Scheduling Blog Series Part 5: Earned Value for Business Owners
Wouldn’t you like to know whether your projects are “on-cost” and “on-time” anytime during the project? Earned Value allows this determination to happen. Earned value is an abstract concept, but it is more understandable to the business person when it’s compared to an income statement’s revenue recognition.
Some project scheduling software allows the computation of Earned Value.
Earned Value also assess schedule performance better than percentage completion.
Revenue Recognition Defined
Generally accepted US accounting principles (GAAP) allows revenue to be claimed based upon the costs incurred to produce, incrementally or fully, a good or service authorized by a client contract or purchase order. For example, if 75% of a contract or purchase order has been completed, then the company can recognize 75% of the revenue, calculated this way: revenue recognized = contract cost to do the work completed * (1+gross margin percent). The contract cost is the estimate used to price the good or service originally.
Actual Cost Adjustment
When actual cost does not equal estimated cost, the accountants change the gross margin accordingly. Fortunately, Earned Value does not require this adjustment.
Pro Forma Comparison
A company periodically compares revenue recognized to pro forma revenue. This is for monitoring and controlling financial performance. Actual costs from Accounting are used in the computations.
Parallel to Earned Value
Activities can have a cost component, too
You need to have schedule software that allows cost assignment to activities.
Cost can be comprised of labor cost, material cost, expense, and salaries. Accounting should advise what kinds of costs a project shall carry.
Actual Cost Adjustment
Earned value is the same except that the 1+gross margin term is left out. Only the final project estimate costs are used. There’s no need to change costs when actual cost differs.
Pro Forma Comparison
Periodically (monthly recommended), actual costs for the types of costs entered in to the project schedule are summed and compared to the earned value reported by the schedule for the same period. This tells management whether the project is costing more or less than estimated.
The schedule reports earned value “EV” or “BCWP” (for budgeted cost of work performed). EV and BCWP are the same thing. When EV is greater than actual cost, the Variance will be a positive number. That’s a good thing. Defined, Cost Variance = EV (or BCWP) – AC (for actual cost).
Schedule Software Capability Needed
Some schedule software reports monthly earned value, others report value to date. If you operate large projects or want to have monthly variances always available, choose software that can report monthly earned value. If you are using Earned Value for the first time, you can do just fine with value-to-date software and avoid the additional administrative effort.
Time Performance Measurement
Earned Value practice has a dimension not found in accounting. It’s called Schedule Variance. This advises how far you’re ahead or behind schedule in terms of cost. This is a bit abstract, but not so if you think being ahead of schedule is the unrecognized cost of work done beyond expectation. And being behind schedule as the cost of work that should have been done.
The schedule reports PV, for planned value (otherwise called BCWS – the budgeted cost of work scheduled). This is what the work would cost if all the Gantt bars of the schedule showed progress just up to the date of interest. Activities scheduled to be completed ahead of this date would be considered 100% complete. The date of interest is called the Status Date. Some schedule software requires you to select it, others assume the current date is the Status Date.
Defined, Schedule Variance (SV) = EV (or BCWP) – PV (or BCWS). A positive result is a good thing.
Schedule Variance is better than relying upon percentage completes for time performance measurement. Percentage comparison doesn’t consider the different cost of activities. Your project could indicate being ahead of schedule based upon percentage complete, but there could be a small number of activities behind schedule that have a lot more cost attributed to them. (As my daughter would say, “Busted!”)
The Fine Print
Necessity to Baseline First
Scheduling software that does Earned Value allows the user to baseline the schedule. If, during the project, activities get moved around (i. e. by changing start or due dates, duration, linkages, or costs), earned value calculations would change. Changing the schedule as time progresses happens, but it would ruin the original data if it weren’t for a baseline. After the original schedule is completed and approved, it needs to be baselined and backed-up to another drive. Baselining saves the current schedule data. The schedule software refers to it for earned value calculations. Baselining is effected by just a selection of a command in the software. It is done once.
Software projects and projects whose objective is planning can cause troubles for Earned Value. Percentage completions in software projects can be found later as unrealistic if code considered complete is found later needing to be re-written. Very often, this happens. Projects that plan are subject to discoveries and findings that can change the direction of work.
Earned Value is a powerful way to measure cost and schedule performance. It has no equal when progress percentage is reflective of the work done.