Earned Value Management

[MUSIC] I'm Zoe. >> And I'm Hatteam. >> And welcome to Project Insights. Today is very exciting. We have two guests. We have Jerry Klanick and Rene's Musa, on to talk about earned value management. Jerry and Rene's wanting you to introduce yourselves. >> Yes, I'm Jerry Klanick. I've been with PMA since 1989. And at one stage, I was managing director, but in 2020, I kind of flipped the script a little bit and became a full-time faculty member at the University of Dayton teaching construction engineering and management. I still have a consulting role within PMA and get engaged on occasional assignments. But my main effort is to try to teach students to be excellent in project management and construction management. Hello all, my name is Rene's Musa. I'm a senior director at PMA Consultants. I love in Chicago. I've been with the company for almost 11 years now. I've been a consultant all my life and one of the advantages of being a consultant is you kind of get exposure to various industries. You know, stuck in a specific project or in a specific market. And so, you know, if you look back at my career, it's mostly project controls. I spent a lot of time in oil and gas, and while I was doing that, I was working for Cherry. So, a lot of things I've learned, even about some of the topics we're going to discuss today, you know, is the reflection of my time spent with Cherry. Lately, you know, I've been getting involved in a lot of manufacturing projects, industrial projects, currently I'm managing a team, a team of project controllers at PMA, who are helping out with really big clients with projects all over North America. Today, we're going to talk about in-value management, and before we delve into the details, let's start by the definition and define the in-value management. Yes, the in-value management is, in essence, a performance management technique that is applied on a variety of items most often on projects. It's a technique where you utilize what your original budget for the project is, as well as your original timetable or schedule for the project, and then assess performance based upon how much money you've spent and what work you've achieved. And there's techniques of analyzing that and using that information to forecast how much more time do you need to finish the project and how much more money you need. And then that's used for overall forecasting. I have run into this technique very early in my career when I was working with Exxon Research and Engineering Company. It was back in 1980. It had different terminology in terms of some of the specifics, but it's definitely a very applicable performance management technique that's very easy to apply and used throughout the world to forecast performance and projects. So really, to further elaborate on what Jerry just said, there are instances where project managers come to me and say, why do I need to do on-value? And the way the way I'd explained to them is, as you're a $1 million project that's going to go on for a year, it starts from January goes all the way to December. If I come to you in November and say, Mr. P.M, you're going to be three months late and $2 million over budget. At that point, it pretty much is a fact for everyone. They don't need an analyst like me to come and tell them that they're going to be late. What tools, like EarnValue does, is it gives you those warnings way ahead of time. Where I can go as early as, let's say, February or March and say, hey, based on what we're looking at, based on how we're trending, it looks like you're going to be late or you're going to be over budget. So that is what EarnValue management is all about, giving them warnings up front. So what are the key numbers needed to calculate EarnValue? Well, the three fundamental, I guess, calculations or I use the term numbers, which is actually good term for it in some regard, that are kind of collected and then analyzed as you're trying to assess performance. The first is what they call PV or planned value. And so what the planned value is, is an assessment of how much of the original budget you're going to use over time. Some people say if you have a budget of $1,000 over 10 periods at period number five, if it's pretty linear, you can say that the value was 500. But you may be a situation where your work is front loaded, maybe your planned value is 600 out of 1,000. So it's an assessment of how you're really going to perform the work given that you had some sort of budget for it and a view of the schedule for the project. So that's the first indicator or number. The second is actually quite easy. It's called actual cost. And so this is the amount of money through some sort of cutoff timing that you've spent to do the work on the project. And the concept is at the cutoff timing, you want to get alignment of your planned value with your actual cost. And then the third item, which is called EarnValue or EV. And then my view, this is the most difficult concept to kind of grasp. If to try to put it in the most simplest terms, it's given that the work you performed, what was the amount of budget money associated with that work? And so if you've got, say a particular set of work, say the initial value was $80. And you're halfway done on that and you've confirmed that you're 50% complete and you would get 50% credit of that $80. It doesn't matter if you spent $60 or $10 to do the work, you get credit for what you