Every project boils down to money. If you had a bigger budget, you could probably get more people to do your project more quickly and deliver more. That’s why no project plan is complete until you come up with a budget. But no matter whether your project is big or small, and no matter how many resources and activities are in it, the process for figuring out the bottom line is always the same!
The Head First Lounge is doing so well that the guys are going to go ahead and open another Lounge near you! They’re renting a basement bar, and now all they need to do is renovate it.
When they start planning out what to buy, they want really expensive original retro stuff—the biggest bar they can find, and seventies textiles for the walls, floor, and upholstery, plus accessories—this is going to cost a lot of money...
Jeff: That bar is soooo cool! I can just imagine mixing up some crazy elixirs at parties!
Alice: Look. I know you want the new Lounge to look as good as the original, but you only have a little spare cash to spend on this. That means you have a limit of $10,000.
Charles: We should be able to get the new place looking so sweet with that!
Alice: Costs can creep up on you if you don’t watch what you’re doing. The best way to handle this is to create a budget and check your progress against it as you go.
Jeff: You always turn everything into a project, even mixing elixirs! Can’t we just have fun with this?
Alice: Not if you don’t want to go into debt.
To make sure that they don’t go over budget, Jeff, Charles, and Alice sit down and come up with detailed estimates of their costs. Once they have that, they add up the cost estimates into a budget and then they track the project according to that budget while the work is happening.
This means figuring out exactly how much you expect each work activity you are doing to cost. So each activity is estimated for its time and materials cost, and any other known factors that can be figured in.
Here’s where all of the estimates are added up and baselined. Once you have figured out the baseline, that’s what all future expenditures are compared to.
Alice wants to keep the Lounge project’s costs under control, and that starts with the Estimate Costs process. Before Alice can estimate costs, she needs the scope baseline. Once she knows who’s doing what work, and how long it’ll take, she can figure out how much it will cost.
Analogous Estimating is sometimes called “Top-Down Estimating”
Take a minute and think about why it would be called “top-down.” When you’re doing bottom-up estimating, first you break it down into pieces, estimate each piece, and add them up. Analogous estimation is the opposite: you start with the whole project (without breaking it up at all), find other projects that were like it, and use those projects to come up with a new estimate.
Good question.
Not all of the estimation techniques for cost are the same as the ones we used for time. Often, people only have a certain amount of time to devote to a project and a fixed amount of money too. So, it makes sense that some of the tools for estimating both would overlap. We’ll learn a few new ones next.
A lot of times you come into a project and there is already an expectation of how much it will cost or how much time it will take. When you make an estimate really early in the project and you don’t know much about it, that estimate is called a Rough Order of Magnitude estimate. (You’ll also see it called a ROM, or a ballpark estimate.) It’s expected that it will get more refined as time goes on and you learn more about the project. Here are some more tools and techniques used to estimate cost:
This estimate is REALLY rough! It’s got a range of -50% to +50%, which means it can be anywhere from half to one and a half times the actual cost! So you only use it at the very beginning of the project.
Project managers will often use specialized estimating software to help come up with cost estimates (like a spreadsheet that takes resource estimates, labor costs, and materials costs and performs calculations).
Sometimes you will need to work with an external contractor to get your project done. You might even have more than one contractor bid on the job. This tool is all about evaluating those bids and choosing the one you will go with.
You’ll see this in action when we look at risk management in Chapter 11.
You need to set aside some money for cost overruns. If you know that your project has a risk of something expensive happening, better to have some cash laying around to deal with it. Reserve analysis means putting some cash away just in case.
Cost of Quality is how much money it takes to do the project right.
You will need to figure the cost of all of your quality-related activities into the overall budget, too. Since it’s cheaper to find bugs earlier in the project than later, there are always quality costs associated with everything your project produces. Cost of Quality is just a way of tracking the cost of those activities.
Since the next chapter is all about quality, you’ll be learning a lot about this in Chapter 8.
There are a few numbers that will appear on the test as definitions. You won’t need to calculate these, but you should know what each term means.
Benefit cost ratio (BCR)
This is the amount of money a project is going to make versus how much it will cost to build it. Generally, if the benefit is higher than the cost, the project is a good investment.
