Cost Variance

Cost Variance (CV) is an Earned Value Management metric that measures the difference between the budgeted value of work accomplished (Earned Value) and the actual cost incurred to accomplish that work, indicating whether a contract is being performed within budget or at a cost overrun.

What is Cost Variance?

Cost Variance is calculated as CV = EV minus AC (Earned Value minus Actual Cost). A positive CV means the work accomplished cost less than budgeted, the contractor is performing efficiently under budget. A negative CV means the work accomplished cost more than budgeted, the contractor is experiencing a cost overrun relative to the value delivered.

The Cost Performance Index (CPI = EV/AC) is the ratio equivalent of cost variance. A CPI of 1.0 means costs are exactly as planned; below 1.0 means over budget; above 1.0 means under budget. The CPI is particularly powerful as a forecast tool: research from DoD program histories shows that the CPI established in the first 15-20% of a contract rarely improves by more than 10%, making the early CPI a reliable predictor of final cost performance.

Cost variance feeds directly into the Estimate at Completion (EAC) calculation. The most common EAC formula, EAC = Budget at Completion / CPI, uses the cumulative CPI to project the final contract cost. If the current CV and CPI indicate a cost overrun, the EAC will project an overrun, which the contractor must explain and address in variance analysis reports submitted to the government.

Why cost variance matters for government contractors

Significant negative cost variance on a government contract triggers variance analysis requirements, government scrutiny, and potential contract action. On cost-type contracts, cost overruns beyond the funded ceiling create receivable exposure. On fixed-price contracts, cost overruns reduce profit. Both situations require proactive management, the contractor must understand why costs are over plan and demonstrate a credible path to recovery.

Example

A federal services contractor reports EVM data for a $15M task order. At month 8, the cumulative Earned Value is $7.2M and the Actual Cost is $8.5M. The Cost Variance is -$1.3M (8.7% of total contract value). The CPI is 0.847. The EAC formula (BAC/CPI) projects a final cost of $17.7M, a $2.7M overrun above the $15M ceiling. The contractor's program manager submits a variance analysis report explaining the root cause (a labor underestimate in the testing phase) and a corrective action plan that reallocates work to less expensive labor categories.

Frequently Asked Questions

How is cost variance different from a contract overrun?

Cost variance is an EVM metric measuring efficiency, cost per unit of work accomplished. A contract overrun occurs when the actual cost of completing the full scope exceeds the contract ceiling. These are related but distinct concepts. A contractor can have a negative cost variance (cost inefficiency) that, if uncorrected, will produce a contract overrun, or can have a positive cost variance early in the contract that reverses as harder work is encountered.

What is variance analysis and when is it required?

Variance analysis is the contractor's written explanation of significant cost and schedule variances, their root causes, the corrective actions being taken, and the expected trend going forward. Most government EVM contracts require variance analysis narratives for any variance exceeding a defined threshold (e.g., 10% of the total budget or $1M, whichever is less).

Does a positive cost variance mean the contractor is definitely under budget at completion?

Not necessarily. A positive CPI early in a program may reflect easy early work being accomplished cheaply, while harder, more expensive work is still ahead. Program managers should assess whether the positive variance is sustainable or likely to reverse as technical risk activities are encountered.

How does cost variance relate to contract fee on cost-plus contracts?

On cost-plus-fixed-fee (CPFF) contracts, the contractor earns the fixed fee regardless of cost performance. On cost-plus-incentive-fee (CPIF) or cost-plus-award-fee (CPAF) contracts, significant negative cost variance can reduce the fee earned. CPIF contracts typically have a sharing formula where the contractor and government share cost overruns, making cost performance directly tied to contractor profitability.