We can think about getting our money’s worth when it comes to project spending as well. If you budget to purchase $1000 in project materials, you expect to receive the proper amount of material, not less. You also don’t expect to receive more than you ordered and be invoiced for the extra, right? Exactly. You expect to receive just what you ordered and to be invoiced for the budgeted cost. However, not all project expenses can be known in advance, so we have to estimate those costs when we plan the project activities and the ensuing budget.
If you estimate and budget to spend $1000 on material, and it ends up costing exactly $1000, then that is pretty efficient estimating! In Earned Value Management terms, we call this efficiency result your “spending efficiency.” For every dollar the project team spends, how much value is received? If you spend a dollar and receive a dollar in value, then your spending efficiency is 100%. If you spend a dollar and only receive 95 cents in value, then your spending efficiency is 95%.
Spending efficiency is also called the Cost Performance Index. It is not an indicator of how well you execute your spending plan, nor is it an indicator of how well you create your spending plan. It is a measure of how well you do both – together – a combined efficiency rating.
For example, suppose your project was budgeted to spend $1000 in the first month. After that month, you have performed the project work that was scheduled, but it ended up only costing $900 instead of the budgeted $1000. So, we consider the value that was achieved to be $1000 (the BCWP – budgeted cost of work performed, or Earned Value). But you achieved that value at an actual cost of $900. So, your spending efficiency, or CPI (Cost Performance Index) is calculated as:
CPI = EV ÷ AC = $1000 ÷ $900 = 1.111, or 111%
“Great, Louis! I like to be efficient in spending a dollar, but what does this have to do with forecasting?”
Recall my previous post (http://wwwqa.gvs-online.website/2011/03/forecasting-when-the-train-is-right-on-track/) about forecasting when the remaining spending is expected to be right on track with the plan. In that scenario, where the actual cost is the same as the budgeted cost, the spending efficiency is 100%.
Now let’s look at the scenario in which actual spending is NOT on track with the budget. Rather than re-estimate the remaining work, let’s just take a look at our spending efficiency. Create the forecast based on continuing the same efficiency throughout the remainder of the project. This is actually the default method to be considered on the PMP® Exam unless you are provided with a specific scenario with a different prescribed approach.
Using this approach, you can calculate the Estimate At Complete with the following formula:
EAC = BAC ÷ CPI
This relationship simply means that to achieve the project value of BAC, you’ll spend EAC due to the spending efficiency CPI. If BAC is $1000 and your spending efficiency CPI is less than 1, then EAC will be larger than BAC, or greater than $1000.
For example, Project XYZ’s budget is one million dollars. During the project life, you find you are over budget, spending more than planned to achieve the project. If you calculate the CPI to be 95%, or .95, then what should you forecast for the Estimate At Complete?
EAC = BAC ÷ CPI = $1,000,000 ÷ .95 = $1,052,632
Your forecast is to be $52,632 over budget at the end of the project. This makes sense for a spending efficiency less than 100%.
For the PMP® Exam candidate, consider this approach to be the default approach. If you are not provided enough information in the question statement to guide you to another scenario and approach, then use this approach.
In my next and last post in this series, I will introduce what I like to call the Double-Whammy. How to forecast when nothing is going as planned!