You’ll get exam questions asking you to use BCR or NPV to compare two projects. The higher these numbers are, the better!
Net present value (NPV)
This is the actual value at a given time of the project minus all of the costs associated with it. This includes the time it takes to build it and labor as well as materials. People calculate this number to see if it’s worth doing a project.
Money you’ll get in three years isn’t worth as much to you as money you’re getting today. NPV takes the “time value” of money into consideration, so you can pick the project with the best value in today’s dollars.
Opportunity cost
When an organization has to choose between two projects, they are always giving up the money they would have made on the one they don’t do. That’s called opportunity cost. It’s the money you don’t get because you chose not to do a project.
If a project will make your company $150,000, then the opportunity cost of selecting another project instead is $150,000 because that’s how much your company’s missing out on by not doing the project.
Internal rate of return
This is the amount of money the project will return to the company that is funding it. It’s how much money a project is making the company. It’s usually expressed as a percentage of the funding that has been allocated to it.
Depreciation
This is the rate at which your project loses value over time. So, if you are building a project that will only be marketable at a high price for a short period of time, the product loses value as time goes on.
Lifecycle costing
Before you get started on a project, it’s really useful to figure out how much you expect it to cost—not just to develop, but to support the product once it’s in place and being used by the customer.
Once you’ve applied all of the tools in this process, you’ll get an estimate for how much your project will cost. It’s always important to keep all of your supporting estimate information, too. That way, you know the assumptions you made when you were coming up with your numbers.
This is the cost estimate for all of the activities in your activity list. It takes into account resource rates and estimated duration of the activities.
Just like the WBS has a WBS Dictionary, and the Activity List has Activity Attributes, the cost estimate has supporting detail called the Basis of Cost Estimates. Here is where you list out all of the rates and reasoning you have used to come to the numbers you are presenting in your estimates.
Along the way, you might find that you need to change the way you measure and manage cost. These updates allow you to make changes to the Project Management Plan to deal with those improvements.
As you figure out how much the activities will cost, you may realize that the scope or schedule or risk register or anything else you have baselined needs to change. When that happens, you need to create a change request and send it through the change control system.
Jeff: OK, how do we start? There are a lot of things to buy here.
Alice: We already have your savings, and the rest will come in July at the end of the quarter. The Lounge is having another great year, so the profits are pretty good. Your savings are around $4,000 and the profits will probably be closer to $6,000. That’s definitely enough money to work with.
Charles: Well the furniture I want isn’t back in stock until June.
Alice: OK, so we have to time our costs so that they’re in line with our cash flow.
Jeff: Oh! I see. So we can start building now, but we’ll still have money in June and July when the furniture comes in. Perfect.
Once Alice has cost estimates for each activity, she’s ready to put a budget together. The she does that using the Determine Budget process. Here’s where you take the estimates that you came up with and build a budget out of them. You’ll build on the Activity Cost Estimates and Basis of Cost Estimate that you came up with in Estimate Costs.
You use the outputs from the last process where you created estimates as inputs to this one. Now you can build your budget.
The inputs to Determine Budget are largely the same ones that you saw in Estimate Costs, with the notable additions of Activity Cost Estimates and Basis of Cost Estimate.
Roll up your estimates into control accounts
This tool is called cost aggregation. You take your activity estimates and roll them up into control accounts on your Work Breakdown Structure. That makes it easy for you to know what each work package in your project is going to cost.
Come up with your reserves
When you evaluate the risks to your project, you will set aside some cash reserves to deal with any issues that might come your way.
Your company’s management plans for project overruns! |
Just because you plan out a budget in your Cost Performance Baseline, that doesn’t mean your project is 100% guaranteed to fall inside that budget. It’s common for a company to have a standard policy for keeping a management reserve to cover unexpected, unplanned costs. When you need to get your project funded, that funding has to cover both the budget in your Cost Performance Baseline and the management reserve. |
Use your expert judgment
Here’s where you compare your project to historical data that has been collected on other projects to give your budget some grounding in real-world experience, and you use your own expertise and the expertise of others to come up with a realistic budget to cover your project’s costs.
