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Earned Value Management

by Geoff Keston

Copyright 2018, Faulkner Information
Services. All Rights Reserved.

Docid: 00018938

Publication Date: 1808

Report Type: TUTORIAL

Preview

Earned value management is a set of techniques providing a
systematic measure of the two most important project metrics: budget
control and adherence to schedule. Understanding the terminology and
calculations used in earned value management helps managers to
accurately guage project performance and quickly identify budget
overruns and schedule problems.

Report Contents:

• Executive Summary
• Description
• Current View
• Recommendations
• Web Links
• Related
  Reports

Executive Summary

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Earned value management is an approach to measuring and
predicting performance on a project.

It can be used for both financial and scheduling calculations.
Project and program managers are the primary users of earned value
techniques, which they employ to oversee projects and determine when
they must issue reports to upper management, customers, investors, or
other stakeholders.

Earned value management is employed more routinely by
government agencies and the private companies that work for them than
it is on strictly private sector projects. The approach assists US
government agencies in meeting regulations imposed by the Budget
Enforcement Act Of 1990, the OMB Circular A-11 Government Performance
and Results Act Of 1993, the Federal Acquisition Streamlining Act Of
1994 (Title V), and the Clinger-Cohen Act Of 1996. In the private
sector, earned value management is much more likely to be used on large
projects than on medium-sized or small efforts.

From one organization to the next, the techniques that project
teams use to measure and manage earned value are fundamentally
similar. Differences in terminology and the way that
techniques are applied can, however, make it difficult for business
partners to use a shared earned value management program.

The three most important elements in an earned value
management program are the following:

1. Baselining – Setting
   standards for budgets and scheduling, against which to compare earned
   value measurements.
2. Issuing Progress Reports – Using
   earned value calculations to measure performance during a project and
   distributing this information to project stakeholders.
3. Responding to Contingencies – Anticipating
   possible events that could alter a project and developing an effective
   response plan.

Using earned value management provides the following advantages, as
described by the American Management Association:

• “Alerts you to potential problems in time to be proactive
  instead of reactive.
• “Allows you to demonstrate clearly your timely
  accomplishments.
• “Provides the basis for significant improvement in internal
  and external communications.
• “Provides a powerful marketing tool for future projects and
  programs that require high management content.
• “Provides the basis for consistent, effective management
  system-based training and education.
• “Provides a more definitive indication of the cost and
  schedule impact of project problems.
• “Allows tremendous flexibility in its application.”¹

But there are also some downsides, most notably the extra
time, money, and effort that using a formal discipline requires.²

Description

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Earned value management is a practice that, based on a series of
metrics and
calculations, is used to measure cost and schedule adherence on a
project.
One prominent user is NASA, whose approach to employing the practice is
available in a detailed handbook published online.³

Differences in terminology and in the way that certain key
values are calculated can create confusion within the discipline and
make it difficult for business partners to apply earned value
principles on a shared project. Despite some conflicts, however, there
is fundamental agreement on what factors should be measured and on how
to derive these measurements.

Project management, a discipline of which earned value
management is a component, has become fairly standardized. Much of the
standardization work was performed by the Project Management Institute,
which publishes the discipline’s key written guideline, the Project
Management Body of Knowledge (PMBOK). The documentation of earned value
calculations provided by the PMBOK has helped to standardize and
popularize earned value management. With the field now more
standardized, there are several commercial applications available to
make earned value management calculations. Examples include Deltek
Cobra, Microsoft Project, Oracle’s Primavera, and QuantumPM Earned
Value Manager.

Table 1 describes the key variables used in making earned
value management calculations; the amounts to be used for these
variables are determined through standard accounting practices and
estimating techniques.

Table 2 describes the key earned value metrics and their
respective formulas.

Current View

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Although cloud and mobile technology have changed IT
dramatically over the past few years, earned value management remains a
relevant practice, even if it is sometimes applied in more flexible
ways to accommodate newer agile development methods.⁴
In particular, the practice remains highly important in government
projects.⁵
Organizations that do business with the government are often required
by agency policies to use earned value techniques. For example, the US
Department of Energy requires the following: “A
contractor must undergo a review by an independent team of DOE
personnel of its EVM policies, procedures and implementation to ensure
the 32 basic guidelines in the EIA-748 standard are met.”⁶
(EIA-748 is a set of earned value management guidelines published by
the National Defense Industrial Association, a non-profit national
security industry group.)

