You won’t ever see any senior leader in any business approve or endorse a project without knowing its cost implications. A business leader has to understand the costs and understand the value that the project or task brings to the business. Projects or tasks can be costly, but business leaders and project managers have no problems taking the plunge if they deem it worth the investment. So how to assess whether any task or project is worth the investment? The answer is Cost Performance Index or CPI.
In the sections that follow, we shall look at what is CPI in layman's terms, its definition as per PMBOK, the CPI formula for PMP, and a few examples to cement the knowledge.
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What is Cost Performance Index in Project Management?
Cost Performance Index (CPI) is a crucial aspect of Project Management studies. Every project management professional must understand the costs involved and the return on investment or rather the value that the investment brings in.
As you might have already guessed, Cost Performance Index (CPI) is a ratio of two quantities, a ratio of value earned to the cost incurred already. The higher this ratio, the better the returns or value. We can then draw two quick inferences already from that description:
- For a CPI to be good, you need good enough value, and
- You need to keep the costs involved to the optimum minimum.
Let’s have a look at the formal CPI definition as per PMBOK.
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Cost Performance Index (CPI) Defined
As per the Project Management Body of Knowledge (PMBOK® Guide) - Seventh Edition, Cost Performance Index or CPI is defined as follows:
“The Cost Performance Index (CPI) is a measure of the cost efficiency of budgeted resources, expressed as a ratio of earned value to actual cost.”
Another simple interpretation of this definition is that it shows how well a project aligns with the budgetary allocations. A constant watch on the CPI will indicate if the project is spiralling out of budget and help investigate the root causes.
From a PMP certification examination standpoint, you should be well versed with this concept and thoroughly understand the CPI formula PMP. Let’s discuss the PMP CPI formula in the next section.
Cost Performance Index Formula
Project Management Body of Knowledge (PMBOK® Guide) - Seventh Edition defines the PMP CPI formula as mentioned below.
Cost Performance Index (CPI) = Earned Value (EV) / Actual Cost(AC)
As per the Cost Performance Index formula PMP, that’s Earned Value over Actual Cost. Now you can straightaway figure out the Actual Cost, but what is Earned Value? Project Management Body of Knowledge (PMBOK® Guide) - Seventh Edition defines Earned Value as below.
Earned Value (EV) = %Work Complete X Budget
What is EVM (Earned Value Management)?
Earned Value Analysis (EVA) is a method to measure how much work was performed on a project in addition to reviewing cost and scheduled reports. A project manager who applies earned value management (EVM) measures the performance, cost, and completion date based on analysis of trends or by applying a "burn rate" calculation while the EVM predicts the future and adjusts accordingly. An accurate Earned Value Analysis begins with a well-developed project plan.
EVMs have the following objectives:
- Establish a relationship between time-phased budgets and specific contract tasks and/or statements of work.
- Asses the progress of work as it relates to the baseline plan.
- Analyze the impact of cost, schedule, and technical performance.
- Proactively analyze and take action using valid, current, and auditable information.
- Ensure managers have the tools they need to make effective decisions.
In other words, Earned Value (EV) is the product of the percentage of work completed and the budget allocation. Earned Value can be construed as the value add that completed work brings in or has already brought in.
Project managers use this PMP CPI formula to keep a reign on the cost of any project while it is being executed. It is important to note that the CPI formula in PMP is only largely relevant to an open and ongoing project, although it can be used for a close project too. Project managers typically use this CPI formula in PMP in every session to make it known to all stakeholders the health and progress of the project on an ongoing basis.
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How to Calculate Cost Performance Index?
You could easily use the formula to calculate the CPI, but how would you infer the values it gives you? Here it is.
Once again, the PMP CPI formula is
CPI = Earned Value (EV) / Actual Cost(AC)
Using this formula, you will either get a value X such that,
X can be less than 1
X can be equal to 1
X can be greater than 1
If X is less than 1, the project is considered running over budget. If the value of X is closer to 1 or equal to 1, the project is considered to be on a budget. And finally, if the value of X is greater than 1, the project is considered to be running under budget.
Tabulating and drawing inferences for each value category will make it much more intuitive.
|Value of X
Can we say the Cost Performance Index shows the cost efficiency of any project? The CPI of any project is an important indicator of the health of an ongoing project and helps to keep it on track as far as budgetary allocations go.
