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Determining project cost performance

CFO: How is your project doing?

PM: Pretty good. We have met 8 of our 12 milestones and have a contingency plan to complete the other 4. We have to contract with a new vendor and increased the development team by 3 developers. Those changes will bring us back on track to hit our usability test dates.


That all sounds good, but the project’s cost performance (or financial performance) metrics may say otherwise.  Furthermore, had the project stakeholders been aware of Cost Variance (CV) and Cost Performance Index (CPI) metrics on a regular basis, financial concerns might have been revealed earlier in the project.

In this blog we will review how to determine and report on your project’s cost performance by calculating the Cost Variances and Cost Performance Indexes.

Warning: in order to produce useful cost performance metrics, the project scope must be fully identified, and all accompanying work packages must be estimated. Refer to the Scope Management Knowledge Area in PMI’s PMBOK for supporting information on developing a Work Breakdown Structure (WBS) and tools and techniques you can use to estimate work packages identified in the WBS.

Cost Management Plan

Your Cost Management Plan should clearly define how you as the Project Manager will manage costs, as well as which project costs will be measured, reported, and controlled.  Specifically, the Cost Management Plan identifies:

  • How to Measure Project Costs
  • The Cost Reporting Format
  • Cost Variance Response Processes

Cost Management Approach

Project costs get tracked and reported using Control Accounts (CAs).  From a cost perspective, a control account is a management control point wherein the costs of all sub-tasks are rolled up or summarized for performance measurement.  Control accounts are placed at selected management points in the WBS. (PMBOK, 4th Ed. Pg. 121.)

The Project Manager determines at which WBS level to create the Control Accounts, based on the size and complexity of the project.  The project estimates are created at the work package level and would ideally be reported at that level.  However, large or complex projects may be deemed too difficult or time consuming to manage costs at the work package level, and in such cases the Project Manager should determine the appropriate WBS level for reporting cost performance. Although activity cost estimates should be created at the work package level, the level of accuracy for cost management will be reported per Control Account.

How to Measure Project Costs

The Project Manager is responsible for managing and reporting on the project’s cost throughout the duration of the project.  During the project status meeting, the Project Manager should report on two cost-related Earned Value measurements: Cost Variance (CV) and Cost Performance Index (CPI).  For many projects, these cost measurements along with Schedule Variance (SV) and Schedule Performance (SPI) provide sufficient financial detail for the Project Sponsor to provide oversight.

Definitions

Earned Value (EV), also known as the Budgeted Cost of Work Performed (BCWP), is the value ($) of work performed expressed in terms of the approved budget assigned to the work for a task or Control Account (WBS component).  It is the authorized work that has been completed, plus the authorized budget for such completed work (PMBOK, 4th Ed.).

Actual Cost (AC), is just as it sounds, the dollar, or other applicable currency, cost to perform the associated task(s).  The Actual Cost has to correspond in definition to whatever was measured in the EV, that is, direct hours (labor) only, direct costs (labor and materials) only, or all costs including indirect costs (PMBOK, 4th Ed.).

Cost Performance Index (CPI) is a measure of the value of the work completed compared to the actual cost or progress made on the project.  CPI is a critical metric because it quantifies the cost efficiency of the work completed.  It is calculated as EV/AC (PMBOK, 4th Ed.).  If CPI is equal to 1 the reportable control account is perfectly on budget.  If the CPI is greater than 1 the control account is under budget, if it’s less than 1 the control account is over budget.

Cost Variance (CV) is a measure of cost performance on a project.  It is equal to EV minus the Actual Costs (AC), (PMBOK, 4th Ed.).  If CV is zero, then the reportable control account is perfectly on budget.  If CV is greater than zero, the control account is earning more value than planned thus it’s under budget.  If CV is less than zero, the control account is earning less value than planned thus it’s over budget.

Now Let’s Look at an Example

The total planned budget for a 4-day task is $100 and it starts on a Monday. When the status date is set to the following Wednesday the Actual Cost (AC) for this period is $70, and the Earned Value (EV) is $60.

CPI=EV/AC or $60/$70=.86 CV=EV-AV or $60-$70=-$10

Cost Variance Response Processes

CPI is Yellow When CPI is between 0.9 and 0.8 (-10%)

CPI is Red When CPI less than 0.8 (-20%)

CV is Yellow When CV of the Control Account is between -.1% and -10%.

CPI is Red When CV of the Control Account is between -10.1% or lower.

According to the CPI and CV the Control Account in our above example is over budget and should be reported as Yellow.

The Cost Management Plan defines the control thresholds for the project, as stated in “How to Measure Project Costs.” If the CPI has a variance of between 0.1 and 0.2 (Yellow), the Project Manager must report the reason for the exception.

If the CPI has a variance of greater than 0.2 (Red), the Project Manager must report the reason for the exception and provide management a detailed corrective plan to bring the projects performance back to acceptable levels.

The Project Manager will present the Project Sponsor with options for corrective actions within an agreed-upon turnaround time from when the violating cost variance was reported. The Project Sponsor will agree to a corrective action or discuss additional options.  Once a corrective action plan has been determined, reviewed, and accepted the Project Manager will update the project plan, and all project reporting controls will reflect the corrective actions.

Try It

The Cost Performance metrics identified in the Cost Management Plan are not difficult to calculate, so long as the project scope is well defined, the estimates have been provided with sufficient accuracy, and the budget has been determined for all planned tasks.  The next time your CFO asks you, “How is project doing,?”  blow her away with your Cost Performance Metrics.

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