What Is a Cumulative Cost Curve?
Cost analysis allows businesses to determine the actual and anticipated costs of a project. Cumulative cost curves provide business owners with a visual representation of cumulative costs and benefits, allowing them to determine when they break even on a project and how project estimates compare to expenditures. Analysis of these graphs can prevent cost overruns, resulting in a higher return on capital investments.
Cumulative cost curves allow businesses to compare the estimated and actual costs of projects and estimated payoffs and actual payoffs, which allows them to modify projects to meet estimates. For example, a business owner who invests in new machinery will notice when the line of actual costs rises substantially above estimated costs, allowing him to go through current expenditures and determine why costs are rising higher than expected. Business owners can identify projects that do not meet estimated benefits and modify or scrap them.
Cumulative cost curves take graph form with the horizontal axis labeled “time” and the vertical axis labeled as “dollars." A graph of a cost curve includes lines representing the estimated budget upon completion of the project and the actual costs of the project. The other two lines show the estimated payoff of a project and the actual payoff. All of these lines usually take an “s” shape, because the initial growth in costs and payoffs starts off small, grows exponentially and then tapers off.
Businesses will usually draw estimated cost and payoff lines on their cumulative cost curves before they implement projects, but they may update these lines on a monthly basis if they have to modify their projects due to incorrect estimates. While the time frame at which they add each new value depends on the length of the project and how closely they monitor it, business owners should update their curves on at least a weekly basis.
Businesses will have to mark a data point each time they calculate actual costs and payoffs. They will determine the point on the horizontal value by the time frame they are on, while they will determine the vertical value by adding up the previous time frame’s total costs and benefits to the current time periods totals. After marking the data point, they can use computer graphing software to draw curves.
A cumulative cost curve becomes smoother and easier to read the more frequently a business takes values, because variances, such as an unexpected rise in expenses over a few days, can cause fluctuations in data points. Variance can cause managers to erroneously believe a project is under or over budget. Variance impacts a cost curve predominately at the starting stages of a project, so management should mark data points more frequently when starting a project.