REAL TIME EARNED VALUE

Kevan Heathcote B.E., M.Eng.Sc., Grad.Dip.Ed.(Tech.), M.Com., PhD, MAIB,MIE(Aust.) University of Technology Sydney Email: Kevan.Heathcote@uts.edu.au Speaker Profile: Dr Heathcote is a Senior Lecturer in the Construction degree course in the Faculty of Design Architecture and Building at the University of Technology Sydney. He lectures in the areas of cost management, financial management, project evaluation and project management. Other interests of Dr Heathcote include structural design, sustainable building technologies, and earth building.

Paper Summary Traditional earned value analysis is little used by general contractors as a control tool. This is mainly because it is based on an inflexible baseline and on cumulative performance. This paper proposes that contractors treat each cost period as a separate sub-project with revised baselines being prepared after each reporting period. It further proposes that trend lines be used to predict the final cost variance.

REAL TIME EARNED VALUE

Kevan Heathcote B.E., M.Eng.Sc., Grad.Dip.Ed.(Tech.), M.Com., PhD, MAIB,MIE (Aust.) University of Technology Sydney Email: Kevan.Heathcote@uts.edu.au

Abstract: Earned Value analysis has traditionally been used by project managers as a basis for controlling progress on a project relative to the original cost versus time schedule (S curve). The principle objective of this analysis is to determine the estimated cost at completion (EAC) and the estimated finishing time (ETC) based on current progress, in order to identify whether remedial action is required. As a control instrument earned value analysis is useful for project managers but is little used by general contractors. The main reason for this is that contractors do not work with a fixed cost-time schedule, but are continually updating the original work program to suit changing circumstances such as variations to the contract or the need to speed up progress of the work. Action plans are prepared for each new cost period and progress before that period is largely irrelevant in monitoring future work. Costs already incurred cannot be changed and overall progress in terms of time is important only in terms of affecting the speed with which the remaining work is programmed to be carried out. This paper proposes that contractors treat each cost period as a separate sub-project, with a planned value (PV) determined in accordance with the periods action plan. Variances calculated for each sub-project are then truly representative of the progress during the cost period and can be used as a management tool to track the performance of the project. The earned value (EV) determined for each sub-project can then be used as a basis for project claims. It is further proposed that trend lines be used to predict the final cost variance of a project. Introduction Earned Value analysis has traditionally been used by project managers as a basis for controlling progress on a project relative to the original cost versus time schedule (S curve) either on a project or an activity basis. It involves recording or calculating three values Cumulative Planned Value (PV)- amount of work planned to be done at a particular stage of a project Cumulative Actual Cost (AC) actual costs up to the particular stage in question Cumulative Earned Value (EV) value of work completed at the stage in question

The value of Earned Value represents the physical progress of the project and is commonly calculated as the value of the project times the percentage complete. From these values the Cost Variance (CV = EV-AC) and the Schedule Variance (SV = EV-PV) can be calculated. The concept of earned value is embodied in an accounting method used in the construction industry for long-term contracts set forth in Accounting Research Bulletin (ARB) No. 45 (AICPA Committee on Accounting Procedure, 1955). Under this method, a portion of the total estimated project income on construction contracts is recognizable each accounting period based on a project' s percentage of completion. In this instance the cost variance is akin to the profit/loss recognised on the contract. Whilst there is no accounting need to calculate a schedule variance at the end of each accounting period it would be a simple matter to do so. In more recent times the term Earned Value has become synonymous with the C/SCSC system developed by the US Departments of Defense and Energy in 1967. It was developed as a means for reporting the performance of large projects with respect to cost and time. Within the C/SCSC system earned value analysis has primarily been of use in predicting the final cost (EAC) of government cost-plus contracts, where

