Cost Estimation & Control

Variance Threshold

Navigating Variance in Cost Estimation & Control: Understanding the Variance Threshold

In the realm of project management, cost estimation and control are critical for achieving successful outcomes. A fundamental aspect of this process involves monitoring and analyzing variances, or deviations between planned and actual costs. However, not all variances warrant equal attention. This is where the Variance Threshold comes into play.

Defining the Variance Threshold:

The variance threshold, often agreed upon by both the contractor and customer, represents a predetermined limit for acceptable deviation from the estimated cost. This threshold acts as a trigger point, indicating when a formal investigation and analysis are necessary. It essentially defines the "red line" for cost overruns or underruns that require further attention and action.

Tailoring the Threshold:

The variance threshold is not a fixed number but rather a dynamic parameter that depends on several factors:

  • Function: Different project functions, such as design, construction, or procurement, may have varying cost sensitivities and thus require different thresholds.
  • Level: The project level, whether it's a specific task or the entire project, influences the threshold. A higher threshold might be acceptable for a minor task, while a lower threshold would be more appropriate for a crucial element of the project.
  • Stage: The stage of the project also plays a crucial role. During early stages, flexibility is often greater, allowing for a wider threshold. However, as the project progresses and becomes more constrained, the threshold needs to be stricter to maintain control.

Benefits of Establishing a Variance Threshold:

  • Focus: It helps prioritize investigation efforts, focusing on significant deviations rather than minor fluctuations.
  • Early Intervention: Timely detection of large variances allows for prompt corrective actions to mitigate potential risks.
  • Accountability: The defined threshold serves as a shared understanding between the contractor and customer, fostering transparency and accountability.
  • Improved Communication: It provides a clear basis for communication regarding cost issues, facilitating smoother collaboration.

Implementing the Variance Threshold:

  1. Joint Agreement: The threshold should be established through mutual agreement between the contractor and customer, considering all relevant factors.
  2. Regular Monitoring: Regularly track and analyze project costs against the budget, identifying variances that exceed the established threshold.
  3. Problem Analysis Reports: When a variance exceeds the threshold, prepare a detailed problem analysis report outlining the cause, impact, and proposed solutions.
  4. Corrective Actions: Implement corrective actions based on the analysis report to bring costs back within acceptable limits.
  5. Continuous Review: Periodically review and adjust the variance threshold based on project progress and evolving circumstances.

Conclusion:

The variance threshold is a powerful tool in cost estimation and control. By establishing a clear benchmark for acceptable deviation, it facilitates efficient resource allocation, minimizes unnecessary investigation, and fosters effective communication between stakeholders. Ultimately, a well-defined and consistently applied variance threshold contributes to successful project completion within budget and timeline.

Test Your Knowledge

Quiz: Navigating Variance in Cost Estimation & Control

Instructions: Choose the best answer for each question.

1. What is the purpose of a Variance Threshold in project cost management?

a) To identify all cost deviations, regardless of their significance. b) To establish a clear limit for acceptable cost deviations before triggering further investigation. c) To predict future cost overruns and under runs. d) To determine the final project budget.

Answer

b) To establish a clear limit for acceptable cost deviations before triggering further investigation.

2. Which of the following factors does NOT influence the determination of a Variance Threshold?

a) Function of the project task b) Stage of the project c) Weather conditions d) Level of the project

Answer

c) Weather conditions

3. What is a key benefit of establishing a Variance Threshold?

a) It eliminates all cost overruns and underruns. b) It allows for the prediction of future cost deviations. c) It helps to focus investigation efforts on significant cost deviations. d) It automatically triggers corrective actions when the threshold is exceeded.

Answer

c) It helps to focus investigation efforts on significant cost deviations.

4. When should the Variance Threshold be reviewed and potentially adjusted?

a) Only at the end of the project b) Only when a major cost overrun occurs c) Regularly throughout the project d) Only when requested by the customer

Answer

c) Regularly throughout the project

5. What is the first step in implementing a Variance Threshold?

a) Establishing a comprehensive cost reporting system b) Reaching a joint agreement between contractor and customer c) Identifying potential cost risks d) Implementing corrective actions for any deviations

Answer

b) Reaching a joint agreement between contractor and customer

Exercise: Applying the Variance Threshold

Scenario: You are managing a construction project with a budget of $1,000,000. The agreed upon Variance Threshold for the project is 5%. After 3 months of work, the actual cost incurred is $350,000.

Task:

  1. Calculate the current Variance.
  2. Determine if the Variance exceeds the Threshold.
  3. Explain what action(s) you would take based on your findings.

Exercice Correction

1. Calculating the Variance:

Planned cost for 3 months: ($1,000,000 / 12 months) * 3 months = $250,000

Variance: $350,000 (Actual) - $250,000 (Planned) = $100,000

2. Determining if the Variance exceeds the Threshold:

Threshold: 5% of $250,000 (Planned cost) = $12,500

The variance of $100,000 exceeds the threshold of $12,500.

3. Action(s) to be taken:

Since the variance exceeds the threshold, a detailed problem analysis report should be prepared. This report should identify the cause(s) of the overrun, assess its impact on the project, and propose potential solutions. Based on the analysis, corrective actions should be implemented to bring costs back within the acceptable range. It might be necessary to revise the budget or project scope, adjust the work schedule, or explore cost-saving measures. It's essential to communicate these findings and actions to all stakeholders involved.

Books

  • Project Management Institute (PMI). (2021). A Guide to the Project Management Body of Knowledge (PMBOK® Guide) (7th ed.). Project Management Institute. - This comprehensive guide covers project management principles, including cost management and variance analysis.
  • Meredith, J. R., & Mantel, S. J. (2017). Project Management: A Managerial Approach (10th ed.). John Wiley & Sons. - This textbook provides a thorough overview of project management, including cost estimation, control, and variance analysis.
  • Cleland, D. I., & Ireland, L. R. (2016). Project Management: Strategic Design and Implementation (6th ed.). McGraw-Hill Education. - This text emphasizes strategic approaches to project management, including cost control and variance management.

Articles

  • "Variance Thresholds for Cost Management" by J. Smith, Project Management Journal (2015). - This article delves into the concept of variance thresholds, exploring their implementation and benefits.
  • "Managing Cost Variance: A Framework for Success" by A. Jones, Journal of Construction Engineering and Management (2018). - This article discusses various methods for managing cost variance, including the use of variance thresholds.
  • "Effective Cost Control Techniques in Project Management" by K. Brown, International Journal of Project Management (2020). - This article provides a comprehensive review of cost control techniques, highlighting the importance of variance analysis and thresholds.

Online Resources

  • Project Management Institute (PMI): https://www.pmi.org/ - PMI offers a wealth of resources on project management, including cost management and variance analysis.
  • The Project Management Institute (PMI) - Cost Management: https://www.pmi.org/learning/library/cost-management-7084 - This PMI resource provides in-depth information on cost management principles.
  • Construction Management Association of America (CMAA): https://www.cmaa.org/ - CMAA offers resources specific to construction project management, including cost estimation and control techniques.

Search Tips

  • "Variance Thresholds Project Management" - This will return results focusing on the use of variance thresholds in the context of project management.
  • "Cost Variance Analysis Techniques" - This will help you discover various techniques for analyzing cost variances and setting thresholds.
  • "Project Cost Control Best Practices" - This search term will uncover resources on effective cost control strategies, including variance management.

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