However, the growth of earned value management and the
magnitude of its role within companies’ decision-making processes may
always be held in check by limitations in the discipline’s ability to
quantify all types of business considerations. Earned value
calculations can identify the costs of an individual project, but they
cannot identify all of the potential benefits, financial and otherwise,
nor can they be used as the ultimate determinant of the value of a
project. For instance, the value of a loss leader, in which a company
decides that a project that loses money is advantageous because it
leads to future profits, cannot be measured through earned value.
Benefits of loss leaders are often subjective and based on gut-feeling
estimates; they include, among other considerations, the value of
gaining favor with a large customer and the knowledge that employees
will gain from implementing a new technology.

Currently, two of the most significant issues within the field
are the differences between projectized and functional organizations
and the relationship between earned value management and a
methodology, known as agile development, for creating software.

Projectized vs. Functional Organizations

The difficult part of measuring actual costs on a project is
ensuring that all applicable expenses are linked to the project. For
instance, if an engineer is dispatched to a remote site in order to
perform work on a project and subsequently submits an expense report
for mileage and meals, are those costs attributed to that particular
project or simply absorbed as part of a company’s general cost of doing
business? Organizations should have mechanisms in place to measure all
of the direct costs associated with performing a project, and there
should be checks to ensure that these mechanisms are not manipulated to
falsely represent a project as being under budget. Despite an increased
emphasis over the past several years on project management and cost
control, achieving these goals remains difficult.

Broadly speaking, organizations can be categorized as
“projectized” or “functional.” A projectized organization manages all
of its business activities as discrete projects. Each project is
controlled by an individual project manager, and the team members may
work on several simultaneous projects without belonging to a particular
department. Functional organizations divide employees into separate
departments, such as accounting or IT. Each department is run by a
manager and operates independently of the activities of the other
departments. Employees are rigidly assigned to their departments.

In practice, most organizations fall somewhere in between the
theoretical descriptions of a projectized organization and a functional
organization. In the past, most organizations closely resembled the
functional model, having few projectized characteristics. Today,
however, the balance is slowly shifting closer to the projectized
model. The more projectized an organization is, the more likely it is
to use earned value management.

A projectized organization’s policies typically require that
all expense requests and purchases be attached to a specific project or
activity, such as training. The record for each expense or purchase
request includes a standardized code attaching it to its respective
project. With the appropriate reporting mechanisms in place, these
expenses will then be associated to a project’s actual cost tally.
Organizations that are heavily projectized also use a standardized
chart of accounts to categorize project expenses. A chart of accounts
is a system for grouping expenses by type and then labeling each type
according to a systematic numbering scheme. For instance, liabilities
may be tagged with numbers beginning in “9” while assets may be coded
with numbers beginning in “8.” Most accounting departments will use a
chart of accounts; using the same numbering system for projects will
simplify financial management.

Agile Development and Earned Value Management

Earned value management depends on a stable baseline for
which, ideally, details are determined at the start of a project and do
not materially change during its course. Many projects,
however, are more volatile and must, by necessity or convenience,
accommodate mid-course corrections. For example, in
software projects, the concept of “agile development” may be
employed.

According to analyst John Zyskowski, “Agile development
rejects the idea that one can determine upfront every feature a new
system should have — especially if a project might take years to
complete because user requirements and priorities will likely change in
that time. Instead, project managers using agile development
start with only a high-level definition of the project’s requirements
— and, of course, a schedule and budget.”⁷

Recommendations

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Earned value management is used in planning, executing, and
controlling projects. Baselining is the key earned value planning step.
Measuring progress and responding to contingencies are the key
applications of earned value techniques in the execution and control
phases of a project.