originally budgeted for the work. So for Uranus, can you just like expand in what you're going to say that I'm exhibiting the EarnValue versus planned value? Like for me, if I'm thinking, maybe if I finished 50% of the work, maybe that's the planned value of 50%. But the EarnValue is a different concept. So can you simply add that? So planned value, you know, so generally at the beginning of the project, you know, you do maybe you do planning sessions with the team, you come up with the baseline schedule, you are, you know, you may be cost loaded, you understand how your cash flow is going to be, or your cost forecast is going to be, that establishes your planned value. According to your plan, you're applying to spend the much money in the first one, second month, third month. EarnValue like Jerry was suggesting is the tricky part, you know, is what, you know, what you think you've earned, what you think you've done. So now talking about EarnValue, so let's assume, you know, you can even, you can even kind of calculate it based on the amount of work that actually gets done outside on site. You know, I've seen instances where, let's say it's a piping job, you know, you've got to lay 100 feet of pipe. And at the end of the first month, you know, you've done, you can go out there, measure and say, look, a 50% complete. So you know, you've earned 50% of the work. And then you can compare with the, with the actual cost the car tractor is coming up, you know, what he thinks is done. So that's, that's one way also to do like EarnValue management through quantity tracking, or through manpower, manner tracking. So they're all through rules of credit. You know, we've, depending on the project, depending on the industry, you know, you can, you can come up with the best way to, to do your, to come up with your EarnValue. But it's very important that, you know, that you select the right way of doing it, because, you know, just like, just like any other metric out there, you know, if you're going to feed garbage in, garbage is going to come out. So you've got to make, you've got to, I mean, we'll discuss further on some of the, some of the pros and cons of this approach. But one thing we want to make sure when it comes to plan value is why you've got to have a good plan. So it's a good plan. I used it. I'll come out of it. And then the way you're extracting your, your data, you know, the, the methodology use is also equally important. Maybe a little bit more discussion on the calculation of EarnValue. The, you know, first of all, you love it to be quantity driven because it's more defendable. In other words, I've installed 200 cubic yards out of 400 cubic yards. And then you can do the math. 200 divided by 400 is, you know, 50% complete. But the other way that I see commonly I used in, in Rene's remarked about it, it's called rules of credit. And so for different types of work that they will have a series of rules of credit giving different types of tasks or items of work. For example, in construction, which is very easy to observe where you're at. If you just go out and visualize what's been done, you can say for a foundation, have a series of rules of credit for the various sub tasks to build a foundation. So you would have a rules of credit for say for excavation, rules of credit for placing all the formwork, rules of credit for putting in the rebar into the foundation scheme, rules of credit for placing a concrete, rules of credit for actually curing the concrete and stripping the forms, which would be the end. And basically you assign a percentage to each of these sub tasks where the percentage total equals 100% and you try to use the percentage that really relates to the intensity of work that is being performed so that you get a fair assessment that say on the foundation example I used that when we actually have the rebar in place, the formwork in place, you've done the excavation, it could be as high as like 75 or 80% of the work and you would want to get that much credit given all the tasks that you've done. And so in the application that I've seen on many projects, there will be a series of rules of credit for the development of the design documents. So even in the engineering office, they'll have rules of credit for say the piping design and how elaborate it is for the various components of the design and then there'll be rules of credit for delivery of materials and maybe fabrication materials and rules of credit for construction. So it can get quite complex, but what the rules of credit do is that if you assign them and agree them up front, it takes a lot of the judgment away. And so you can actually get consistency of how you apply the principles of earned value analysis to come up with a much better indicator of the performance of the project. How we can use these indicators to calculate values that we can present it to the project managers and to the stakeholders to know where the project at is it behind is it in front. So how we can use this value to come up with other indicators and other calculations to provide values to our customers. When you're doing earned value analysis, so we're at a point in time in a project where we want to assess performance. So we now have in hand the planned value for that period up to that period of time, we're going to calculate the actual cost and then we're going to calculate the earned value. So we've got three metrics to use and apply. And so the