EAC = Actual Costs to Date (AC) + Estimate to Complete (ETC) and ETC = [(Budget at Completion (BAC) Earned Value (EV)] / Performance Index (eg CPI). In the past earned value analysis has been seen by contractors to be an impost imposed by Government organisations and it is only in fairly recent times that they have begun to recognize its possibilities as an operational management tool. The adoption of the industry developed EVMS outlined in ANSI/EIA-748-1998 has made the concept more workable for contractors, but even so Fleming and Koppelman (1998) note that it is likely that more than 99 percent of the projects in the world do not employ the earned-value management concept Earned Value and the Contractor In order to understand the reluctance of industry to embrace earned value principles it is necessary to look at the particular requirements of contractors as opposed to project managers. The use of earned value principles in project management is widespread on cost-reimbursable contracts, where the project manager has the task firstly of limiting the final cost of the project and secondly of ensuring that the project finishes within a reasonable time frame. In this case the contractor supplies the Project Manager with a record of all of his costs, the PM can ascertain what work has been done and the cost and schedule variances and EAC are readily calculated. In the case of fixed price contracts the usefulness of earned value analysis is limited because in this case the earned value (EV) is by definition equal to the actual cost (AC) claimed by the contractor. In this case the Clients cost variance is zero. The Contractors cost variance is only of importance to the project manager in so far as the PM needs to be aware of large losses that might cause bankruptcy. Fleming and Koppelman (2002) recommend that in this instance contractors be required to supply a financial projection of their anticipated costs and certify each cost period that they have not exceeded their own forecasted values and if they have, to disclose the amounts of their costs incurred. Whilst an admirable concept this approach is unlikely to be accepted by Contractors, who as Fleming and Koppelman point out, Are often reluctant (they adamantly refuse) to disclose to the owner how much profit they are making on a given job and are just as unlikely to disclose losses. The Contractor in a fixed price contract is concerned with three requirements relating to cost and time performance. 1. His estimated costs at completion of the project, as this determines his profit/loss on the project. The expected cost variance at the end of the project represents a reduction/increase in the profit made on the project. 2. His performance in relation to the planned schedule of works. This is mainly monitored by use of a scheduling program such as Microsoft Project . Although progress may be compared to the original baseline schedule the Contractor usually ends up providing a new baseline at the end of each reporting period, which is then used in the subsequent period to measure progress during that period. 3. His cost performance in relation to the actual work done during a reporting period. Traditional earned value analysis is unable to provide the third requirement and is of limited use in the second, unless the schedule variance is related to time. Either way the actual schedule is a better indicator of program slip. Real Time Earned Value According to Wilkins (1999) the concept of earned value was actually developed as early as the 1800s as a means of measuring performance on the factory floor. In this case the value of the physical output (earned value) for a given period was compared to the actual costs in order to calculate a cost variance which was used to assess the cost efficiency of the factory (Fleming &

Koppelman, 1998). The schedule efficiency of the factory was obtained by comparing the planned output to the physical output. Because factories operate on a continuous basis costs were compared on a periodic basis rather than on a continuous (S-curve) basis as used in modern earned value as applied to projects. Results obtained during a particular reporting period would be used to assess the efficiency of the factory and production methods altered if needed for the next reporting period (Plan-Do-Check-Act). Two elements of this approach are relevant to Contractors 1. Analysis is carried out in real time i.e. cost variances are relevant to the time period in question. 2. Baseline plans are not fixed but can vary from one reporting period to the next. In order to adopt these principles into a form of real time earned value which would be of use to Contractors the project management form of earned value will need to be modified as follows. 1. Planned costs, earned values and actual costs are reported and analysed periodically rather than cumulatively. Each reporting period is treated as a separate case (sub-project). Consider the following planned S-Curve cost schedule
120 100 Cumulative Cost 80 60 40 20 0 0 1 2 End of Month 3 4 0 20 50 80

100

Figure 1 Original Base Cost Schedule Assume that after the end of the first month project costs are $15 and the project is 10% complete, so that AC = $15 CV = -$5 PV = $20 CPI = 0.67 EV = 10% $100 = $10 SV = -$10 SPI = 0.50

Figure 2 shows the traditional graphical earned value representation

PV 120 Cumulative Cost 100 80 60 40 20 0 0 0 1

15 10

AC

EV

2 End of Month

Figure 2 Earned value Graph at End of Month 1 The original base cost schedule shown in Figure 1 can be broken down into monthly costs, as shown in Figure 3.

35 30 25 20 15 10 5 0 1 2 Month
Figure 3 - Monthly Planned Cost Schedule

Monthly Cost

Now if we redefine real time earned value as EV* = Earned Value for Period = % Complete PV for the Period Planned Value then EV*= 0.5 $20 = $10 (In this case the work expected to be done in month 1 is 50% complete) AC* = Actual Costs for period = $15 PV* = Planned Value for Period = $20 Cost Variance = EV* AC* = $10 - $15 = -$5 The work remaining is equal to BAC EV* = $100 $10 = $90 These results are shown graphically in Figure 4.

35 30 Monthly Cost 25 20 15 10 5 0 1 2 Month 3 4 CV SV PV* AC* EV*

Figure 4 - Real Time Earned Value 2. The schedule of planned costs is updated each period to form a new planned value for the forthcoming period. Contractors do not generally work with a fixed cost-time schedule, but are continually updating the original work program to suit changing circumstances such as variations to the contract or the need to speed up progress of the work. Most contractors also use Gantt charts for keeping track of their schedule so in that sense there is nothing really to be gained by separately calculating a schedule variance in terms of a dollar amount. Action plans are prepared for each new cost period and progress before that period is largely irrelevant in monitoring future work. Costs already incurred cannot be changed and overall progress in terms of time is important only in terms of affecting the speed with which the remaining work is programmed to be carried out. Consider the example given in Figure 1 and assume that at the end of month 1 PV, AC and EV are as per Figure 2. Assume now that possible savings are identified by the Contractor and the work is rescheduled so that it will be back on track at the end of month 2. A revised baseline schedule is then prepared as per Figure 5. Here the planned value at the end of month 1 is the earned value, i.e.$10 .