Baselining

A baseline is a plan against which project
performance is
judged. A project will typically have separate baselines for cost and
schedule. Key variables such as budget at completion and planned value
are determined relative to the appropriate baseline. An important goal
of measuring costs and schedule adherence against a baseline is to
prevent “scope creep,” a phenomenon in which the original goals of a
project expand without authorization. The metrics cost variance and
schedule variance (see Table 2) provide “early warning signs” of scope
creep, enabling project managers to take action soon after a problem
first appears.⁸

Earned value measurements are most effective when they are
performed on individual project tasks, at the same level at which the
project schedule is broken down. A “work breakdown structure” is a
division of a project’s deliverables into units that are small enough
to apply effective forecasting and management techniques. Organizations
sometimes apply the “8/80 rule,” which says that projects should be
divided into units that will take no less than eight hours and no more
than 80 hours to complete. Baseline considerations include the
following:

• Material Costs – Material
  costs include the purchase of raw materials used in manufacturing, as
  well as materials such as patch cables used on a data networking
  project. On a project performed under a time and materials contract,
  the cost of materials is billed directly to the customer, although
  there may be limits as to how much can be purchased. Under any type of
  contract, it is essential to forecast all of the materials that will be
  needed to complete a project and to have a system through which
  material costs are recorded and assigned against particular projects.
• Labor Costs – Organizations
  should define a cost for each employee’s labor. For contractors, that
  amount is simply the amount directly paid out to them. For full-time,
  salaried employees, however, the cost calculation can only be used as a
  rough guideline because other factors come into play. While the labor
  hours of subcontractors can be measured based on their hourly rate, the
  cost of labor for salaried employees is more difficult to determine. If
  an employee spends 10 hours on a project, the cost of that labor cannot
  be determined by simply translating that person’s salary to an hourly
  wage and then multiplying that hourly wage by the number of hours
  worked. During a slow business period, any billable work that an
  employee performs amounts to a positive sum, since the alternative is
  that the person does not help to generate any income. If the employee
  is working on a high-value project, however, the opportunity cost of
  pulling the person away from that project may be substantial.
  Opportunity cost is the term used to describe the value of an
  opportunity that was foregone in order to focus time and resources on
  something else.
• Service Costs – Service costs
  include expenses for third-party services such as the following:
  • Transportation – This
    category includes mileage, airfare, and other transportation expenses.
  • Lodging – A baseline
    should identify hotel and per-diem fees for workers.
  • Communications – Fees for
    phone calls, videoconferencing services, and other communications may
    become significant on a large project, particularly those that span
    multiple countries.
  • Shipping – The cost of
    shipping everything from routine letters to heavy equipment weighing
    hundreds of pounds should be considered.

Services costs tend to accumulate in small increments and are
therefore often the most difficult to predict and record. Their
cumulative impact can be significant, however, and cannot be ignored as
part of baselining. The list above focuses on the most common types of
direct costs. Measuring indirect, or “soft,” costs remains elusive
within the practice of earned value management. Soft costs should still
be considered when creating a project plan, however, although they will
not typically play a role in earned value management.

The term “earned value” implies financial concerns, but earned
value management is used as much for measuring time as for
money. Time on a project is typically marked in the following ways:

• Calendar Units – A calendar
  unit is the basic unit of measurement for charting time on a project. A
  schedule baseline will define the calendar units to be used on a
  project. Labor hours (the total number of hours worked by each person)
  or days are the most common units.
• Management Control Points –
  Also known as a “cost account plan” or a “control account plan,” a
  management control point is a scheduled point in a project’s work
  breakdown structure at which cost, progress, and other key factors are
  measured. A baseline will define the management control points on a
  project.
• Phases – Projects of a
  significant scale are usually divided into phases. Each phase may have
  a separate baseline, and the results of an early phase may alter the
  baseline of a later phase.

Progress Reports

Organizations must determine how frequently they will perform
earned value measurements. Compiling the data necessary to perform
earned value calculations often takes time and effort, so scheduling
progress reports too frequently may create an undue burden. Progress
reports can be scheduled based on the completion of particular tasks or
phases, or they can be scheduled at discrete time intervals. The former
approach cannot capture delays that may hold up a task while it is
being performed, and the latter approach is often too arbitrary and not
adequately adjusted to the project’s specific elements. A combination
of both approaches will be most effective.

