Earned value management is an essential part of the Project Cost Management knowledge area and an important topic for the PMP® certification exam. There are several terms and formulas in earned value management that those in PMP certification training must understand and memorize for the exam.
In this article, we will take a look at these important terms and formulas that are useful for earned value calculations.
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What Is Earned Value?
To understand the concept of earned value, think about the concept of debits and credits. In a double-entry accounting system, for every debit to one account, there is a corresponding credit to another account. Earned value is similar to this concept. When you spend a dollar on labor for your project, you are “earning” a dollar’s value back into your project. Therefore, all project tasks—including code development, documentation, and other functions—earn value back into your project.
History of Earned Value Management
EVM emerged as a financial analysis specialty in United States Government programs in the 1960s, but it has since then become a significant branch of project management and cost engineering. Early EVM research showed that the areas of planning (remember: planning is iterative!) & control is significantly impacted by the use of an objective technique such as EVM. The use of EVM also provides a useful analysis of overall project performance. The use and popularity of EVM have grown significantly prompting many to rely on it extensively over the years and in multi-faceted projects.
The importance of EVM can be exemplified by the fact that in 1991, Secretary of Defense Dick Cheney canceled the Navy A-12 Avenger II Program due to performance issues detected by EVM.
An overview of EVM was included in the first PMBOK® Guide in 1987 and expanded in subsequent editions. The construction industry was an early commercial adopter of EVM. Closer integration of EVM with the practice of project management accelerated in the 1990s.
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Understanding Earned Value Management
The foundation principle of EVM does not depend on the size or complexity of the project. However, the implementations of EVM can vary significantly depending on the circumstances.
- The first step is to define the work. This is typically done through WBS, or work breakdown structure which is a hierarchical arrangement of activities. A WBS is a top-down approach, breaking down project deliverables into activities that can be controlled & measured. (See PMBOK® chapter 3 & PMP® Exam Prep 7th Edition by Rita Mulcahy Chapter 5).
- The second step is to assign a value, called planned value (PV), to each activity. This value can be in units of currency or labor hours and is a part of the total budget allocation of the project for that particular deliverable. (See PMBOK® guide & PMP® Exam Prep 7th Edition by Rita Mulcahy chapters on Time & Cost Management).
- The third step is to define “earning rules” for each activity. This simply means how the progress of each activity is measured. Some popular rules are 0/100, which means that no credit is available for starting the activity & 100% credit is applied when the activity is finished. 50/50, 25/75 & 20/80 are some other rules which are applied basis the activity complexity & significance. (See PMP® Exam Prep 7th Edition by Rita Mulcahy, Chapter 7).
- The final step is to execute the project according to the plan and measure progress. When activities are started or finished, EV is accumulated according to the earning rule.
Henceforth, Earned value Management is used to analyze the project performance, calculate the variance for schedule and cost and indicates where the project stands in comparison to the estimates calculated earlier for this point in time.
Earned Value Formulas
Budget at Completion (BAC)
BAC is the sum of all budgets established for the work to be performed. It indicates how much was initially planned for the project to cost. No single formula exists. BAC is derived by looking at the total budgeted cost of the project.
Planned Value (PV), or Budgeted Cost of the Work Scheduled (BCWS)
Planned value is the authorized budget assigned to the scheduled work and does not include management reserve. It indicates how much work should have been completed at a point in time based on a plan. It is derived by measuring planned work completed at a point in time.
- PV = Planned % complete * BAC
Earned Value (EV), or Budgeted Cost of the Work Performed (BCWP)
The earned value management indicates how much work was completed during a given period. It is the budget associated with the authorized work that has been completed. It is derived by measuring actual work completed at a point in the schedule.
- Actual % complete * BAC
Actual Cost (AC), or Actual Cost of Work Performed (ACWP)
The actual cost is the realized cost incurred for the work performed on an activity during a specific time period. It indicates the money spent during a given period of time.
- The sum of the costs for the given period.
Cost Variance (CV)
Cost variance is the difference between what we expected to spend and what was spent. It is expressed as a difference between earned value and the actual cost.
- CV = EV - AC
Schedule Variance (SV)
Schedule variance indicates the difference between where we planned to be in the schedule and where we are in the schedule. It is expressed as a difference between the earned value and the planned value.
- SV = EV - PV
Cost Performance Index (CPI)
Cost Performance Index is the rate at which the project performance is meeting cost expectations during a given period of time. It is expressed as a ratio of the earned value to the actual cost.
- CPI = EV / AC
Schedule Performance Index (SPI)
Schedule Performance Index is the rate at which the project performance is meeting schedule expectations up to a point in time. It is expressed as a ratio of earned value to planned value.
- SPI = EV / PV
Estimate at Completion (EAC)
Estimate at completion is the expected total cost of completing all work. It projects the total cost at completion based on project performance up to a point in time.
- EAC = BAC / CPI – If the CPI is expected to be the same for the remainder of the project, the EAC can be calculated using this formula.
- EAC = AC + BAC - EV – If the future work is accomplished at a planned rate, the EAC can be calculated using this formula.
- EAC = AC + Bottom-Up ETC – If the initial plan is no longer valid, the EAC can be calculated using this formula.
- EAC = AC + (BAC - EV ) / (CPI * SPI ) – If both the CPI and SPI influences the remaining work, the EAC can be calculated using this formula.
Estimate To Complete (ETC)
The estimate to complete is the expected cost to finish all the remaining work. It projects how much more will be spent on the project, based on past performance.
- ETC = EAC - AC – Assuming that the work is proceeding to plan, the cost of completing the remaining authorized work can be calculated using this formula.
Variance at Completion (VAC)
Variance at completion is the projection of the amount of budget deficit or surplus. It is expressed as a difference between budget at completion and the estimate at completion.
- VAC = BAC - EAC
To Complete Performance Index (TCPI)
To complete performance index describes the performance that must be achieved to meet the financial or schedule goals. It is expressed as a ratio of the cost to finish the outstanding work to the budget available.
- TCPI = BAC - EV / BAC - AC – The efficiency that must be maintained to complete to plan.
- TCPI = BAC - EV / EAC - AC – The efficiency that must be maintained to complete the current EAC.
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It’s safe to conclude that earned value management is an important topic to determine if you’re working on your project management certification. If you’re looking for a PMP course online, Simplilearn has several project management courses, including PMP certification training that is designed to help you pass the PMP exam in your first attempt. You’ll get project management training online by faculty with at least ten years of industry experience.
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