Project managers spin lots of plates, but if you had to sum up their job in three words, it’d be these: time, cost, scope. Together, they make up what’s known as ‘the triple constraint,’ and they’re all tightly bound together. If a project runs over budget or behind schedule, it eats into profits and jeopardizes completion. If it runs under budget or is completed way ahead of schedule, it could look like corners were cut and threaten future grants.
Being able to keep an iron grip on cost is a must. If a project manager isn’t able to do that, their competency comes under question. Luckily, there are lots of tools and techniques out there to help busy PMs keep budget in sight.
Of those, a cost variance analysis is perhaps the most vital. Not only does this process play a crucial role in determining project budgets and guiding resource decisions, but it’s also part of the Project Manager Professional (PMP)® certification exam… so if you plan on taking that, you’ll need to know the formulas.
Whether you’re studying for a test or brushing up on your project management skills, this article will guide you through cost variance, variance analysis, and budgeting. Let’s start!
What is a budget?
We all know what a budget is, right? When it comes to project management, things get a little more complicated.
A budget means the money assigned to a particular task or project. The budget is assigned, and in an ideal world, the project is delivered by a certain time, as expected. Product budgeting is the process of working out how the team spends the money.
Here are some budgeting terms you need to know in project management.
- Master budget: This is the overall budget. It comprises all the lower-level budgets added up. It usually spans one fiscal year.
- Flexible budget: This is a budget with a range that can be flexed depending on what’s going on in the company and the project. It lets project managers predict results while taking different circumstances into account.
- Fixed budget: This is exactly what it sounds like: a budget with no flex. This helps keep managers financially responsible and is used for providing accurate results.
- Continuous budgeting: This is a rolling budget, where each prediction is based on the prior and current budget periods.
- Incremental budgeting: This involves the PM taking the current budget or actual performance as a starting point, then adding small amounts on top for the new period.
Now you know the different types of budget terms and what they mean, let’s dive into the cost and project variance formulas that help you manage those budgets. First, a quick summary of three essentials: Earned Value, Actual Cost, and Planned Value.
What is Actual Cost (AC)?
Actual cost is the total cost incurred in completing tasks so far. To use a real-world example — say you’re building a house, and the project has cost $2,000 for each of the first four months. The actual cost of work is $2,000 x 4, which = $8,000. This is your AC figure.
What is Planned Value (PV)?
PV (also referred to as Budgeted Cost of Work Scheduled (BCWS)) refers to the budget for all scheduled costs, including labor, materials, rent, and overheads. It’s a figure that shows you how much budget should have been spent by a particular time. As time goes on, this number increases incrementally. With that time, you can create an incremental budget for each new time period. Here’s the formula:
Planned Value = (Planned % completed work) X (Budget At Completion)
How to calculate Earned Value (EV) in project management
Earned Value Management shows you whether you’re on schedule, behind, or over budget. You can calculate it by multiplying the percentage of complete work by the master budget. For example, say you’re 50% done, and your master budget is $500,000, then your EV is $250,000. Easy!
EV is best used in tandem with cost and schedule variance analysis — which we’ll go into a little more detail below.
What is Cost Variance (CV) in project management?
CV is the difference between Actual Cost (AC) and budgeted cost. Or, to put it another way, what you thought you’d spend vs. what you actually did.
You can figure out the cost variance via a simple cost variance analysis formula:
Cost Variance (CV) = Earned Value (EV) – Actual Cost (AC)
To work this out as a percentage, the formula is as follows:
CV % = Cost Variance (CV) / Earned Value (EV)
If you have a CV of 0, you’re on budget. If you have a negative CV, you’re over budget, and a positive answer tells you you’re under.
Here’s a real-world example: Imagine you’re building your dream house. You’ve got 12 months to do it, and the budget is $500,000. After six months, you’ve spent $250,000, and 50% of the work is complete. To find out the CV, you need to do the following sum:
AC = $250,000
EV = 50% of $500,000 = $250,000
CV = EV – AC … or $250,000 – $250,000
So the CV = *drum roll* … Zero! Congratulations, you are dead on target.
These formulas will come up in PMP certification exams, so it’s a good idea to memorize both the formulas themselves and the concepts behind them.
What is Schedule Variance (SV)?
SV is the difference between your progress estimates and actual progress. The calculation for this is as follows:
Earned Value (EV) – Planned Value (PV)
To use a real-world example: Imagine you’re building a house, and it’s due to take 10 months. You’re 5 months in, but only 10% complete. Your EV = 1 month (10% of 10 months) and your PV = 5 months. Your SV is therefore 1 – 5, which equals -4.
Because it’s a negative number, you can see right away that you’re behind schedule and need to take steps to get things back on track. This is all the more important if your budget is fixed as opposed to flexible.
How do you calculate Schedule Performance Index (SPI)?
SPI is a handy formula to know because it turns progress into numbers that are comparable across tasks. With this, you can make an accurate prediction about where your project will end up. Here’s the formula:
SPI = Earned Value / Planned Value.
If your number is above 1, you’re ahead of schedule. If it’s 0 and below, you’re behind. Calculating your SPI can show your progress per task and for the entire project. For example, if you work out the SPI per task then compare it to the overall progress, you’ll be able to see (for example) that you’re on schedule despite two tasks being behind. With SPI, you can get a better understanding of how these tasks impact the wider project.
How do you calculate Cost Performance Index (CPI)?
CPI is another formula for helping you drill down into the numbers so project managers can have an even clearer view of what’s going on and where the project’s headed. Here’s the formula:
CPI = EV/AC
If your result is over 1, you’re under budget. Anything below that, and you’ll need to take steps to make sure you get back on track. CPI is helpful for forecasting, too — you can use it to work out your Estimate at Completion (EAC) figure. Here’s the formula for this:
EAC = Total budget / CPI.
If your result is bigger than your budget, it means that if you carry on as you are, you’ll overspend by the difference.
Cost management is a vital part of the triple constraint triangle, and therefore a key part of your project’s health. Knowing these formulas inside out and understanding how they can help you will help keep projects running efficiently. It also means that if you have to answer to stakeholders or negotiate budget terms, you’ll have detailed information to support your case.
Using project management software will give you the biggest chance of success when it comes to cost management. Not only does it help you track expenditure in real-time — but it’s also handy for visualizing cost and schedule estimates. You can also compare them to actual costs thanks to automatically-generated diagrams. No need for spreadsheets or manual calculations because the software does all the heavy lifting for you.