Make sure you haven’t blown your limits
This tool is Funding Limit Reconciliation. Since most people work in companies that aren’t willing to throw unlimited money at a project, you need to be sure that you can do the project within the amount that your company is willing to spend.
Build a baseline
Just like your scope and schedule baselines, a Cost Performance Baseline is a snapshot of the planned budget. You compare your actual performance against the baseline so you always know how you are doing versus what you planned.
Figure out funding requirements
It’s not enough to have an overall number that everyone can agree to. You need to plan out how and when you will spend it, and document those plans in the project funding requirements. This output is about figuring out how you will make sure your project has money when it’s needed, and that you have enough to cover unexpected risks as well as known cost increases that change with time.
Update your project documents
Once you have estimated and produced your baseline and funding requirements, you need to update your cost management plan with anything you learned along the way.
Join the Head First PMP community at http://www.headfirstlabs.com/PMP You can add your Head Libs answer, and see what Head Libs other project managers came up with!
When something unexpected comes up, you need to understand its impact on your budget and make sure that you react in the best way for your project. Just like changes can cause delays in the schedule, they can also cause cost overruns. The Control Costs process is all about knowing how you are doing compared to your plan and making adjustments when necessary.
The tools in Control Costs are all about helping you figure out where to make changes so you don’t overrun your budget.
Here’s where you measure how your project is doing compared to the plan. This involves using the earned value formulas to assess your project.
The to-complete performance index (TCPI) is a calculation that you can use to help you figure out how well your project needs to perform in the future in order to stay on budget.
Reviews are meetings where the project team reviews performance data to examine the variance between actual performance and the baseline. Earned value management is used to calculate and track the variance. Over time, these meetings are a good place to look into trends in the data.
Use the information you have about the project right now to predict how close it will come to its goals if it keeps going the way it has been. Forecasting uses some earned value numbers to help you come up with preventative and corrective actions that can keep your project on the right track.
You can use software packages to track your budget and make it easier to know where you might run into trouble.
Throughout your project, you are looking at how you are doing as compared to your plan. The variance between planned and actual performance needs to be carefully analyzed so you can head off problems before they make your project go over budget.
Forecasting and performance measurement are very important! You use them to find the changes you need to make in your project.
The tools in Control Costs are all about helping you figure out where to make changes so you don’t overrun your budget.
How much money are you planning on spending on your project? Once you add up all of the costs for every activity and resource, you’ll get a final number... and that’s the total project budget. If you only have a certain amount of money to spend, you’d better make sure that you haven’t gone over!
If you look at your schedule and see that you’re supposed to have done a certain percentage of the work, then that’s the percent of the total budget that you’ve “earned” so far. This value is known as Planned Value. Here’s how you calculate it.
First, write down your
BAC—Budget At Completion
This is the first number you think of when you work on your project costs. It’s the total budget that you have for your project—how much you plan to spend on your project.
Then multiply that by your
Planned % Complete
If the schedule says that your team should have done 300 hours of work so far, and they will work a total of 1,000 hours on the project, then your Planned % Complete is 30%.
The resulting number is your
PV—Planned Value
This is how much of your budget you planned on using so far. If the BAC is $200,000, and the schedule says your Planned % Complete is 30%, then the Planned Value is $200,000 × 30% = $60,000.
Not yet, it doesn’t.
But wouldn’t be nice if, when your schedule said you were supposed to be 37.5% complete with the work, then you knew that you’d actually spent 37.5% of your budget?
Well, in the real world things don’t always work like that, but there are ways to work out—approximately—how far on (or off) track your budget actually is.
When Alice wants to track how her project is doing versus the budget, she uses Earned Value. This is a technique where you figure out how much of your project’s value has been delivered to the customer so far. You can do this by comparing the value of what your schedule says you should have delivered against the value of what you actually delivered.
Your schedule tells you a lot about where you are supposed to be right now.
The actual cost of this project on May 14th is $1,650. The planned value was $2,200.
If you could estimate each activity exactly, every single time, you wouldn’t need Earned Value. Your schedule would always be perfectly accurate, and you would always be exactly on budget.
