Implementing Earned Value Method On Lump Sum Contracts

Construction Contractors who are keen on implementing the earned value method (EVM) technique to monitor and evaluate their projects’ performance understand that EVM cannot be implemented as is on lump sum contracts. Those contractors understand that the amount earned for completing works on site does not necessarily tally with the actual cost incurred in completing the same scope of work. This could be attributed to many reasons including but not limited to front loaded contracts, unbalanced bids, differing progress percentage complete calculation for invoicing the project owner than those used by subcontractors and suppliers, subcontracts and material supplies using currencies different than the project currency, site and home office overhead cost, contingency and management reserve allowance, funding and project finance cost among others.

To resolve this issue and take advantage of the EVM technique in providing objective performance metrics that are critical for assessing the project’s efficiency in meeting the target performance budget, the organization needs to run two sets EVM of metrics. The first will be based on the contract that the contractor has with the project owner, also known as Revenue Contract, and the second will be based on the project’s cost commitments for awarded subcontracts and purchase orders and non-commitment cost for site and home office overhead and miscellaneous invoices.

Establishing the Project Performance Budget

The first step for EVM performance reporting is to ensure that there is an approved project performance budget. This budget is based on the approved cost estimate for the different work packages that were established using the Work Breakdown Structure (WBS). In addition, it covers the additional project cost that are attributed to site and home office overhead, contingency allowance for accepted risks, management reserve for unknown risks, project funding and finance cost, profit among others. PMWeb Project Management Information System will be used to capture all budget versions until the organization has an approved performance budget baseline.

The budget planned spending (PV) will detail the spending that organization anticipates to have during the project duration. This requires aligning the budget with the project’s integrated schedule by associating each budget line item with the relevant project schedule activity. The spending plan for each financial period covered by the activity could be front loaded, back loaded, linear, bell shaped or any other curve format that is aligned on how actually the budget will be sent.

The project performance budget will be used to establish the project’s bid proposal. It should be noted that some of the budget’s WBS levels will not be displayed in the Bill of Quantity established by the project owner. Those would usually include site and home office overhead, contingency allowance for accepted risks, management reserve for unknown risks, project funding and finance cost, profit among others. In addition, the contractor might decide to front load some of the early planned work packages to secure additional revenue to fund the project. Further, some contractors might decide to unbalance their bids to take advantage of scope of work that could be subject to increased where those items will be priced with higher profit margin than other scope of work that might not be subject to change. The most important that the total of the performance budget should not change regardless how the project budget is distributed.

PMWeb project revenue module will be used to capture all proposal versions including the one that the formal awarded contract represents. The revenue module allows capturing the retention on completed works and material stored on site, advance payment recovery, VAT and other adjustments. In addition, it allows capturing all change orders as well as progress invoices which will detail the schedule earned value.

In addition, the project performance budget will become the basis for awarding the subcontracts and purchase orders that the contractor will use to procure work packages that will be delivered by the selected subcontractors and suppliers. During the procurement stage, the project performance budget line items could be subject to increase or decrease depending on actual values of the awarded subcontracts and purchase orders. Some contractors might decide to create a new performance budget taking into account the new values while many others prefer to adjust the values of the approved performance budget to match the values of the awarded commitments. This will require using PMWeb budget request module to increase or decrease budget line items by shifting funds from one work package to another including shifting funds from the project contingency.

Monitoring and Evaluating Project’s Schedule Variance and Schedule Performance Index

The awarded project contract or revenue contract will be distributed on the project’s integrated schedule activities to produce what is known as the cost loaded project schedule using applications like Oracle Primavera P6. This will establish the Schedule Budget At Completion (SBAC) value for each project schedule activity. This cost loaded schedule will be used to calculate the Schedule Planned Value (SPL) for each period and Schedule Earned Value (SEV) which will be based on the approved percent complete at the end of each specific progress period multiplied by the Schedule Budget At Completion (SBAC) for the relevant activity. This will provide the two EVM metrics Schedule Variance (SV) and Schedule Performance Index (SPI).

