Expected Monetary Value is abbreviated to EMV, so you may also see it called that.
It’s a concept that took me a while to get my head around, but it’s a useful measure to know when thinking about project cost management and project selection.
The challenge I had with understanding EMV is that it’s a calculation about a probability. I prefer to deal in ‘real’ numbers, like payback period or ROI. Having said that, EMV is a tool out there and in use, so it’s worth knowing more about.
How do you calculate EMV?
One of the disadvantages of EMV is that so much of the calculation relies on professional judgement and expert input. In other words, guessing.
EMV is calculated like this:
Probability x (financial) Impact
Let’s take an example.
You have identified a risk with a 20% chance of occurring.
If the risk occurs, it could cost you £500 to deal with it.
The EMV for this risk event is:
Probability = 20%
Impact = -500
0.2 * -500 = -100
You should make sure there is a risk budget allocated of £100 to help offset this risk.
The challenge I have is that if the risk occurs, it is going to cost you £500, not £100, so you won’t have enough. If the risk doesn’t occur, you don’t need any money.
That’s what makes EMV feel very abstract to me, but I understand that it works better across a wider pool of risks. They won’t all happen, so the money you’ve put aside will hopefully be enough to act as contingency for the risks that do occur.
What do you use EMV for?
EMV is a useful measure to help you work out the contingency funds you might need. As we’re talking about probability and the chance of things maybe happening, you can see that there is a strong link to risk management.
You can also use EMV calculations to help determine the best course of action for risk management. If you have two possible ways to mitigate a risk, which one would give you the best EMV result? Do the maths and that helps you with a recommendation for next steps.
You wouldn’t need to use EMV calculations on small projects. It’s really a technique for larger initiatives where you have a lot of risks requiring financial amounts to manage them. It can help you spread the risk budget between risks.
Do you use EMV on your projects? Is there a better way to explain the probability and why it’s OK to not have the full amount of risk budget in your reserve? Or is it just me who finds this concept not very practical?!
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Project managers often get concerned about project cost control. This video talks about what project cost control actually is and why you shouldn’t be worried about getting to grips with your budget. Most of what you have to do is the same type of ‘monitoring and controlling’ you do on other areas of the project, so it isn’t really that different… just with large amounts of cash attached!
This video aims to demystify project cost control and share some thoughts about just getting started.
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You know I’m interested in the financial aspects of project management – I’m even thinking of teaching a workshop on project budgeting and accounting later this year. I feel like I’ve got quite a good understanding of the topic, but I’m constantly learning.
Having only done a very small amount of work in a team I would say is using agile practices, I am by no means an expert in the practical ways of making agile approaches work on project teams. However, there is a lot of guidance out there for people like me who want to learn more.
The Agile Practice Guide, in particular, has some interesting information about how to apply information from the PMBOK® Guide Knowledge Areas to agile work processes. From a financial perspective, here’s my interpretation of how this would work.
Project Cost Management in Agile Environments
Typically, on predictive projects you would do a lot of costing and estimating in advance. For projects with a high degree of uncertainty, or those where you don’t have a fully-fleshed out scope (hello, agile projects), then obviously you don’t have the data to do this level of cost analysis.
Instead, the recommendation is to use “lightweight estimation methods” (although no detail is given as to what these might be) to come up with fast, high level cost forecasts for resource costs. I can see this working when you are forecasting the general length of a particular engagement – even if you simply plan out the resource costs for the next financial period as a basic benchmark.
Detailed costs for things that aren’t people costs do still need to be done. You can’t run a successful business if you aren’t aware of what project work is costing you. It is OK, however, to do those detailed analyses on a more just-in-time and rolling basis.
To be honest, on some of the long programmes I’ve been involved with we’ve taken the same approach. The business case costs might have been fixed from the start, but frankly they were only ever our best estimate at the time. I then worked out detailed forecasts for the actual year we were in, so the Finance team could manage cash flow and we could accurately account for the capital outlay in the current financial year.
Where your budget is fixed, but you still need to be agile in other respects, then your choice is simply to flex scope and schedule to stay within the cost constraints.
Project Procurement Management in Agile Environments
Procurement management is another area where we incur costs, and as project managers, we need to be aware of how to manage that – in all environments.
Typically, procurements I have been involved with have had a protracted contract negotiation at the beginning to come up with a Master Services Agreement, and then you define the current engagement with a Statement of Work. As we needed suppliers to do extra things, we created new SoWs detailing that engagement. This is also how change control worked: the change control process generated either a credit note (when something was being changed and the end result was the development cost less) or a purchase order and an addendum to the current SoW.