But you know that real projects don’t really work that way! That’s why Earned Value is so useful—it helps you put a number on how far off track your project actually is. And that can be a really powerful tool for evaluating your progress and reporting your results. Here’s how you calculate it.
When you do work, you convert the money your sponsor invests in your project into value. So, Earned Value is about how much work you have been able to accomplish with the money you’ve been given. When you calculate Earned Value, you’re showing your sponsor how much value that investment has earned.
First, write down your
BAC—Budget At Completion
Remember, this is the total budget that you have for your project.
Then multiply that by your
Actual % Complete
Say the schedule says that your team should have done 300 hours of work so far, out of a total of 1,000. But you talk to your team and find out they actually completed 35% of the work. That means the actual % complete is 35%.
The resulting number is your
EV—Earned Value
This figure tells you how much your project actually earned. Every hour that each team member works adds value to the project. You can figure it out by taking the percentage of the hours that the team has actually worked and multiplying it by the BAC. If the total cost of the project is $200,000, then the Earned Value is $200,000 × 35% = $70,000.
What’s the difference between Actual Cost and Planned Value? What does it mean if your AC is bigger than your PV? What if it’s smaller?
This is a harder problem to solve than it seems! Take a minute and really think about it before you turn the page.
You’ll be doing a lot of calculations in a minute. The best way to approach any calculation is to understand what it’s for and why you use it. So before you go on, go and grab a cup of coffee and think for a few minutes about the the difference between BAC and PV. Also, how do you compute Actual % Complete on a real project? Doing that will really help you get these ideas firmly embedded into your brain!
Earned Value is one of the most difficult concepts that you need to understand for the PMP exam. The reason it’s so confusing for so many people is that these calculations seem a little weird and arbitrary to a lot of project managers.
But they make a lot more sense if you think about your project the way your sponsor thinks about it. If you put yourself into the sponsor’s shoes, you’ll see that this stuff actually makes sense!
Think about Earned Value from the sponsor’s perspective. It all makes a lot more sense then.
Let’s say you’re an executive:
You’re making a decision to spend $300,000 of your company’s money on a project. To a project manager, that’s a project’s budget. But to you, the sponsor, that’s $300,000 of value you expect to get!
So how much value is the project delivering?
If you put the value in dollar terms, your sponsor knows what return he’s getting for his investment.
If you’re the sponsor, you’re thinking about the bottom line. And that bottom line is whether or not you’re getting your money’s worth from the project. If the team’s done 50% of the work, then you’ve gotten $150,000 of value so far.
But if the schedule says that they should have done 60% of the work by now, then you’re getting less value than you were promised!
The sponsor doesn’t care as much about how you spend the budget. He just wants to get the most value for his money!
You can definitely use them to track the schedule and budget on smaller projects.
But once your projects start getting more complex, your formulas are going to need to take into account that you’ve got several people all doing different activities, and that could make it harder to track whether you’re ahead of schedule or over budget.
So now that you know how to calculate PV and EV, they’re all you need to stay on top of everything... What are you waiting for? Flip the page to find out how!
Figuring out if you’re on track in a small project with just a few people is easy. But what if you have dozens or hundreds of people doing lots of different activities? And what if some of them are on track, some are ahead of schedule, and some of them are behind? It starts to get hard to even figure out whether you’re meeting your goals.
Wouldn’t it be great if there were an easy way to figure out if you’re ahead or behind schedule? Well, good news: that’s exactly what earned value is used for!
If you want to know whether you’re ahead of or behind schedule, use SPIs. The key to using this is that when you’re ahead of schedule, you’ve earned more value than planned! So EV will be bigger than PV.
To work out your SPI, you just divide your EV by your PV.
It’s easy to see how variance works. The bigger the difference between what you planned and what you actually earned, the bigger the variance.
So, if you want to know how much ahead or behind schedule you are, just subtract PV from EV.
You can do the same thing for your budget that you can do for your schedule. The calculations are almost exactly the same, except instead of using Planned Value—which tells you how much work the schedule says you should have done so far—you use Actual Cost (AC). That’s the amount of money that you’ve spent so far on the project.
Measuring your cost difference in dollars is easy, but what if your schedule variance is negative?