key ones to use are what they call the Schedule Performance Index SPI and the Cost Performance Index CPI. And they're basically derivatives of those sets of metrics where the Schedule Performance Index is what you have determined is the earned value through that period of time divided by the planned value. The Cost Performance Index is very similar. It's the earned value divided by the actual cost. And then once you have these indicators, the SPI and CPI, you use the SPI to have some sort of perspective of what is the projection of the timing of the completion of the project. So you would actually take the original duration for the work and an essence divided by the SPI. And see what it gives you in terms of a new duration. Similarly for the cost performance of the project, you can calculate the overall final cost of the project based upon the original budget, which is used the term BAC for budget at completion divided by the CPI. And then that will tell you if you're on track to, you know, stay within the budget or exceed the budget. And then once you understand whether you're going to be overrun or underrun and time, overrun, underrun and money, you react to what that says and adjust as necessary, especially in the case of overrunning in both time and money. Ideally, you want to see these as early as in the project as Rene's mentioned. It's an early signal that things may not be going well. And the earlier know it gives you more options to fix it. So, you know, when we do this on a real project and then when we show them these numbers, you know, one of the questions they ask is, okay, what is this number? So let's take CPI first. Okay, so if your CPI is 1.0 perfect, what that means basically is, you know, you're trending to be on budget, you're doing really good. Okay, if your CPI is greater than one, if it's a value that's greater than one, then the project is trending to be on the budget. And if it's lesser than one, it's trending to be over budget. Okay, so that's what those numbers mean. And from a scheduling perspective, again, if it's a 1.0 perfect, you know, you're trending to be on schedule. And then if it's greater than one, then you're ahead of schedule. If it's lesser than one, you're behind schedule. Okay, now one thing, one thing I point out is, like the key word here is trend. You shouldn't jump to a conclusion that, you know, this project is going to finish well. We've got to go and revisit this every week, every month, every quarter, depending on how big of a project it is. And you're looking for trends to try and forecast the future using these numbers. If we use these indicators, like, as you said, we're going to, like, present them not just as one point, but over time, and that we're going to give us a trend where the project going, is it going behind or going ahead? Can we use like plot it in a plot or in a graph, and we can show it to the stakeholders to see what the situation of the brigade, because everyone, I believe everyone of these indicators show us something different. Yes, definitely. You can take the calculations you use for the CPI and SPI and do kind of a time series graph of the data and see what the trends are, whether they're, you know, going to a point that's a betterment for the project or going to a point where there's concern. And so they're very effective. Sets of information that a good project control specialist would provide to the team. So to implement the use of earned value calculations on a project, do you need a good plan in place at the start of the project to be able to implement this? The quality of doing earned value management is actually influenced by a number of things, okay? So the first one and kind of where the question started is having good starting points, meaning that I have a reliable, complete cost estimate for the project, and then I actually have a reliable, complete schedule for the project, okay? And so if they are faulty, the whole earned value analysis will break down over time because of the faults that become evident later on in the project, okay? Other things that influence the quality of doing earned value analysis is how you treat changes to the project because ultimately that is work you need to do, and so you have to adjust your calculations to reflect the effect of changes that may happen. Another one that affects the quality of earned value management is if you have to do things over meaning to rework because even that's not a change, it's work you have to do and account for appropriately as you assess these metrics for CPI and SPI given what work you really do. And lastly, the quality of doing all this is making sure that your data is all aligned in time, and the thing that's most sensitive is the actual cost because sometimes there is a lag of what the financial information becomes available to do the analysis, and if there is a lag, you need to adjust your numbers so that everything is in the same time. If you don't have alignment in time, you can get faulty results from your earned value analysis. And that takes me to a question for Renese, like if I have a change order in the middle of the project, how I'm going to treat that change order? Is it going to be part of the bland value or part of the actual value or part of the earned value? Wait, wait, going to show up. You may not like this answer, but the real answer is it depends. It depends on the change order. Now, when we get a change order, some