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Introduction to Earned Value Management
Implementing any new process involves cultural change, emotional and financial investment, and acceptance of new ways of doing the familiar. So, why are more and more organizations opting to endure these difficult transitions to implement earned value management? Simply stated, over 30 years of experience demonstrate that earned value management is one of the most effective means available to monitor project cost and schedule performance.
Today's projects operate in an environment of overcommitted resources, demanding stakeholders, and changing technologies. Corporate fiduciary responsibilities are increasing, and CEOs and CFOs must forecast earnings that may be dependent on both their internal projects and customers' projects. The current status of projects, their likely completion date, and their final cost are crucial data items that CEOs and CFOs must possess. Earned value management provides a powerful tool for obtaining these data.
Earned value management is applied toward the end of the project planning effort and is dependent on good project plans. Because it is a way of instrumenting a project for monitoring cost and schedule during project execution and control, it quickly reveals poor project planning or the inability to execute a good plan. During project execution and control, earned value management provides insight into the project's current cost and schedule status, helping the project manager balance the triple constraints of cost, schedule, and requirements.
Three metrics form the basis for earned value management (they are explained in more detail later in this chapter). At any point in the project, these three metrics reveal:
The project work that should have been completed
The work actually completed
The cost of completing that work
It may appear that earned value management adds little to the traditional concepts of project monitoring. Any project manager should know what is to be delivered, what has been delivered, and how much has been spent delivering it. However, the power of earned value management is its ability to shift the point of view from deliverables planned, deliverables completed, and funds spent to the value of work planned, the value of work done, and the funds spent. This transformation to an all-economic basis allows analysis that is otherwise not possible.
To understand the limitations of traditional project metrics, consider the common practice of monitoring projects using a schedule (or a list of met and unmet milestones) and a financial report. The schedule (Figure 1-1) reveals the activities started, completed, underway, early or late in starting, and early or late in being completed. The schedule provides a general sense of current project status by comparing where each activity stands relative to its planned status. However, the schedule does not differentiate between types of activities: some are small efforts and some are large efforts, some are on the critical path and some are not. The schedule may be able to provide a qualitative sense of the project being ahead or behind schedule, but quantifying the schedule condition is difficult or impossible.
You might look at a list of milestones (Figure 1-2) or deliverables and compare the planned completion dates with the current status. Here you have even less information than you did when looking at the schedule. Some milestones were supposed to be met at this point and some milestones have been met. Some milestones may have actual dates different from the planned dates, other milestones may have a best guess completion date different from the planned completion date. Using a list of milestones, you might obtain some qualitative insight into the project's progress, but you don't have enough quantitative information for any depth of analysis.
The project financial report (Figure 1-3) reveals how much of the total project budget has been spent. However, it cannot provide answers to such questions as: "Were the funds spent well?" or "Was any work completed?" Without such information it is impossible to know whether the project budget will ultimately be underrun or overrun. All that is known is that money has been spent on the project.
Earned value management quantifies project progress and compares actual progress to planned progress and funds spent. It does so using three metrics: Planned Value (value of work planned to be completed), Earned Value (value of work actually completed), and Actual Cost (funds spent). These parameters are determined for each project time period, and also cumulatively from project inception. While some suggest that earned value management is difficult, it really only adds one element to traditional project management — Earned Value.
Earned value management provides information that is useful to all levels of management. The project manager can use earned value management data to help manage the project. Team leaders can use these data to help manage their teams. Program managers and project portfolio managers can use earned value management data collected across all their projects to help identify poor project performance, reallocate resources, reset priorities, and terminate efforts that are likely to fall short of return-on-investment expectations. Chief project officers and CFOs can forecast project expenditures and completion dates, allowing better predictions of corporate revenues, expenditures, and profits. The CFO can employ these forecasts to develop financial statements detailing next year's projected corporate financial outlooks. Moreover, earned value management data can provide data for reports required under the Sarbanes-Oxley Act of 2002.
Whether the industry is information technology, new product development, aerospace, pharmaceuticals, construction, or any other, earned value management provides valuable project insight for any project stakeholder, from the team leader to a corporate stockholder.