A lot of people worry about that, but it’s actually not bad. Planned Value just means that you planned on delivering a certain amount of value to your sponsor at a certain time. An SV of, say, –$5,000, tells you that you haven’t delivered all the value you promised.
This tells you the difference between what you planned on spending and what you actually spent.
So, if you want to know how much under or over budget you are, just take AC away from EV.
This tells you how well your project will need to perform to stay on budget.
CPI is greater than or equal to 1 and CV is positive. When this happens, your actual costs are less than Earned Value, which means the project is delivering more value than it costs.
Earned Value Management (EVM) is just one of the tools and techniques in the Control Costs process, but it’s a big part of PMP exam preparation. When you use these formulas, you’re measuring and analyzing how far off your project is from your plan. Remember, think of everything in terms of how much value you’re delivering to your sponsor! Take a look at the formulas one more time:
Remember, your sponsor always cares most about what the project is worth to him. BAC says how much value he’s getting for the whole project, and EV tells him how much of that value he’s gotten so far.
Name | Formula | What it says | Why you use it |
BAC—Budget at Completion | No formula – it’s the project budget | How much money you’ll spend on the project | To tell the sponsor the total amount of value that he’s getting for the project |
PV—Planned Value | What your schedule says you should have spent | To figure out what value your plan says you should have delivered so far | |
EV—Earned Value | How much of the project’s value you’ve really earned | EV lets you translate how much work the team’s finished into a dollar value | |
AC—Actual Cost | What you’ve actually spent on the project | How much you’ve actually spent so far | The amount of money you spend doesn’t always match the value you get! |
SPI—Schedule Performance Index | Whether you’re behind or ahead of schedule | To figure out whether you’ve delivered the value your schedule said you would | |
SV—Schedule Variance | SV = EV – PV | How much ahead or behind schedule you are | This puts a dollar value on exactly how far ahead or behind schedule you are |
CPI—Cost Performance Index | Whether you’re within your budget or not | Your sponsor is always most interested in the bottom line! | |
TCPI—To-Complete Performance Index | How well your project must perform to stay on budget. | This will let you forecast whether or not you can stick to your budget. | |
CV—Cost Variance | CV = EV – AC | How much above or below your budget you are | Your sponsor needs to know how much it costs to get him the value you deliver |
The whole idea behind the Earned Value Management is that you can use it to easily put a number on how your project is doing. That’s why there will be exam questions that test you on your ability to interpret these numbers! Luckily, it’s pretty easy to evaluate a project based on the EVM formulas.
If the SPI is below 1, then your project is behind schedule. But if you see a CPI under 1, your project is over budget!
You can tell that your project is on track because the two index numbers—CPI and SPI—are both very close to 1, and the variance numbers—CV and SV—are very close to zero dollars. It’s very rare that you’ll get exactly to a CPI of 1 or a SV of $0, but a SPI of 1.02 means you’re very close to on time, and a CV of –$26 means you’re very close to on budget.
If the CPI is much bigger than 1, it means you’re under budget. And you can tell how much under by looking at the CV—that’s what variance is for! It helps you see just how much the actual cost varies from the value you were supposed to earn by now.
When you see a SPI that’s between 0 and 1, that tells you that the project is behind schedule... and that means you’re not delivering enough value to the sponsor! That’s when you check the SV to see how much less value you’re delivering. And the same goes for cost—a low CPI means that your project is over budget, and CV will tell you how much more value you promised to deliver to the sponsor.
Exactly! And when your CPI is really close to 1, it means that every dollar your sponsor’s spending on the project is earning just about a dollar in value.
The biggest thing to remember about all of these numbers is that the lower they are, the worse your project is doing. If you’ve got a SPI of 1.1 and a CPI of 1.15, then you’re within your budget and ahead of schedule. But if you calculate a SPI of 0.6 and a CPI of 0.45, then you’re behind schedule and you’ve blown your budget. And when these ratios are below 1, then you’ll see a negative variance!
Remember:
Lower = Loser
If CPI or SPI is below 1, or if CV or SV is negative, then you’ve got trouble!
