What is cost variation?

 

From changes in scope of work to omissions and additions, variations are a common occurrence in the building and construction industry. 

When you have so many moving parts and variations to manage, it can be easy to find yourself in a sticky budget situation at a project’s end. By understanding what causes variations in project costs, you can more effectively manage your project and its profitability.

In this article, we’ll explore cost variation, negative versus positive variations, and how to leverage these insights to avoid project blowouts.

 

What is cost variation?

Cost variation is the difference between your budget and actual spending, helping you track your budgeted cost of work performed (BCWP) versus your project’s actual cost of work performed (ACWP). While it’s used heavily in building and construction projects, it’s used by project managers across many industries.

It can be used not only to track differences in specific areas or line items but also the project’s overall financial performance. Some project managers might also refer to BCWP as earned and ACWP as actual cost, however, they are used and calculated in the same way.

Cost variations can be calculated for a number of project costs, including:

• Labour and contractor costs
• Fixed or variable overhead spending
• Material costs
• Point in time variations

 

How cost variation is calculated

Cost variation is calculated by subtracting the actual cost of performed work against the budgeted cost:

Budgeted Cost of Work Performed (BCWP) – Actual Cost of Work Performed (ACWP)
= Cost variation

Depending on how you’d like to report the information, it can also be calculated as a percentage:

(BCWP – ACWP) / BCWP = Cost Variance %

Cost variation analysis is regularly used by our business advisors to help our building and construction clients get a better understanding and track their project budget and spending. When used throughout the project lifecycle, it can bring powerful cost-effective insights to projects in any industry.

 

Why is cost variance important?

Cost variation analysis can be a key insight into the financial viability of your project. It also helps you assess if you have enough money budgeted to complete the project.

By tracking your cost variation through its lifetime and at specific milestones, you can assess and make proactive changes to spending before it becomes an issue.

For building and construction projects, cost variation can help you understand:

• Potential project risks
• Areas where over/under spending is more likely to occur
• Whether project and labour tracking processes are effective
• How much funding you need to set aside to complete the project
• Improve projections and how you estimate project costs for future projects
• Strategies to better manage external price and cost fluctuations
• Financial progression and overall project performance

 

Negative vs positive cost variations

When it comes to cost variations, they can be negative, positive or zero. Each outcome provides valuable insight into the health of our project budget.

While it might seem a positive cost variation should be the aim, you want to come out as close to zero as possible.

Cost variation type	Definition	What it tells us
Positive cost variation	Your actual spend is less than your budgeted amount.	You have underspent and are below budget.   This can indicate: Effective processes reducing costs Unsuccessful or missed activities Over estimation during your budget process
Negative cost variation	Your actual spend is more than your budgeted amount.	You have overspent and are above budget.   This can indicate: Incorrect assumptions made during your budget process Fluctuations in pricing, materials or other external factors Inefficient in your processes or production schedule You may not have enough money to complete your project
Zero cost variation	Your actual and budget amounts are equal.	You are aligned and on track with your budget.   This can indicate: New strategies are working Assumptions and estimation processes are accurate Your project is running efficiently and will meet cost projections

 

Cost variations can change throughout your project and be impacted by many internal and external factors.

This is why our business advisors work through this analysis regularly with building and construction clients, making sure they are working ahead of variations and have time to implement strategies to get back on track.

 

Cost variation in action: How using cost variation can help you avoid project blowouts

Mini case study

The most beneficial part of cost variance analysis is it can play an important role in budget management, allowing you to understand variations against your budget at any stage of the project.

For example, Jake has a 12-month construction project and a budget of $100,000. Six months into the project, he’s spent $60,000 but only 40% of the project is complete. 

Applying the cost variation formula, we can not only assess how Jake is tracking against his budget but forecast if he will meet the overall budget at the end of the project.

Here, the Budgeted Cost of Work Performed is 40% of Jake’s overall budget. 

[Budgeted Cost of Work Performed (BCWP)] x [% of project completed so far]
= BCWP at 40% project completion

100,000 x 40% = $40,000

This will tell us how much of his overall budget at 40% completion.

Taking this one step further, we can now apply this to his actual spending at this stage of the project and work out the project’s current cost variation

[Budgeted Cost of Work Performed (BCWP) at 40% completion] – [Actual Cost of Work Performed (ACWP) at 40% completion]
>= Cost variation

$40,000 – $60,000
= $20,000 over budget

This shows us at this stage of the project, Jake is already $20,000 over budget.

While this isn’t an ideal situation to find yourself in, working with your business advisor you now have the opportunity to put cost reduction strategies in place and reduce any further impacts. This could be:

• Negotiating cheaper prices for upcoming materials
• Looking for price discount, rebate or promotion opportunities
• Reviewing your estimates for later parts of the project and testing pricing assumptions
• Putting strategies in place to maximise margins where possible
• Improving your financial controls
• Reviewing your WIP reporting process

This also unlocks opportunities to put processes and strategies in place during the scope of work and estimate stages of the project to avoid price fluctuation impacts in the future.

Working alongside our business advisory team, we can leverage cost variation analysis to undercover tailored strategies specific to your project and business model.