by John Chaney

[Editor's note: The following blog post originally appeared on DexterChaney.com. It is the fourth in a four-part series from Dexter + Chaney co-founder John Chaney, sharing his insights on business and the construction industry at Construction Dive. Check out his previous contributions, "Negotiating the cash flow minefield" part 1 and part 2, as well as "Cash flow—below the surface."]

In the last cash flow discussion, we served up an alphabet soup of acronyms and terms surrounding the concept of cash flow. This week let’s continue by discussing a simple but powerful measurement that pulls together many of these aspects of cash flow into a single term: Earned Value.

To understand earned value, consider a simple example. The graph below is what a typical contractor might use when tracking job progress.

The projected (i.e., forecasted or planned) costs over time for the project are shown in red, the actual costs-to-date in green. At the point in time shown, it would seem that this project is on track to come in under budget.

But this is not the whole story. Actual job progress cannot be measured solely by costs incurred. A project that is at the halfway point in time and cost of completion may have far less than half of the actual work completed. In this case, the actual Earned Value may be far less than it should be at this point in time. And this is the best indicator to both finance and project management that a job may be in danger of losing money.

Back to our simple example. The addition of one more line to the graph provides the real story on the health of the project. Consider the graph below:

Here we can see that at our chosen point in time, the blue line represents the budgeted value of the work actually completed, in other words, the earned value on this project at this time. Regardless of what costs have been incurred or remittances received, the blue line tells us, how far off a job is with respect to both time and money.

In our example, this job is in trouble. At the selected time, we had expected a lower amount of incurred cost and planned to have completed more of the work. This is a very different (and more realistic) conclusion from the one drawn when only looking at projected versus actual costs.

The concept of earned value is simple and it’s powerful. But it does rely on two things:

1) Gathering real time information
2) Connecting information from the field

How well connected is your company? How do you ensure you are working with the most updated data? 

John Chaney, CPA/MBA, co-founded Dexter + Chaney with Mark Dexter in 1981 after working together at the Seattle office of Arthur Andersen & Co. They decided to form their own company after determining there was a market need for construction management software for construction companies with $1 million or more in annual sales.

John is an active member of the Construction Financial Management Association's Puget Sound chapter and is a former member of the chapter's board of directors and a former chairman of its Academic Scholarship Committee. John is an industry leader in the design of construction management software, and is a frequent contributor to major industry magazines. He earned his Masters of Business Administration from University of Washington and his Bachelor of Science from University of the Pacific.