Beyond the obvious, secondary inferences can be taken away from the CPI. What are such inferences, and how do they impact the project? Let’s take a look:
- One important takeaway from a CPI running over budget could be that the initial project estimates were too conservative. This can prompt correction of budgetary allocations further down the project timeline to improve the cost-efficiency of a project. Conservative budget estimates can throw off budgetary calculations and should be avoided at all costs. Estimates should always be on the higher side in any project, baking in all factors that could potentially influence the cost.
- Another takeaway is that the budgetary allocations were probably not aligned with the project outcomes or goals. This, again, is dependent on the project cost incurred. These two aspects trigger the re-estimation of budget allocations to a project.
- Further, it can be inferred that given the project estimations were reasonable, the current project costing may spiral out of control and appropriate measures have to be put in place to reign in cost. This could come at the cost of reduced quality based on how important is quality to the project.
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How to Understand the CPI value?
Let’s go through some simple examples that will put things into perspective.
Cost Performance Index Calculation Examples
A simple example is that of office furniture servicing and repair.
The project estimates have been made and pegged at Rs. 50000 or thereabout. The project, as per reports, is close to 40% complete. The business has incurred a cost of Rs.27000 as of the last update. Here is how we calculate the CPI using the formulas listed above.
CPI = Earned Value / Cost Incurred
Earned Value is an unknown and needs to be calculated using the formula,
Earned Value = %Work Completed X Budget
Earned Value = 40% X 50000
Earned Value = 20000
CPI = 20000 / 27000 = 0.074
The CPI of 0.074 is less than 1. This clearly indicates that the cost of the project is running over budget and needs measures to be put in place to keep it around Rs. 50000 by the time the project completes.
You could also infer that the project cost estimation of Rs. 50000 might have been a tad on the conservative side. Reassessment exercises should be taken up to arrive at a more realistic overall budget figure.
Let’s take another example for further understanding
A software development project is nothing but a project to design, develop, test and release the product under tight project deadlines. The project requires multiple resources like IT, application developers, testing professionals, and project managers, among others. A project manager will be accountable to the business for successfully executing the project while keeping the cost of executing the project within project cost estimates.
A project manager will keep an eye on the CPI throughout the project to keep a tight rein on the project developments.
Let’s say the project is estimated to cost just under Rs. 500000 (5 Lakhs) and has racked up a cost of 200000 and is about 50% through.
Earned Value (EV ) = 50% X 500000 = 250000
CPI = EV / Actual Cost (AC)
CPI= 250000/200000 = 1.25
We now have a CPI of 1.25, which indicates the project is currently running under budget. This does not mean the project is going the right way, and the project could have started on the wrong footing with overestimated budgets. The project manager should also check to ensure that all costs have been accounted for and there are no surprises near project completion.
Schedule Performance Index (SPI) and CPI
Another interesting metric is used in conjunction with CPI, and it is the Schedule Performance Index (SPI). SPI measures the adherence to schedules and milestones baked into the project. It is a good indicator of whether the project is on schedule to complete in the time earmarked at the beginning of the project.
Like CPI, there are three ranges of values that an SPI can take, as shown below:
|Ahead of Schedule
Both SPI and CPI are critical to project tracking, execution and completion. CPI is usually recorded along with SPI during project update meetings and usually represented in the form of gauges as shown here.
Perform Well on All Indexes
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Frequently Asked Questions (FAQs)
1. Where can I learn other concepts like CPI and SPI related to project management?
Ans. For a detailed understanding of all the concepts involved in project management, join a PMP certification training course. It takes you through the nitty-gritty of project management and helps you showcase your knowledge to potential employers.
2. How do I gain industry expertise in project management?
Ans. While it is not necessary to have a PMP certification to be a good project manager, it is a certification that employers look for to validate your knowledge and hands-on experience in project management.
3. What is CPI (Cost Performance Index)?
Ans. As per the Project Management Body of Knowledge (PMBOK® Guide) - Seventh Edition, Cost Performance Index or CPI is defined as follows:
“The Cost Performance Index (CPI) is a measure of the cost efficiency of budgeted resources, expressed as a ratio of earned value to actual cost”.
4. The difference between CPI and SPI
Ans. CPI measures the cost efficiency of the project parameters while SPI measures the time efficiency of the project parameters.
5. How to understand the value of CPI?
Ans. The value of CPI can be understood as the ratio between the earned value and the actual cost incurred.