In the Portfolio Management as well as in all other areas of the organization the financials are paramount and need to be tracked and kept under control and the Portfolio Management is no exception here. Three respectively four - depending on the maturity of the PMO organization - are important to track. This article will focus on financial forecasts and how to use them.
First let’s have a look at some important definitions.
The budget of the project is defining the spending limit and also an component of the value KPIs. So it is the financial figure on which the decision to execute the project is basing.
The actual spending or actual costs (AC) is the amount that is or was already spent. It is reducing the amount of money that still can be used. Furthermore it is an indicator for the project progress.
The forecast which is a very important figure. Together with the actual spending it builds the Estimation at Complete (EAC). Important to note is that this figure is not a fact as the spending our budget but an estimation so it will (almost) never be 100% accurate.
The sum of all forecasts is also called Estimation to Complete (ETC). The sum of the actual costs and the estimation to complete is called Estimate at Complete (EAC)
The last of the four are the commitments that have been made for example with external suppliers. The commitments are not yet spent money but as good as because of contractual liabilities. The actual spending and the commitments should never be above the budget limit.
All these figures can be aggregated on portfolio level and are this way very interesting for the portfolio manager but also for the other stakeholders of the portfolio.
Spending Performance of Projects
The spending of the project is the most visible KPI in the project management and hence also one of the most misleading ones. It is one of the three sides of the so called magic triangle. The others are schedule (time) and scope. One approach to track the progress of two sides of the triangle (cost and schedule) is the Earned Value Analysis (EVA) a method that was developed by the US Army to track their projects by measuring and comparing three financial parameters:
PV – the Planned Value. This is the predicted spending at a certain point in time. This point in time can be a milestone in the project plan or on activity that has been executed. It depends how detailed the analysis is performed. The more tracking points you have the better the execution can be controlled.
EV – the Earned Value. Sometimes difficult to explain to the project managers, but value doesn’t mean here the value that the project is adding to the organization at the point in time (in fact in most cases there is no value for the organization until the project is fully completed). The earned value is the total spending for a milestone or activity when it is completed resp. achieved. If your project is 100% on track then EV = PV and you earn as much in a certain point in time as you have planned for.
AC – Actual Costs. This parameter is easy to understand. These are the actual costs summed up from the start of the project until the point in time when you are measuring your performance.
PV, EV and AC can be drawn on a chart to illustrate the planned, actual and predicted progress of the project.
The blue Planned Value shows the typical S-curve of a project with a slower start, going into full speed in the middle and slow down towards the end of the project again.
For each activity in the Work-Breakdown-Structure (WBS) a value is defined (equal to the planned total costs of the activity) which is “earned” once the activity is completed. The Earned Value is the sum of all completed planned values at the current state of the project.
There are various approaches of earning and each project management office can define its own way. The common three ways are
- The earned value is “charged” per 100% at the end. This is the conservative approach and the project manager only counts what was delivered.
- 50% of the Earned Value is given to the project when the activity starts and the rest of 50% at the completion of the activity. This gives a more balanced picture of the progress, but leads to the situation that Project Managers are triggering a lot of activities to gain value for their project, especially before an important steering committee meeting.
- The other extreme is to earn the full 100% of the activities value when the activity is started. This approach has even more the disadvantage to “cheat” concerning the progress and hence is not recommended.
Important is that whatever you choose as an approach is needs to be the same for all activities and milestones.
With this three figures you can calculate the progress on a cost and deliverables basis.
The ratio between actual costs and planned value (which is equivalent to planned cost) gives the project manager and indication about his or her spending progress.
Cost Variance (CV)
The cost variance is defined as the difference between the Earned Value and the actual costs.
If the Cost Variance is positive it means that you have used less money as planned and your project is currently below budget. The difference between underspending and being below budget is, that the project is progressing but with costs that are below the current cost plan. Very ofthen it is the case that risks didn't materialized but in can also be a sign that there is too much contigency reserves in the project.
Cost Performance Index (CPI)
Only looking at absolute numbers such as the cost variance can give you the wrong picture because for example a value of 10’000 USD is a great value for a small project whereas for a large multi-million program it means that the progress is more or less as planned (which is also a good sign but not great). To better understand the relation between Earned Value and Actual Costs the Cost Performance Index is used together with the CV.
A value above 1 means the project is below budget.
With the Earned Value Analysis it is also possible to track the schedule performance and this is one feature that makes EVA very powerful. The Earned Value can be compared with the planned one and the deviation gives some insights how the project progresses on the schedule side. The process is analogous of the Cost Variance.
Schedule Variance (SV)
The difference between the Earned and Planned Value is giving you information of how much your project has delivered more (or less) value versus the schedule.
A positive value means that the project has delivered more than what was planned and is hence ahead of the schedule. Of course a negative value means the opposite.
Schedule Performance Indicator (SPI)
As with every Variance a look at the relative deviation is useful to enable yourself to judge better if the variance is material or not. For this the SPI is useful to be considered as well.
The CV, CPI, SV and SPI are good KPIs to understand the progress from the start of the project until now. But what about the future of the project? The portfolio manager not only needs to have a look in the back mirror but also ahead of the road where his or her portfolio is moving. Here the importance of good forecasts comes into play.
Two major approaches of forecasting are important to understand
- Bottom-Up forecast
- Top-down forecast
The bottom-up forecast is performed by the project or program manager and is done on the lowest level.
- Period, e.g. month
- Cost Element, e.g. travel costs, third party personnel costs, etc.
The forecasted spend can be aggregated on period and cumulated to what is called Estimate to Complete (EAC). In the Earned Value Management the Estimate at Complete is defined as the Estimation to Complete (EAC) plus what was spent so far (AC)
Now this figure can be can be validated by the portfolio manager by using the top-down EAC.
BAC stands here for Budget at Complete as is the overall project or program budget that has been agreed when the project or program had been approved. Basically the top-down EAC is the budgeted cost divided by the cost performance indicator. Remember a CPI above one means the project is performing below the planned budget and so in this case the EAC will be lower than the BAC, which means the project will probably not fully need the assigned money.
You as a portfolio manager can now compare the EACtop-down against the EACbottom-up.
One-time effects are triggered by risks and opportunities that occur or occur not and they can be easily explained and tracked as such. For the portfolio manager it is beneficial to understand if the risk management of the project was appropriately performed. Questions to ask are for example was the likelihood of a risk estimated realistically or the impact. In any case the one-time effects impact the project plan in higher or lower costs (or shorter or longer duration) but do not change the remaining estimation to complete. The estimation to complete needs to be adjusted according the one-time impact but no other actions are necessary, except a lessons learnt session to get a better understanding of the deviation and how similar situations can be avoided in the future.
On the other side there are deviations to the project plan that are not originating in an one-time effect but are deriving from a planning failure. In most of the times this failure is coming from wrong assumptions and this makes it so important that the assumptions are reviewed at the beginning. An example could be that the project manager assumes that the installation time of a certain device needs half of a day, but in reality it needs one full day because the process is much more complex than assumed. So if there are hundreds of devices then the project cannot be implemented as planned as there is a systematic failure in the whole planning.
The implementation of the Earned Value Method is not easy to implement. For each element of the Work-Breakdown strucutre (WBS) a special account or accounting rules need to be defined to assign the costs to the right WBS element to track the actual costs (AC). This is of course extra work for the project manager as well and has to be performed carefully so no costs flow into the wrong activity.