Original Schedule 120 100 Cumulative Cost 80 60 40 20 0 0 0 1 10 2

Revised Schedule

100 80 50

End of Month
Figure 5 Revised Schedule

Now suppose that costs in month 2 were $35 and the project is 50% complete. Now, according to the original baseline (traditional analysis) AC = $15 +$35 = $50 CV = 0 CPI = 1.00 PV = $50 SV = 0 EV = $50 SPI = 1.00

According to the Client we are now back on track. However in terms of the revised budget for month 2 AC* = $35 CV* = $5 (positive)
45 40 Monthly Cost ($) 35 30 25 20 15 10 5 0 1 2 Month 3 4

PV* = $40 (50-10) CPI* = 1.14

EV* = 100% $40 =$40 SV* = 0 SPI* = 1.00

Cost Variance

PV* AC* EV*

Figure 6 Earned Value Graph at End of Month 2 Figure 6 gives us much more useful information than the traditional cumulative analysis. It shows that we have turned the project around in month 2 and the cost and schedule variances can be read directly off the figure. The CPI was 0.67 in month 1 and is 1.14 for month 2. Let us look at the more normal situation that would be faced by the Contractor at the end of month 1. Seeing as he still has 90% of the work to do this will probably mean that the schedule will have to be extended into the next month. Also seeing as the cost variance is $5 it will mean that if the cost of the remaining work is as planned the final cost will be at least $105. The Contractor will then revise his budget accordingly, possibly as shown in Figure 7. Note that in this case the original budget for month 1 is ignored it is past history. The Contractor is only interested in what the earned value was for month 1, which becomes part of his revised budget.
Original Budget Revised Budget

40
Monthly Cost

30 20 10 0 1 2 3
Month

Figure 7 Original and Revised Budgets (PV)

Now assume that at the end of month 2 actual costs are $34 and the work planned for that month is 90% complete Then PV* = $30 EV* = 0.90 $30 = $27 AC* = $34 Cost Variance = -$7

This is represented graphically in Figure 8.

Orig. PV

PV*

AC*

EV*

40 30 Cost 20 10 0 1 2 3 Months
Figure 8 - Graphical Representation of Progress 3. A trend line analysis is used to predict the final cost variance based on a tracking of the cumulative cost variances Figure 9 is the same as Figure 8 but with the cumulative cost variance plotted. Since the variance is negative it is plotted below the x axis.

Orig. PV 40 30 20 10 Cost 0 -10 -20 -30 -40 1 2

PV*

AC*
Time Now

EV*

Cum Cost Var

Months

Figure 9 - Real Time Progress Chart

Cost variances are plotted at the end of each reporting period and extrapolated by a trend line analysis to predict the final cost variance to be expected on the project. The trend line could be a straight line , curve or moving average. Figure 9 shows that the cost variance at the end of month 1 is -$5, at the end of month 2 is -$12, and that the predicted cost variance at the end of month 5 will be -$30, or -$26 if the work is finished in the middle of the month. Conclusions The traditional use of earned value analysis has been as a cost and schedule control tool that can be used by management to keep an overall track on the performance of a project. The main deficiency in this approach for a contractors project manager is that it is cumulative and fails to separate recent performance with that of the past. In order for earned value analysis to be useful as a performance management tool for a contractor it needs to be modified to reflect real time performance ,i.e. planned costs, actual costs and earned value need to be calculated on a periodic basis, and baselines adjusted to reflect reality. References 1. 2. 3. 4. 5. Wilkens, Tammo T,1999, Earned Value, Clear and Simple, http://www.acq.osd.mil/pm/paperpres/wilkins_art.pdf Fleming,Q.W., & Koppelman, J.M., 1998, Earned Value Project Management, A Powerful Tool for Software Projects, http://www.stsc.hill.af.mil?crosstalk/1998/07/value.asp Christensen,D.S.,1999,Using the Earned Value Cost Management Report to Evaluate the Contractors Estimate at Completion, Acquisition Review Quarterly, Summer. Fleming,Q.W. & Koppelman,J.M., Earned Value Management Mitigating the Risks Associated with Construction Projects, PM, March-April. ANSI/EIA-748-1998, "Earned Value Management Systems