One of the most important area in project management is Cost. Project Managers are responsible to identify and manage the budget of the project and its costs.
One of the main techniques to monitor and control costs in a project is the ‘Earned Value Management'.
I will try, in this post to explain some concepts related to this tecnique (EVM).
The actual cost of the project is the sum of the collection of:
- amount charged on invoices from vendors and consultants
- the ‘money’ amount assigned to the team members’ hour or the tasks the are completing.
A commited cost is the amount of money approved and assigned to a portion, or the entirety, of a project.
The comparison of the actual and commited cost should reflect on the cumulative budget cost for the entire project.
The key to controlling finances within your project is to safeguard your budget and react to cost variances as soon the appear. When cost variances happen (and sooner or later they will), you will need a plan to analyze the costs and see what offsets may be made to control the total actual costs for the project.
Earned Value (EV) is an excellent system to test, in an ongoing process, if the work completed on a project is in allignment with the budgeted costs of a project. Earned Value is a measure for project performance.
Earned Value Management (EVM) has a few fundamental values:
- Budget at Completion (BAC). The amount of money budgeted for your project prior to the start of the project implementation phase. This is the expected cost of the project.
- Planned Value (PV). It is how much the project should cost to get to a specific point in the schedule. Planned Value used to be known as the Budgeted Cost of Work Schedule (BCWS). For example, if a project has a budget of 100.000€ and month six represents 50% of the project work, the PV for month six is 50.000€.
- Earned Value (EV). It is representative of the work completed to date regardless how long it took to accomplish it. Earned Value used to be known as the Budgeted Cost of Work Performed (BCWP). The value of the work performed (Earned value i a ‘money’ amount assigned to the value of the work performed by the project team or vendors). The percentage of the work completed allows the project manager to compute the amount of the Earned Value for the work unit. For example, it a project has a budget of 100.000€ and the work completed to date represents 25% of the entire work, its EV is 25.000€.
- Actual Costs (AC). The amount of money actually incurred by the project to date. Actual Costs is the actual cost of monies the project has required to date. For example, if a project has a budget of 100.000€ and 35.000€ has been on the project to date, the AC of the project would be 35.000€.
- Cost Variance (CV). The difference in the amount of budgeted expense and the actual expense. A Cost Variance occurs when the actual cost of the project is different than the EV. For example, your EV is calculated to be 25.000€, but you had to spend 35.000€ to get there.
- Schedule Variance (SV). A Schedule Variance occurs when the EV is less than the PV. For example, the project is supposed to be worth 75.000€ in month six; however, at month six your EV is only 45.000€. You’ve got a whopping SV of 30.000 €.
Earned Value (EV) can be calculated a few different ways, but the most accessible formula is simple “EV=% of work complete over BAC”. For example, if the project’s BAC is 200.000€ and the work is 10% complete, the EV is 20.000€.
The primary benefit of predicting Earned Value is than project manager can predict if the project is going to be in finantial trouble early on the implementation phase.
To apply the formula, project manager needs to first have completed all the planning stages. The project manager must have the WBS completed with accurate predictions fo the amount of time required for each of the work packages.
Le't’s take an example:
“We have a project that has a budget of 250.000 €. The project is 15% complete, but it should be 20% complete by this point in the calendar and, in addition, the project manager has had to spend 43.000 € of his budget just to get to this point in the project.
Let’s calculate the different values:
- Budget at Completion (BAC): 250.000 €
- Actual Costs (AC): 43.000 €
- Earned Value (EV): 37.500 € (15% of 250.000 €)
- Planned Value (PV): 50.000 € (20% of 250.000 €)
- Cost Variance (CV): AC – EV = 43.000 – 37.500 = 5.500 €
- Schedule Variance (SV): PV – EV = 50.000 – 37.500 = 12.500 €
At last, we have two other indicators (Cost Perfomance Index and Scheduled Perfomance Index) that we can use in order to predict the result of the project.
- The Cost Performance Index (CPI) is a reflection of the amount of actual cumulative dollars spent on a project’s work and how close that value is to the predicted budgeted amount. To compute the CPI, we divide EV by AC. CPI = EV / AC.
- The Scheduled Performance Index (SPI) is a formula to calculate the ratio of the actual work performed versus the work planned. The SPI is an efficiency rating of the work completed over a given amount of time. SPI = EV / PV
- A project has a budget at completion (BAC) of 209.300€, amnd to date the project has spent 34.500€ on Actual Costs (AC). Based on the percentage of the completed project, which is 15%, the EV is 31.395€. The Planned Value (PV), however, is 36.000€. The project also has a Cost Variance of 3.105€.
So, the Cost Perfomance Index (CPI) is EV/AC = 31.395/34.500 = 0,91, which means the project is 9% off the target rate of spending for this stage in the project.
- If the EV is 18.887€ and PV is 20.875€, the SPI (Scheduled Performance Index) is 0.90 (EV/PV) which is less than one, so this project is not on schedule
To predict how much harder you and your project team will need to work to finish the project on time and on schedule, you’ll need to calculate the TCPI (To-Complet Performance Index). If this index is greater than 1, you’ll have to buckle down and work harder. If the result is 1 or less you can make it on your current schedule.
The formula is TCPI = Budget – Earned Value (EV) / EAC – AC, where EAC is Estimated Cost at Completion
Let’s do an example:
- Let’s assume the BAC of our project is 75.000€ and EV is 5.000€. The Estimated Cost at Completion is 75.000€ and the AC is 7.500€. The TCPI is (75.000-5000)/(75.000-7500) = 103.7%. It means that the project team will have to work 3.7% harder than originally planned to finish on time and on budget.
I know it is hard to understand the first time, but it is easy when you realize the meaning of echa index and value.