Article #141 Why Contractors Need to Use the Earned Value Method to Monitor, Evaluate and Report their Project Budget Performance?

In the Middle East and North Africa (MENA) region, having unbalanced bids is not forbidden. Unbalancing a bid will result in having some bid line items overpriced while others are underpriced but ensuring that the overall total bid price is competitive enough to win the bid. In other words, part of the project’s scope of work will have a high-profit margin while others will have a very low-profit margin if not a loss. Although this will be of great concern to project owners as this might encourage fraud when high-priced items increase while low priced decrease, nevertheless for a contractor, this means that the awarded contract priced line items cannot be used to benchmark the project’s budget performance.

Therefore, it is critical to have a formal process to manage the budget performance. To start with, the contractor needs to finalize the Budget at Completion (BAC) which was the basis for coming up with the winning bid price. The BAC excludes the contractor’s overhead including finance cost and profit as well as the management reserve (MR) and will only include the project direct and indirect cost and project contingency. Management reserve is defined as the cost reserve that is used to manage the unidentified risks or “unknown-unknown” and it is not a part of the budget at completion baseline, and the contractor’s project manager needs management’s permission to use this reserve.

The indirect cost will include in addition to the profit allocated to the project management team, site overhead cost which will be captured using timesheets and miscellaneous invoices for other types of overhead expenses. The direct cost will include all outsourced subcontract and material supply agreements as well as internal company agreements like for example the agreement between the project and the company batching plant for the supply of concrete. Similar internal agreements will be made for the supplied material which is usually purchased in bulk by the contractor for all projects. The actual cost for all those agreements will be captured using interim progress invoices.

The Project Budget At Completion (BAC) and Planned Values (PV)

Project management information systems (PMIS) like PMWeb provide the organizations with a single integrated platform to monitor, evaluate and report the project’s earned value performance. The Budget Module and Budget Request Module will be used to develop the project budget at completion (BAC) which will cover all direct and indirect cost elements as well as the project contingency. The cost elements can be aligned with the project’s work breakdown structure (WBS) or the company’s own cost control accounts. Nevertheless, the PMWeb budget module allows assigning the WBS level to each cost element when the cost control accounts are used. In addition, the PMWeb budget module allows creating the planned spending projection curve for each cost item to calculate the planned budget spending value (PV) for each period. The distribution of the budget projection can be based on one of the available distribution levels or manually distributed. In addition, PMWeb allows linking the relevant project schedule activity to capture the planned start and finish date of each cost item.

Actual Cost Against Outsourced and Internal Company Contracts

PMWeb Commitment module will be used to capture the details of all outsourced scope of work contracts to subcontractors and suppliers as well as internal company contracts. Internal company contracts could be the contract between the project team and the contractor’s batching plant, plants department among others. Those commitments will become the basis for capturing the progress invoices for each period which represents the actual cost (AC).

Site Overhead Cost Using Timesheets

PMWeb Timesheet module will be used to capture the contractor’s site overhead expenses. The timesheets will be used to capture the actual hours of all labor and equipment resources spent on the project. PMWeb allows defining different rates for the resource charges to cover normal, overtime, weekend, holiday, and other types of pay rates that the contractor might need to have.

Non-Commitments Actual Costs

PMWeb Miscellaneous Invoices will be used to capture other non-commitment costs including the cost imported from the contractor’s ERP or accounting system. This module will be also used to capture the cost of permits, tests, fees, and other charges that could be applied against the project.

Managing the Project Contingency

Commitment contracts are not only created from actual contract agreements between the contractor subcontractors and suppliers but they can be also used to create internal company commitments. For example, a commitment contract will be created between the Contractor Company and the Contractor Project Manager which will be created for the project contingency. The commitment invoice module will be used to capture all consumptions of the project contingency.

Importing the Updated Project Schedule and Percent Complete Values

On monthly basis, the updated contractor’s schedule will be imported into PMWeb to capture the approved percent complete values for the progressed activities. Those percent complete values will be the basis for calculating the earned value (EV) for each cost item associated with the activity. PMWeb Scheduling module allows importing and storing the updated project schedule for each period.

Capturing the Earned Value Method Input Values

PMWeb Forecast module will be the module to capture all of the above cost information. For each period, the forecast module will capture the budget at completion (BAC), planned value (PV), actual cost (AC), and earned value (EV) for each cost item. The forecast will also include the project schedule activity linked to each cost item along with the imported percent complete. As an option, the percent complete can be added directly without the schedule import.

Calculating the Earned Value Metrics

The above PMWeb modules will provide auditable, traceable, and trustworthy values for the four key components to earned value being Budget At Completion, Planned Value, Earned Value, and Actual Cost. The Budget at Completion (BAC) is the approved budget set by the contractor to deliver the project’s complete scope of work, Planned Value (PV) is the physical work scheduled or “what the contractors plan to do”, Earned Value (EV) is the quantification of the “worth” of the work done to date or “what the contractor has physically accomplished” and Actual Cost (AC) is the cost incurred for executing work on a project or “what the contractor has spent”.

Those values will be the basis for calculating earned value metrics which will include Cost Variance (CV) which is “EV – AC”, Schedule Variance (SV) which is “EV – PV”, Cost Performance Index (CPI) which is “EV/AC” and Schedule Performance Index (SPI) which is “EV/PV”. It should be noted that for lump sum (not remeasured) commitments, the cost variance (CV) should be always equal to “Zero”.