Basic Concepts of Earned Value Management
Percentage spent is not percentage done! Does this statement surprise you? Many projects exceed their budget yet still fail to deliver the promised outcome. If percentage spent was percentage complete, when 100% of the project budget is spent the project would be done and everyone would be happy. Most project managers know firsthand this is rarely the case. Percentage spent simply makes a statement about financial expenditures; it is not an indicator of project progress.
The same holds true for time. Spending time on a project does not mean the work is being accomplished at an appropriate pace, or even that the right work is getting done. It just means that the clock on the wall has moved forward.
Schedules can provide some insight as to progress, as can deliveries or completed milestones. But is the completed work worth what was spent to get it done?
Earned value management asks you to think about what has been accomplished without thinking about how much has been spent or how much schedule time has been consumed. Understanding this concept, and using it in estimating the work completed, is the major cultural impediment to using earned value management correctly.
PLANNED VALUE: THE PLANNED VALUE OF WORK
The most fundamental concept of earned value is that work is worth the planned or negotiated value (budget) of the work. Depending on the industry, this value might be set by a formal contract, an annual budget, or a price to be paid for the end product. This concept flows down into the project as teams, subcontractors, and vendors agree to provide certain goods or services for a set budget or contract. Earned value uses the budget as the metric to answer the question "How much work do you have to do?" In earned value management terminology, scope is synonymous with budget.
A $10 million budget means that the sponsor (customer, stakeholder, resource provider, etc.) agrees that the project results are valued at $10 million. Otherwise, the two parties would have agreed on a different value. The value simultaneously represents two separate concepts: (1) the expectation of spending $10 million and (2) the work is worth $10 million. (The inclusion of contingency funds in earned value management will be discussed later.)
For example, consider building a custom home. You ask an architect to design a home worth $500,000. The architect looks at the local housing market and develops blueprints for a home worth $500,000. You select a contractor to build the home and upon completion you receive a bill for $600,000. You pay the bill, reluctantly, consoling yourself with the thought that you now own a $600,000 home. It comes as a surprise when the local real estate broker exclaims, "You have a nice half-million dollar home." The value of the work is not what you pay for it; it is what you agreed it's worth at the start.
Planned Value is the earned value management term for the value of work. The Planned Value is the value of all project activities. While it might sound like the project budget, it really is the sum of each activity's time-phased budget, created by associating the applicable budget to each detailed work activity and the work schedule. Thus, each piece of work has two attributes: its value (allocated budget) and its planned completion date (allocated time, or schedule). The sum of the Planned Value for all project activities should equal the total project budget, less any funds set aside for risk management or not yet allocated to a specific activity. Today's powerful scheduling tools, resource pools, and planning make it easy to determine the Planned Value. It is simply the cost of resources to be applied to activities over their time frame.
For example if an activity is planned for four months, and is expected to use one person in month one and two people for the remaining three months, the Planned Value for the activity is the cost of seven staff-months. Further, the expectation is to spend one staff-month in month one and two staff-months in each of the final three months. When we use the term time-phased budget we are indicating what we expect to spend each month based on the work planned to be completed that month and the cost of the planned resources.
Plotting the cumulative value of all project activities and their budgets on the y-axis with time on the x-axis reveals a cumulative Planned Value going from zero to the total value of the project. The total Planned Value for a project is also termed the Budget at Complete, or BAC. This is the value of all work in the project plan and thus also represents the scope, in financial terms, of the project. The plot will not be a straight line because it reflects the value of activities and products to be completed each period (month). This curve, called the Performance Management Baseline (PMB), is the cumulative Planned Value of all the products and services that should be accomplished each period. In Figure 2-1, the cumulative value is $15 million. The PMB captures both the value and time frame of all project work. It is the reference line against which monthly project performance is measured.
The PMB can be viewed as a conversion of project funds to project deliverables, internal products, and support tasks. At the start of the project we have all our funds and no work has been completed, so the Planned Value is zero. At project's end we have spent our funds and all the work is done, so the Earned Value equals the Planned Value, which equals budget at complete (BAC). The project's schedule performance will determine when the Earned Value line meets the BAC.