of the analysis we do on the owner's end is how much of a cost impact is this making? How much of a schedule impact is this making? If it is a substantial change order where it's creating a huge change in your plan. Now, how do you define what is huge? Some clients may say, if it is going past, if it's creating a 5% variance, and it depends what that changes. Let's say it's a small change order, then you're not going to take the effort of going back and rebase lining your project and trying to come up with new planned values, but if it's a big change order that's impacting your plan, it may not even be one. Let's say you get like a series of change orders in a quick time frame. If you reach a point where your plan does not make any sense, then that's when you kind of go back and rebase line so that you have got good planned values to start your analysis going forward. So really to summarize your answer, it depends on the change order. It may not be one change order, it could be multiple change orders. If you reach a point where the plan does not make any sense, then at that point you go and rebase line and create new planned values. I'll give an alternate approach to what Rene's just explained, which is very valid, is that you may want to keep two sets of books. The first set of books relates to the original plan that is not altered by any changes, and then you do your earned value across that set of work. But as changes are added to the project, you create this other dynamic book because the changes are going to be introduced, and then you do calculations on performance of just the change work. Now the thing you got to do, it's not a one-for-one analysis that you have to do some sort of waiting of the effect of the changes versus the waiting of the base work given the value of the changes. But that is another way to address this and try to keep it as complete as possible into reporting period. So, what if the underlying basis you're using for your forecasting is wrong? Basically, you've got to start from scratch again and correct your working documents on what the base costs should have been and what the base schedule is, and learning everybody that there is, and Rene's using the term re-baseline, that you have to do this re-basiting effort. Now, this could be very painful, because sometimes when you do this, you find out that you're going backwards in progress, because you now realize you've got a lot more work to do than how much you advance as far as a smaller number when you put the whole picture in place. So, that's always a very difficult time for the project manager, project control specialists to explain why we went backwards in progress or backwards in earned value. But theoretically, the revised number is the best number because it reflects reality. What odds of limitation of and value? Well, there's a couple of things that you got to be careful. I wouldn't say limitation, I think you just got to be careful with. One is that, let's talk schedule first, is that you can calculate the SPI and apply to come up with a projected new duration for the project. And it may say that I'm ahead a schedule or behind schedule, and it is what it is in terms of the numbers. You need to validate it with what you're using as your CPM schedule, because I've seen jobs where they're saying that, hey, we're way ahead of schedule using earned value, but if you look at the critical path, they're not ahead of schedule, maybe straight on, or maybe they're delayed on the critical path. So, you've got now two pieces of information on schedule performance. And so, you have to use your best judgment what makes sense. And if your CPM schedule is well assembled and it's being well maintained, I would rely more on the CPM schedule giving you a forecast than the earned value analysis. So, that's one limitation you need to consider. The other limitation is, and we kind of just talked about this a little bit, when you have a lot of rework and a lot of changes going in, we want to ensure they have been representative, it represented in your calculations adequately, so that whatever you're using as your performance measurement is really based upon what is known as the complete scope of work, and that your assessment is based on that. If I could just add on to that, I mean, I made this point earlier on garbage and garbage out. So, really the way you're coming up with the fact that you need to come up with a realistic plan, a good cost baseline, a good schedule baseline, the fact that you come up with a good way to calculate your earned value, the fact that you come up with a good way to calculate your actual cost, so that you're comparing apples to apples. All that is essential, the team is aligned on how they are collecting that and how they are reporting that, so that you get meaningful results out of it. I have seen in my career a fair share of projects that they think they are doing earned value, but because they don't focus on these fundamentals at times it takes them the wrong direction. And then once you lose trust in it, then it just becomes a checklist. It's just because of a report that you're generating every week and really no one is looking at it. So, as project controls analysts, we should be extremely careful not to follow these traps. If you actually do some sort of academic research into earned value in the underlying calculations, you're going to find there are multiple formulas to use to calculate