There is a growing trend to have pre-agreed activity accomplishment weight values to calculate the percent complete for the progressed project schedule activities. This will expedite the process on agreeing on what percent complete each activity should have based on tangible achievements or deliverables. Usually, those are calculations are done in MS XLS and then the weighted percent complete for each activity will be either uploaded manually or imported by having an interface between Oracle Primavera P6 and MS XLS.

Those EVM metrics will provide the contractor along with the critical path method (CPM) total float (TF) value with a better understanding on the project schedule performance from two aspects. The first is how good the contractor in earning the revenue contract value in alignment to the cost loaded baseline schedule while the second aspect is how good the contractor in achieving the project’s milestone dates including the project completion date.

Managing the Project Cost Variance and Cost Performance Index

The same approved project budget will be used to place the actual commitments against the project. Those could be subcontract agreements, material supplies as well as internal company commitments such as plant, project management, overhead contribution. The different commitment agreements will be detailed to the same cost breakdown structure levels, which could be identical to the WBS levels, used in the project performance budget and revenue contract.

On monthly basis, the subcontractors, supplier and contractor’s project management team and other business units involved in the project delivery will submit the monthly project invoice for completed works and material on site. This will represent the actual cost (AC) incurred by the contractor for delivering the project’s scope of work. It is highly recommended to use the same percent complete used in the revenue contract to calculate the percent complete of commitments unless there are pre-agreed percentages to evaluate the actual cost of completed work in those commitments. Those could include for example cost of material procured and equipment mobilized. Retention of completed works and material on site will adjust the amount that the subcontractors and suppliers will be entitled to have.

Should the actual cost for delivering the project is not fully captured in the awarded commitments, PMWeb allows capturing actual cost from timesheets and miscellaneous invoices. The timesheet module allows capturing the labor and non-labor resource hours against each cost breakdown structure as well as project schedule activity. The captured hours can be based on normal working hours, overtime, weekend and other type of hours. The rate for each hour type will vary depending on the organization’s approach in calculating premium hours.

The miscellaneous invoices can be used to capture cost of services, material and other items that are not part of a commitment contract. The progress invoices can have multi-currency value that could differ from the project budget currecny depending on what is being purchased.

Using the budget’s earned value (EV) and actual cost (AC) captured in the commitments’ progress invoices and non-commitment actual cost captured in miscellaneous invoices and timesheets, the project’s cost variance (CV) and cost performance index (CPI) will be calculated. The earned value (EV) for each cost center will be calculated by multiplying the current budget with the approved percent complete for the cost center as calculated by the updated project schedule. This will allow calculating the other cost metrics including estimate to complete (ETC), estimate at completion (EAC) and variance at completion (VAC).

The Earned Value Performance Report

The schedule and cost earned value metrics calculated above will become the basis for reporting the project’s performance using the earned value metrics. In addition, they will be used to create a new metric that will called Risk Alert Index (RAI) which is based on the values of the schedule and cost performance indices. Further, the report will display the current project Total Float (TF) value to indicate the delay in the project’s completion date. This report will exclude the details of the project budget and commitments as those considered to be internal transactions and not to be shared. Of course, those cost transactions and metrics will be closely monitored and evaluated by the assigned project team members using other reports with restricted access.

The schedule variance and cost variance as well as schedule performance index and cost performance index metrics, risk alert index and total float performance trends can be also monitored and evaluated across the project periods. The report will also have a chart to display the planned percent complete for each period as per the approved cost loaded schedule as well as the actual percent complete to date.

Conclusion

The earned value method is an excellent technique to monitor and evaluate the performance of construction projects. Nevertheless, for lump sum contracts, the earned value method cannot be implemented as it is as the selling price will not only not match the target cost price but also could have different funds allocation for each WBS level. This occurs because of front loading and unbalancing the selling price to take into consideration the contingency and management reserve allowance, project financing cost, home office overhead, profit among others. To overcome this issue, two planned spending values and earned values need to be calculated for the project. The first will be based on the selling price and the second will be based on the approved current budget. This will enable having the EVM metrics be used in a way that are best suited for Lump Sum contracts.