The PMB is relatively easy to create when a project is properly planned using contemporary project planning and scheduling software. If the project's activities are properly linked and scheduled, and resources with expected costs are assigned to each activity, the expected cost of resources for each activity sets the value of the activity. Summing the value of all the activities to be completed each month and then adding that sum to all the previous months' Planned Values yields the cumulative Planned Value. Plotting the cumulative Planned Value on the y-axis over time on the x-axis provides the PMB. The final cumulative Planned Value at the end of the project is the total value for all the activities from the start of the project to the end; this is the project's BAC. The BAC might not be the contract or project value — instead, it is the expected cost of all the resources needed to complete the planned work. Depending on the nature of the project this value might be an internal budget for the project or the cost to a customer for a cost-reimbursable contract.
The BAC should be ultimately derived from a bottoms-up estimate of all project works. However, the estimate might be performed to determine a bid amount in a competitive environment. Profit and contingency might be added to the bid amount. Once the project is awarded and negotiated, the final BAC may be less than estimated. This amount is then distributed to the project activities. So, in either case the amount may be less than the estimate for the proposal, but it is still a valid Planned Value for the work since the contract value was determined by the marketplace. This is the value and cost that should not be exceeded if the profit and cost to the customer are to be met.
When a financial reserve or profit has been set aside, we have two distinct budget amounts:
The contract budget, which is an amount agreed to by buyer and seller or sponsor and project manager. It is called the contract budget base (CBB).
The project manager's plan, which sets aside some funds for contingencies, profits, or other categories. In earned value management parlance, the remaining amount of funds is the BAC.
The project plan expects to consume all the BAC, but hopes not to use contingency or profit funds to complete the work.
The BAC is the term of most interest in earned value management. Earned value management uses the term management reserve (MR) for contingency. Figure 2-1 shows that there is a $3 million contingency in the project. An overall expenditure of $18 million is authorized, but plans call for only $15 million to be spent.
EARNED VALUE: THE VALUE OF COMPLETED WORK
Earned Value accrues as a result of completing activities. It is a parameter unique to earned value management. Completion of each activity contributes to the project's Earned Value. At project beginning, the total Earned Value is zero. As the project progresses, completion of each activity adds to the project's total Earned Value. When lengthy activities are underway, objective, or if necessary subjective, measurement methods provide partial Earned Value until the total activity is complete. At the end of the project, the total Earned Value equals the cumulative Planned Value (recall this is the value of the BAC) because all the scheduled work is done.
Excerpted from "The Earned Value Management Maturity Model"
Copyright © 2006 Management Concepts, Inc..
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Table of Contents
Part I: Earned Value Management Basics, 1,
Chapter 1: Introduction to Earned Value Management, 3,
Chapter 2: Basic Concepts of Earned Value Management, 9,
Chapter 3: Requirements for Earned Value Management, 47,
Chapter 4: Real and Imagined Impediments to Earned Value Management, 59,
Part II: Implementing Earned Value Management via the Earned Value Management Maturity Model, 67,
Chapter 5: The Need for an Earned Value Management Maturity Model, 69,
Chapter 6: Overview of the EVM3, 73,
Chapter 7: EVM3 Level 1: Initial Level, 79,
Chapter 8: EVM3 Level 2: Localized/Partial Implementation, 83,
Chapter 9: EVM3 Level 3: ANS I/EIA 748–Compliant Implementation, 103,
Chapter 10: EVM3 Level 4: Managed Implementation, 125,
Chapter 11: EVM3 Level 5: Optimizing Implementation, 135,
Appendix A: Common Earned Value Management Work-in-Process Measurement Methods, 147,
Appendix B: EVM3 Level and U.S. Office of Management and Budget Scoring Rules, 151,
Appendix C: ANS I/EIA 748 Guidelines (Unabridged), 153,
Appendix D: Concepts of Earned Value Management System Metrics, 159,