In my previous blogs, I describe the framework around how to manage a project, the process groups and we started with the first two knowledge areas Scope & Schedule. I now continue with the third knowledge area - Cost.
Cost is the third side of the “Iron Triangle” – the other two being Scope and Schedule which we have previously covered. You change any one these and you will have to alter another. Therefore, whilst you are focusing to control what you do and when you do it, you don’t want to lose focus on how much this is going to cost. After all, a project that did exactly what the customer wanted and arrived on the date they wanted yet cost the company a small fortune is not going to be viewed as a success!
Finding out at the end of the project (or even halfway through) that we’ve blown the project budget is going to be too late. Therefore, we need some mechanism of tracking how much we’ve spent and comparing that against the budget. This can be achieved using Earned Value Management (EVM). EVM introduces several tracking indices which are calculatable from the project plan, easily explainable to management and thus can be used to report clearly whether you are behind/ahead of schedule and under/over budget.
In describing the usage of EVM, I need to define 4 terms:
- Planned Value (PV) – This is an estimate of the effort you planned to have completed at this stage of the project
- Earned Value (EV) – This is an estimate of the effort you have completed
- Actual Cost (AC) – This is how much you have spent so far
- Budget at Completion (BAC) – The total budget of the project
Let’s consider an example:
Suppose you want to build a wall consisting of 1000 bricks. Each brick costs £1 and we estimate it will take 10 minutes to lay. The brick-layer is employed at £10 an hour. We pay for each brick as we use them, after all they are just inventory and if the project was cancelled they could be returned to the supplier. At a quarter of the way through the project we perform a checkpoint and discover that we have laid 200 bricks:
- Planned Value = At the quarter mark we should have laid 250 bricks, 6 per hour. Therefore, PV = £250 (bricks) + 250 / 6 x £10 (labour) = £666
- Earned Value = But we’ve only laid 200 bricks. Therefore, EV = £200 (bricks) + 200 / 6 x £10 (labour) = £533
- Actual Costs = We’ve paid for the bricks and the work so far. Therefore, AC = £200 (bricks) + 250 / 6 x £10 (labour) = £616
- Budget At Completion = Total cost of materials and labour. Therefore, BAC = £1000 (bricks) + 1000 / 6 * £10 (labour) = £2666
From these, we can calculate some indices that can be shown to management for them to see how good (or badly) we are doing:
- Schedule Performance Index (SPI) = EV / PV (=1 on track, <1 behind-schedule, >1 ahead-of-schedule)
- Cost Performance Index (CPI) = EV / AC (=1 on budget, <1 over-budget, >1 under-budget)
In our example, we have SPI = 533 / 666 = 0.8 and CPI = 533 / 616 = 0.86. Unless something changes with our brickies performance we are going to over-run and the iron triangle tells us that unless we change the scope of the work that is going to cost us some money! But how much? We can calculate this, called the Estimate At Completion (EAC), depending on what we want to do:
- The brick-layer just had a bad week and will be back to normal performance from now on. We have a one-off budgetary problem and EAC = BAC + (AC – EV) = £2749
- We’ve mis-estimated the work-rate and so the current performance will be the norm. EAC = BAC / CPI = £3100
- We must meet the budget and thus should re-hire a brickie that can work to the required rate. The CPI needed is calculated by (BAC – EV) / (BAC – AC) = 1.04 or one brick needs to be laid every 9 minutes.
We thus have the required information to present to management and make the right decision. Of course, this is a simple example with a single resource and a single material cost. Real projects will have hundreds but fortunately there are tools that will track the cost expenditure and do the calculations automatically.
When the cost of a more complicated project is tracked against time it is usually apparent that most of the budget is spent in the middle of the project i.e. projects ramp up and ramp down. The middle of the project is where all the work is done, and this is also the best time to affect the outcome of a project. It’s not too early that you’ll waste effort because you don’t know the situation and it’s not too late the mitigations will have limited effects.
Project Expenditure [PMI PMBOK 5th Edition]
This is a brief insight into using EVM for managing Cost. With this you should generate some confidence (and your boss’s) that you can complete the project to budget. In the next blog, I will continue our examination of the knowledge areas with the Quality knowledge area.
Andrew Miles PMP
Andrew Miles is a physical implementation engineer turned project manager. He is PMP certified and has led many projects for a number of tier one companies. He helps to run the Sondrel Project Management Office (PMO). If you'd like to know how Sondrel's project managers can help your project then please contact email@example.com