The Earned Value Method

Everybody has heard of a project whose cost spiralled out of control.  Even big megaprojects where the difference measures in the billions are not immune to cost pressures.  In fact, they are even more likely to go over budget.

What is the official project management methodology for controlling project costs? 

To answer this question, we consult the Project Management Institute’s (PMI) Project Management Body of Knowledge’s (PMBOK). The Control Costs process is defined as follows:

To do this, the PMBOK utilizes the Earned Value Method.  But before dive into that, this method requires a proper project setup.

Project Setup

Before the earned value method can be executed, several prerequisite building blocks need to be in place.  Firstly, the project needs to be divided into tasks, called a Work Breakdown Structure (WBS).  Each task is assigned an estimate, which includes a contingency for “known unknowns.”

The task estimates are rolled up into an overall project estimate and a second contingency, called a Management Reserve, is added to the overall estimate account for “unknown unknowns.”

Finally, the overall estimate is combined with the schedule to determine the expenditure of funds over time, called the cost baseline.

The physical manifestation of all of this can be summarized in a table, for example:

Task	Start Date	End Date	Budget
Task A	Jan. 1	Jan. 10	$5,000
Task B	Jan. 5	Jan. 20	$10,000
TOTAL			$15,000

This cost baseline is what progress will be measured against.

The Earned Value Method

Project control takes place against the cost baseline using a technique called Earned Value.  In this technique, several variables are determined from actual progress on the project tasks, and several more variables are calculated from them, and reported.

Inputs

There are three inputs to the Earned Value method.  Each of these variables must be obtained from each task’s actual progress:

• Planned Value (PV) is the planned expenditure of funds to the date of analysis, taken from the project schedule.  For example, if a task is anticipated to last from January 1 to January 10 and today is January 5, PV = 50% of task budget. 
• Earned Value (EV) is the actual progress of the task to the date of analysis.  This is expressed as the percentage of the total effort and/or resources expended, and could be measured in units completed (such as number of fence posts driven or number of holes dug), or hours of labor expended.  For example, if the same task above is 40% complete, EV = 40% of task budget.
• Actual Cost (AC) is the actual expenditure of funds to the date of analysis.  This is usually tracked via software or manually with receipts, etc.

Calculations

The calculations are relatively simple and should not scare anyone away.  In order to report on project progress, there are four variables which tell the project manager about the health of the project.

• Cost Variance.  The amount that the project is above or below budget at the point of analysis.
  CV = EV – AC
• Cost Performance Index.  The amount that the project is above or below budget, relative to the overall size of the project.
  CPI = EV / AC
• Schedule Variance.  The amount that the project is ahead or behind schedule at the point of analysis.
  SV = EV – PV
• Schedule Performance Index.  The amount that the project is ahead or behind schedule relative to the overall size of the project.
  SPI = EV / PV

Analysis

Calculations are always fun, but what do they mean?

• A positive CV means the project is under budget (positive = good).  Negative means over budget.  The CPI tells you how much above or below the budget it is, in percentage terms, for example, CPI = 1.25 means the project is 25% below budget.
• A positive SV means the project is ahead of schedule (again, positive = good).  Negative means behind schedule.  The SPI tells you how much ahead or behind schedule the project is, in percentage terms, for example, SPI = 0.9 means the project is 10% behind schedule.

Forecasting

The above variables tell you where the project is right now (or at the point of analysis), and can be very useful for decision making.  But what if you wanted to see where the project was trending?  That’s where the following three metrics come in.

• Estimate at Completion (EAC).  This is the estimated final cost of the project.  There are several ways to calculate this, based on the assumptions that are made.
  • If past project performance is expected to continue:
    EAC = BAC / CPI
  • If past project performance is considered one-time, and future performance will revert back to the planned rate:
    EAC = AC + BAC – EV
  • If the cost and schedule performance both factor into the future performance (the previous formulas used only the cost performance):
    EAC = AC + [(BAC – EV)/(CPI x SPI)]
  • When something unexpected has arisen and you need to throw out the original estimate and produce a new one.  In this case, start with the AC already spent:
    EAC = AC + New Bottom Up ETC
• Estimate to Complete (ETC):  This represents the amount left to spend to complete the project.  It’s the amount of money that needs to be “in the bank” to complete the project.
  ETC = EAC – AC
• To Complete Performance Index (TCPI):  This value tells you how efficient you need to be to complete the project according to the original plan.  For example, if you were inefficient at CPI = 0.9 throughout the first quarter of the project, a TCPI = 1.03 means you have to pick it up and be 3% more efficient than the original plan to finish on target.
  • In order to finish on the original budget:
    TCPI = (BAC – EV) / (BAC – AC)
  • In order to finish on the revised budget if current project performance continues:
    TCPI = (BAC – EV) / (EAC – AC)

These forecasts could be used to update financial metrics such as Net Present Value (NPV), payback period, or Return on Investment (ROI) which were used to justify the project.

Project Changes

Inevitably, the earned value analysis results in project changes.  In fact, the big advantage of the method is the early warning sign that corrective actions need to be taken.  These actions could be schedule changes, budget increase requests, or reductions in project scope to get back on track.

Normally, each task should have a contingency, and the overall project should have a management reserve.  These amounts, if available, can be tapped into to avoid major project changes.

When changes need to be made, the PMBOK’s Perform Integrated Change Control process is invoked.  This includes making changes to the project management plan and getting them approved.  It also includes updating the risk register, because project schedule and budget changes will almost always add or remove risks.  Additionally, any assumptions and lessons learned should be recorded in the project management plan.

Reporting

Management likes to see reports.  On a regular basis, the earned value variables should be summarized in a standard progress report and presented to stakeholders.  The data format could look like this:

Task	Start Date	End Date	BAC	PV	EV	AC	CV	CPI	SV	SPI	EAC	ETC	TCPI
Task A	Jan. 1	Jan. 10	$5,000
Task B	Jan. 5	Jan. 20	$10,000
TOTAL			$15,000

This table is written in project manager language, but project stakeholders could be kept informed with a commentary.  Most stakeholders would be impressed with a commentary similar to this:

• “Although the project has been 10% less efficient than planned, we have taken steps to ensure that a 5% efficiency rate is maintainable throughout the rest of the project, allowing us finish on budget.”

Additionally, the contingency and management reserves can be removed as the project goes on and risk goes down, freeing up additional budget space.

Risk Register

The project risk register, which is the list of important risks to the project’s success, is a critical reference tool during the budget and cost control process.  Almost all risks have a budget impact.  Therefore, the cost control process is effectively a risk re-analysis process, providing an up to date status as to what risks are occurring, or not occurring.

The earned value management process provides a laser sharp, up to date project budget status, which is an early warning signal for project risks beginning to manifest themselves.

Hence, the risk register should be re-inspected and updated during the earned value analysis procedure.