De-mystifying Earned Value – Forecasts

In many cases, tell a project manager they must use earned value analysis on a project and you will hear a groan.  Earned Value Management has been tainted with an aura of overwhelming bureaucracy and incomprehensible numbers and ratios.  While some organizations may have done their best to confuse and confound project managers and project teams with Earned Value Management – it is really a very basic and easy to use set of project analytics.  This blog post will explain the earned value project forecasting analysis and other blog posts will discuss project baselines, variance analysis, and cost account managers.  Or get everything in one ebook that can be ordered below..

Earned Value Management

Earned value management is an analytical approach for determining the current cost and schedule status of a project and for forecasting the final cost of a project.  It combines scope, schedule and resource management into one set of measurements.  When used properly it will simplify and reduce the effort needed to provide effective project management control.

Earned Value Management is based upon the comparison of three different perspectives on a project.  The first perspective is the project planned value (PV) which is the estimated cost of each activity time phased according to the project schedule.  The next baseline is the earned value (EV) which is the estimated cost of the project activities that have been completed.  The final baseline is the actual cost (AC) which is the amount of money spent completing the work that has been done on the project.  These baselines are discussed in more detail in the blog post, “Demystifying Earned Value – theBaselines."

Forecasts

On the one had we could say the original baseline project plan is a forecast.  However, in project management terms, forecasting is normally providing an updated estimate from the original plan.  I recommend that this be done at the beginning of each phase.  It may also be done following a major high risk milestone.  I recommend starting the forecasting when the project is 20% complete.  By that time several significant items should be completed on the project and enough work is done so that a small underrun or overrun is not magnified out of proportion.  Prior to that time, the baseline plan is the forecast.

Throughout the lifecycle of the project, the project manager is often asked to provide a forecast for the final cost of the project which is referred to as the Estimate at Completion (EAC).   As the project gets underway, real costs occur and now actual costs can be used instead of budget estimates for the completed tasks.  The EAC is then the sum of the Actual Costs (AC) plus an estimate of what the costs will be to complete the remainder of the project.  This estimate for the remaining work is the Estimate to Completion (ETC).  This can be expressed with this formula:

EAC = AC + ETC 

The key then to effective forecasting is to be able to calculate a realistic ETC (since AC is already occurred and cannot be affected).

Forecasting Indices with Earned Value

To assist the project manager in the calculation of ETC, the Earned Value Management methodology creates several performance indices.  These indices consider what has happened on the project since its start.  There are two indices, a Cost Performance Index (CPI) and Schedule Performance Index (SPI).  

The CPI is a ratio of the earned value (EV) divided by the actual costs (AC).   Since the EV is the estimated cost of the work completed and the AC is the actual cost, the CPI is a ratio of underrun or overrun for the work completed.  The index can be calculated for the entire project or for a subset of tasks, such as all of Phase 3, or all the tasks performed by the IT organization.  

CPI = EV / AC

The SPI is a ratio of earned value (EV) divided by the planned value (PV).   Since the EV is the estimate for the work completed and the PV is the estimate for the work that was planned to have been completed, it is a ratio of ahead or behind schedule.  Again the index can be calculated for the entire project or a subset of the project tasks.

SPI = EV / PV

Earned Value Forecasting Methods

There are four methods for forecasting the ETC:  

• The first method is to create a new estimate.  In this case, the project manager and core team create a new estimate for all uncompleted work.  This often done if there is a major scope change to the project.  I also will use this approach when near the very end of the project because I normally have an excellent understanding of what is left to be done.  The formula for the project estimate is: EAC = AC + (new estimate for remaining work).


• The second method is to stick with the original estimate. In this case the ETC is the originally budgeted estimate for the remaining work. This is a good approach to use when any underruns or overruns that have occurred were due to unique or isolated events and are not likely to be repeated on the project. This is calculated as the Budget at Completion (BAC) which was the total for the planned value and therefore the original estimate of all work, minus the EV (original estimate of the work that has completed). The formula for the estimate of the remaining work is:  ETC = (BAC – EV).  The formula for the total project estimate is then:  EAC = AC + (BAC – EV).


• The third estimating method is used when established trends on the project will continue. This method requires the use of the CPI performance index. It assumes that any pattern of cost overruns or underruns that has been occurring on the project will continue to occur at the same rate. It can be applied to just a subset of tasks, or the entire project. The estimate created in this method will take the originally estimated value of the remaining work (BAC – EV) and divide that by the CPI. This has the effect of increasing or decreasing that value of the remaining work by the same ratio that it has been increasing or decreasing. The formula for the remaining work is: ETC = (BAC – EV) / CPI. The formula for the total project estimate is then: EAC = AC + (BAC – EV) / CPI.


• The fourth method is used with projects that are behind schedule and must be accelerated. It requires both of the earned value performance indices, CPI and SPI. This method assumes that the underrun or overrun pattern will continue and that an effort will be made to finish the project on the original date, so increased costs will occur to accelerate the remaining work. To create the acceleration effect, the estimated cost of the remaining work (BAC – EV) must be divided by the SPI. The ETC in this case then must include an effect for both cost and schedule. The estimate for the remaining work is: ETC = (BAC – EV) / (SPI * CPI). The estimate for the total project becomes: EAC = AC + (BAC – EV) / (SPI * CPI).

Which method you use will depend upon the project conditions. However, in each case the math is straightforward if you have the earned value metrics.  If you want to learn more about earned value, order my ebook below.