There’s another piece of the Earned Value Management, and it’s part of the last tool and technique in Cost Management: forecasting. The idea behind forecasting is that you can use Earned Value to come up with a pretty accurate prediction of what your project will look like when it’s at completion.
If you know your CPI now, you can use it to predict what your project will actually cost when it’s complete. Let’s say that you’re managing a project with a CPI of 0.8 today. If you assume that the CPI will be 0.8 for the rest of the project—and that’s not an unreasonable assumption when you’re far along in the project work—then you can predict your total costs when the project is complete. We call that Estimate at Completion (EAC).
Alice is forecasting how the new Lounge project will look like when it’s done.
There are two useful numbers that you can compute with the EAC. One of them is called Estimate to Complete (ETC), which tells you how much more money you’ll probably spend on your project. And the other one, Variance at Completion (VAC), predicts what your variance will be when the project is done.
You can use EAC, ETC, and VAC to predict what your Earned Value numbers will look like when your project is complete.
Most of the Earned Value questions on the exam will be pretty straightforward: you’ll be given the numbers that you need to plug into a formula, and when you do it you’ll get the answer. But once in a while, you’ll get a question that isn’t quite so straightforward.
... the CPI and Earned Value, and you want to figure out the actual costs. Why would you ever see this? Sometimes it’s hard to figure out how important a project is unless you know how much it’s really spending—if a project is more expensive, people in your company probably care more about it. If you’re told that a project’s CPI is 1.14 and its EV is $350,000, how do you figure out the actual costs?
... the Earned Value and actual percent complete, and you want to figure out the project’s budget. This can be really helpful when you need to “read between the lines” when you need to make a decision about a project when someone doesn’t want to give you all the information you need. When you have a project’s EV of $438,750 and its actual % complete of 32.5%, how do you figure out the total budget (BAC)?
There are some times when you’ll need to flip the formulas upside down! Sometimes you’re going to be on the receiving end of Earned Value numbers. If you’re working at a company with a bunch of project managers, then sometimes you’ll get a report from one of them that only gives you part of the picture!
The Earned Value formulas have numbers divided into or subtracted from EV. SV and SPI use PV, while CV and CPI use AC.
You can use Earned Value to gauge where you need to be to get your project in under budget. TCPI can help you find out not just whether or not you’re on target, but exactly where you need to be to make sure you get things done with the money you have.
Have you ever wondered halfway through a project just how much you’d have to cut costs in order to get it in within your budget? This is how you figure that out!
This number represents a target that your CPI would have to hit in order to hit your forecasted completion cost. If you’re performing within your budgeted cost, it’ll be based on your BAC. If you’re running over your budget, you’ll have to estimate a new EAC and base your TCPI on that.
There are two different formulas for TCPI. One is for when you’re trying to get your project within your original budget, and the other is for when you are trying to get your project done within the Estimate At Completion you’ve determined from Earned Value Calculations.
Alice figured out the BAC and EAC for the bar project and realized that the lounge was over budget, so she did a TCPI calculation to figure out exactly where needed to keep her CPI if she wanted to get the project in without blowing the budget. Alice’s Earned Value calculations have put the lounge renovation project’s numbers here:
The project is over budget! So Alice uses the BAC-based formula to figure out where she needs to keep the CPI for the project if she wants to complete it within the original budget. Here’s the calculation:
So, if the project were going to get back on budget, it would have to run at a 1.17 CPI for the rest of the project to make up for the initial overage. Alice doesn’t think that’s going to happen. Jeff and Charles pushed for stucco in the lounge that cost an extra $750 in the beginning, and, the way things are going, it’s probably a safe bet that there will be a few more cost overruns like that as the project goes on. She prepared a second TCPI to see what the number would be to complete the project based on the current EAC.
When you’re looking at the TCPI for a project, a higher number means it’s time to take a stricter cost management approach. The higher the number, the more you’re going to have to rein in spending on your project and cut costs. When the number is lower than one, you know you’re well within your budget and you can relax a bit.
Jeff and Charles finished the new Lounge! It looks great, and they’re really happy about it... because Alice managed their costs well. She used Earned Value to correct their budget problems, and they managed to cut a few costs while they still had time. And they had just enough money left over at the end to throw a great party for her!