, and variance at completion—you can take proactive measures to prevent budget overruns and ensure profitability.

Tools like Productive simplify this process by providing real-time insights into your project cost management, from budgeting to profitability analysis.

By leveraging Productive’s comprehensive features, including resource planning and cost tracking, you can enhance your decision-making, optimize resource utilization, and ultimately deliver successful projects within budget.

Book a demo with Productive to start optimizing your cost performance today.