The integrity of the data used to perform earned value
calculations is commonly undermined by two forces: techniques that are
insufficient to measure essential figures and deliberate
miscalculations to hide cost and schedule overruns. Organizations
should implement checks and balances to ensure that earned value
calculations are developed according to best practices and that
progress reports give an accurate view of a project.

A communications plan is the component of a project plan that
determines what information will be distributed, who will receive each
type of information, and when the information will be distributed.
Earned value calculations provide information in various levels of
granularity. For executives and other stakeholders who are interested
only in the big picture, the most effective metrics are the cost
performance index and schedule performance index.

An approach that is used on some large-scale construction or
manufacturing projects, particularly by government agencies, is weekly
earned value. By performing earned value calculations each week,
organizations get a current status of a project’s progress and are able
to identify potential problems more quickly than they could by
performing the calculations less frequently. The amount of time spent
performing weekly calculations adds a cost to the project, however.
Weekly earned value management is most efficient when it is limited to
measuring only key metrics rather than the full set of metrics that
might be calculated at key project milestones. The approach is also
best suited for projects involving new technology, as it is difficult
to make reasonable estimates in advance without a historical reference
point, and for projects in which tight deadlines make even minor delays
unacceptable.

Responding to Contingencies

Progress reports are ultimately useful only if a project team
responds to variances that are reported. A comprehensive risk response
plan will identify the variances that may occur and detail the steps
that will be taken to address them. The component of a risk response
plan relevant to earned value management is the contingency reserve,
which is an amount of money set aside at the beginning of a project to
account for negative cost variances. The main calculation used for
contingency planning is as follows:

• Likelihood of Event x Effect of Risk = Financial Impact.
• Calculate the sum of the financial impacts.
• The cumulative financial impact is the contingency reserve.

In project management lingo, the term “risks” sometimes refers
equally to positive outcomes as to negative ones. An example of a
positive risk would be an unexpected reduction in the cost of materials
needed to complete a project. Table 3 is a sample exercise for
calculating a contingency reserve; an actual contingency list would
include many more items.

Based on the sample above, an organization would set aside
$13,000 to cover a potential budget overrun based on unscheduled events.

References

¹ Paul C. Dinsmore and Jeannette
Cabanis-Brewin. “The AMA Handbook of Project Management.”
American Management Association. 2014.

² Ibid.

³ See

“Earned Value Management (EVM)
Implementation Handbook.” NASA. January 2018.

⁴ Donovan Burba. “EVM Still Has Value.”
Project Management Institute. February 2015.

⁵ Jason Miller. “OFPP Tells Agencies to Trust But Verify Acquisition Oversight Systems.” Federal
News Radio. November 9, 2015.

⁶ “Earned Value Management.” US Department of Energy, Office
of Environmental Management.

⁷ John Zyskowski. “Project Management’s
Not-So-Odd Couple.” Federal Computer Week.
January 12, 2011.

⁸ “Earned Value Management As a Best Practice for Program Management.” Artemis. January 30, 2018.

Web Links

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• American Management Association: http://www.amanet.org/
  Deltek:http://www.deltek.com/
• Microsoft: http://www.microsoft.com/
• NASA EVM: https://www.nasa.gov/offices/oce/functions/evm/index.html
• NASA EVM Implementation Handbook: https://evm.nasa.gov/handbooks.html
• National Defense Industrial Association: http://www.ndia.org/
• QuantumPM: http://www.quantumpm.com/
• Oracle: http://www.oracle.com/
• Project Management Institute (PMI): http://www.pmi.org/
• US Government Accountability Office (GAO): http://www.gao.gov/

About the Author

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Geoff Keston is the author of
more than 250 articles that help organizations find opportunities in
business trends and technology. He also works directly with clients to
develop communications strategies that improve processes and customer
relationships. Mr. Keston has worked as a project manager for a major
technology consulting and services company and is a Microsoft Certified
Systems Engineer and a Certified Novell Administrator.

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