EAC, the Estimate Act Completion, which is the total, the forecasted total cost of the project. All these formulas are good, but you have to understand the underlying assumption with the formula. The classic formula for EAC is that it's calculated as the BAC, the budget at completion, divided by the CPI. And the key part of that is there's an assumption that the current performance you've seen to date will continue for the rest of the project. If that is the case, fantastic. That is the right formula. Okay. There is an alternate formula that's commonly used where the EAC is calculated as what we have to spend today, meaning the actual cost, plus the calculation of the BAC minus the earned value. What does this mean? This means that we believe the rest of the project will behave like we originally planned. Whatever impacts whether good or bad that have occurred are going to stop and that the rest of the job is going to be the same way we originally thought. And so part of using earned value analysis is a judgment by whoever's going to be up doing these calculations on how they see the future. And so when I was a project cost engineer and many, many moons ago, I actually do these calculations many ways and sit down with my project manager and explain them and then it was his call which forecast basis I would use because he had a better handle on projecting the future than I did because I was a junior engineer at the time. And so the point I'm trying to make is that you need to look at these things in multiple ways before declaring a forecast. Is there a way that you typically, that you may be this is a question for Renese that you typically find yourself calculating it on projects these days or on the types of projects you encounter? It's usually the second one that Jerry mentioned that I've used mostly which is actual cost plus budget minus earned because I mean most of the issues are impacts we see at the project level. I mean very rarely week, I mean there are instances where let's say you pick up a bad contractor and they're performing not performing up to the mark then you can expect that performance to continue through the end of the project but you most of the issues we face is you know like a one time thing where we're not expecting that to happen again you know at least we're not planning for that to happen again. So it's really the second method that Jerry mentioned that I found myself using a lot. Finally Jerry do you have any closing remarks or any any addition you want to add to this topic? I would say you know earned value analysis is a key technique in the toolkit of a project controls specialist and so they need to be very comfortable about the technique and we talked about some limitations and things you need to be careful but if you can set this up adequately it kind of makes project controls a little bit of fun as you go reporting period by reporting period and compiling all the data and see what performance is and then you know interacting with the team and seeing what the numbers say and getting into interpretation why did why were things good this period why were things not so good this period and then using this as a technique to get overall better in performance on the project. And Renys do you have like any advice for any new junior or really good controlling engineer who gets starting their career and they want to work on the earned value or user earned value or use a different method what your advice. So it's a very powerful tool use it wisely you know many a times the majority of the people in your project are just concerned about the current starters and the current issues and not many people look into the future and try to forecast. So as project controllers we have the ability to kind of predict the future and earned value is one of the tools we use so it's a very powerful tool but you've as Jerry mentioned you've got not to be comfortable with it if you're someone new to this if you're starting a career in project controls then if you're a part of a team or if you're under a supervisor who's a lot more experienced with this you know then sit back and observe and see how they come up you know with all these metrics because you know the calculation part is really easy the formula is pretty basic you know anyone can do that it's how you collect your data how you arrive at your conclusions how you can you know at times you're going to be delivering bad news you know and no PM is going to sit back and say I agree with you you know just because you came up with this formula you've got to stand there and justify why you think this project is not going in the right direction so a very powerful tool you know just I mean if you're someone starting your career in project controls and I would say yeah be part of a team or under someone supervision who can kind of guide you through. That's great advice and that brings us to the end of our episode thank you so much Jerry and Rene's for joining us. Well thank you Zoe I hope it's going to be a very informative podcast for our listeners and certainly if you've got any questions please search us out and we'll try to answer them. Same here this was fun let's you know let's do this more this was fun let's share the knowledge with others. Thank you as well too had Tim my co-host and our listeners for joining us we look forward to giving you more knowledge on this topic and other topics in the future on our next episodes.