It turns out that, according to the Agile Practice Guide, this is a pretty agile way of working.
There probably are projects where it is prudent and necessary to sign a massive contract upfront (ERP deployments spring to mind, from experience!) but generally, staying small with the engagement and working in a flexible way will suit both parties on the majority of projects.
Either way, something that is the same regardless of the project management approach you are taking is the need to document contractual arrangements and file them somewhere you can easily find them again. I have had a few moments in my career where I have sheepishly rung a vendor and asked for a copy of the executed contracts because – whisper it – it wasn’t possible to find our version of the same document.
Don’t make that mistake! Be agile. Be tidy!
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This question: What is project cost control? comes up quite a lot. I’m not sure exactly why, but I think it’s to do with project managers wanting to make sure they are putting adequate measures in place to monitor and control spending. After all, it’s not our money. We are responsible for making sure it gets spent in a way that supports the project’s objectives and is fiscally responsible. It can feel like a lot to ask.
In my experience, it is actually easier managing huge sums of money than it is managing smaller amounts. On a teeny budget, every dollar counts. The larger the budget, the easier it is to manage because you have latitude to make decisions within your control and tolerance limits, such as approving an extra $50 for something or dealing with an invoice that’s 10% more than you expected. Having financial responsibility is a good way to help manage roadblocks and get things done on a project.
OK, so what do we mean by cost control? Generally, we’re talking about processes to do with:
All of these help to ensure the project can be completed within the approved budget.
One of the biggest areas of focus for cost control is budget tracking.
What do you track in a budget?
Let’s say you’ve started the work. What is it that you should be tracking through the project?
You can track:
Actual expenditure itself is a bit of a vague term because it’s often used to encompass three other terms:
Tracking budget KPIs
Another part of cost control is making sure that any financial reporting for the project is complete. Cost is normally a big factor in deciding whether the project is on track for success or not – I’ve certainly found execs to be very interested in the cost performance of projects, especially the larger budgets. They want to know the money is being spent in the way they expect and that we’ve got enough of it to get to the end.
Cost is typically a key performance indicator, but you might find it worthwhile to track other budget related KPIs. In a programme, you might track return on investment for projects that have completed, for example.
Who does project cost control?
The project manager is often fully responsible for project budget management, but you could also have a Finance person attached to the project (I had this once – he was great). Depending on the size of the project, and the size of the budget, you may be able to have someone on the project’s senior team leading on cost tracking.
Your corporate Finance team will also be involved, even if much of the day to day handling of invoices etc comes to you. They may rely on you to approve invoices (because you are best placed to confirm the work is complete) but they’ll be processing the payments in operational systems and checking they have been correctly posted to the right cost centre for accounting purposes.
Another part of cost control happens when the project is formally reviewed. The review happens anyway, and cost is part of the discussion, and part of the decision about whether the project is still viable.
One of the factors to take into consideration is sunk costs – costs that can’t be recovered because they have already been spent or committed including costs that would be incurred if you cancelled a contract or similar.
However, execs sometimes look at sunk costs and think they must continue the project because they’ve already spent money on it, even if all other signs point to the project being stopped. The viability check needs to take that into account: but why throw good money after bad? If you can’t salvage the project, don’t spend more on it just to get it to ‘done’. That would continue to be a waste of resources.
The project manager’s role is to input to these kinds of discussions with full facts and an approach that draws on commercial acumen, so the team ends up making the right decision for the future of the project.
Planning for risk
Finally, cost control also involves planning for financial risk – in fact, planning for any type of risk.
Dealing with risk costs money, because you’d want some kind of budget to pay for risk management actions such as mitigating the potential problem. Risk and issues can mean paying out for things you didn’t expect to have to fund.
The more risk budget planning you can do, the better prepared you will be, and the less likely it is that your overall budget will suffer. You’ll have more time and money to deal with the problems because you planned for them.
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Staying on top of your project expenses is really important if you want to bring the project in on budget. However, how you actually do that changes as you go through the project. You’ll want to take a different approach to cost control depending on where you are in the project and how you need to respond to the project budget situation.
The graphic below shows four tools for cost control at each point in the project lifecycle. You can pick and choose from these to select a way to manage expenses on your project, wherever you are in the lifecycle.
For more on this idea, check out this article.