In addition, those values will be used to calculate the other earned value metrics which include Estimate To Complete (ETC) which is “BAC – EV” and Estimate At Completion (EAC) which is “ETC + AC” which can be also considered as the Latest Revised Estimate (LRE) for the project. Further, the Variance at Completion (VAC) will be calculated which is “BAC – EAC”. The VAC indicates the project’s probable cost underrun or overrun. That is to say, a positive VAC indicates that the project is projecting an “underrun” while a negative VAC indicates that the project is projecting an “overrun”.

In addition, the To Complete Cost Performance Index (TCPI) can be also calculated which is “(BAC-EV)/(EAC-AC)”. The TCPI is the cost performance index that the contractor needs to achieve to ensure that there will no variance between the BAC and EAC.

The Estimate To Complete (ETC) will be adjusted to reflect the past period’s performance which will be reflected in the calculated Cost Performance Index (CPI). If the current variances are seen as atypical and similar variances will not occur in the future, then ETC will equal (BAC- EV). That is to say, it will not be adjusted.

Nevertheless, if the current cost variances are seen as typical of future variances, then ETC will equal (BAC- EV)/CPI. In addition, for the case of being seen as typical of future variances, the ETC can be also influenced by factors of 80% of past cost performance and 20% past schedule performance (ETC = (BAC-EV)/ (0.8 X CPI + 0.2 X SPI)), be influenced by last 3 months cost performance (ETC = (BAC-EV)/ (CPI1+ CPI2+ CPI3)) or be influenced by past cost and schedule performance (ETC = (BAC-EV)/ (CPI X SPI)). Of course, there is also the option to calculate the revised ETC by adding all potential additional costs to commitment contracts to the non-adjusted as well as adjusted ETC.

All those values, variances, indices, and other earned value measures will be calculated and captured in the PMWeb Forecast module. In addition to the default metrics included in the Forecast module, PMWeb allows adding ten new fields with each having its value calculation formula.

The Earned Value Measures History and Trend

PMWeb Forecast module allows capturing the earned value measures and metrics for each elapsed project period. This is a must requirement for creating the earned value trend reports which is one of the reports commonly generated when reporting projects’ earned value performance.

Supportive Documents and Formal Approval of All Processes

Similar to all other PMWeb modules, all supportive documents including the updated project schedule report can be uploaded into the PMWeb document management repository and attached to the relevant budget, budget adjustment, commitment, change order, progress invoice, timesheet, miscellaneous invoices, imported project schedule, and forecast period report. In addition, links to the approved progress invoice as well as other PMWeb records and imported MS Outlook emails can be linked to those forms.

To ensure that the above processes are formally reviewed and approved, similar to other PMWeb forms, a workflow will be assigned to relevant budget, budget adjustment, commitment, change order, progress invoice, timesheet, miscellaneous invoices, imported project schedule, and forecast modules to ensure formal review and approval for the reported information. The workflow will include all the steps assigned to the relevant project team members to review and add all necessary comments before it is formally approved.

Reporting the Project’s Earned Value Performance

The captured project’s performance data can be designed in different forms and formats to Fulfill the organization’s reporting requirement. Nevertheless, the one that is used most is a report that details the earned value method key values for each period which include the approved budget at completion (BAC), planned budget value for the current period (PV), earned value for completed works (EV), total actual cost to date (AC), estimated cost to complete the balance of the works (ETC) and project estimate at completion (EAC).

In addition, the report will display the variances at each period those being the schedule variance (SV), cost variance (CV), and the estimated cost variance at completion (VAC). Further, the report will display the schedule performance index (SPI) and cost performance index (CPI) for the same periods. The report will also display the variances and performance indices trend charts.

In addition, the organization could monitor, evaluate and report on the variances and indices across the organization’s complete projects portfolio or selected projects that could be part of a program or any other attribute like location, type, sponsor among others. The organization might display the earned value as a scorecard or link it to a map that will display the location of the selected projects as well as the performance indices. The size of the bubble on the map could be used to reflect the project’s approved current budget.

About the Authorfounder

Bassam Samman, PMP, PSP, EVP, GPM is a Senior Project Management Consultant with more than 35-year service record providing project management and controls services to over 100 projects with a total value over the US $5 Billion. Those projects included Commercial, Residential, Education, and Healthcare Buildings and Infrastructure, Entertainment and Shopping Malls, Oil and Gas Plants and Refineries, Telecommunication, and Information Technology projects. He is thoroughly experienced in complete project management including project management control systems, computerized project control software, claims analysis/prevention, risk analysis/management (contingency planning), design, supervision, training, and business development.

Bassam is a frequent speaker on topics relating to Project Management, Strategic Project Management, and Project Management Personal Skills. Over the past 35 years, he has lectured at more than 350 events and courses at different locations in the Middle East, North Africa, Europe, and South America. He has written more than 250 articles on project management and project management information systems that were featured in international and regional magazines and newspapers. He is a co-founder of the Project Management Institute- Arabian Gulf Chapter (PMI-AGC) and has served on its board of directors for more than 6 years. He is a certified Project Management Professional (PMP) from the Project Management Institute (PMI), a certified Planning and Scheduling Professional (PSP), and Earned Value Professional (EVP) from the American Association of Cost Engineers (AACE) and Green Project Management (GPM).

Bassam holds a Masters in Engineering Administration (Construction Management) with Faculty Commendation, George Washington University, Washington, D.C., USA, Bachelor in Civil Engineering – Kuwait University, Kuwait and has attended many executive management programs at Harvard Business School, Boston, USA, and London Business School, London, UK.


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