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Understanding Cost Performance Indexes

Understanding Cost Performance Index

The Cost Performance Index (CPI) is a metric that influences construction management decisions globally. However, a low CPI does not necessarily mean that a project's performance is poor. There are additional criteria necessary to consider before making decisions on a project's viability. These also take into account the CPI operating range. 

Without further ado, let us demystify the Cost Performance Index and its impact on construction.

What is a cost performance index?

The Cost Performance Index measures the earned value of a project against the actual cost incurred. When the CPI is equal to 1, the project's performance is on target; if it is greater than 1, the project performance is better than expected. If the CPI value is lower than one, the project's implementation is lower than expected. In construction, we express the CPI as a ratio between the cost of the budgeted work and the actual cost of the work performed.

The formula 

We express the formula for calculating CPI in any project as:

Cost Performance Index = Earned Value/ Actual Cost

The earned value refers to the authorized project budget, while the actual cost refers to the expenses accrued on a project. Knowing your Cost Performance Index is paramount as it shows you whether you are operating within budget or need to come up with cost-saving measures.

For example, say you have a project with a contract sum of $60,000 for six months. However, you realize you have already spent $38000 and completed 40% of the work by the third month. In this case, the CPI will be:

Actual Cost = $38,000

Earned Value = 40% of $60,000

= $24,0000

CPI = $24,000/$38000 = 0.63

This means that for every dollar spent, the project gives back $0.63 and shows that the project is operating over budget and the project team needs to take efficiency measures.

Can cost performance fluctuate?

The Cost Performance Index fluctuates throughout the project's lifecycle. This is due to fluctuations in the actual project costs as it draws to a close. The most significant factors that cause differences in actual expenses are labor rates, weather, and purchase prices.

For instance, an employee is not expected to work at 100% efficiency continually. Sometimes the employee may have a sudden energy boost and complete a task faster than expected. In other cases, fatigue kicks in, and the employees take longer than expected on a job. This creates an imbalance that fluctuates, starting a series of peaks and valleys that denote the operating range.

The cost fluctuations are referred to as Cost Variance and as denoted by the formula below:

Cost Variance = Earned Value – Actual Value.

The fluctuation in cost variance leads to changes in the Cost Performance Index. A favorable cost variance leads to a favorable CPI.

operating range

What is the operating range?

Each project is unique, and different factors affect the outcomes of a project. The expected fluctuations on the cost performance index throughout a project's lifecycle are referred to as operating range. A project in a well-controlled environment has a narrow operating range compared to a project running in an unpredictable background.

It is prudent for the project management team to agree on an operating range before work commences. We evaluate this range through past performance in projects, expert opinions, and industry benchmarks. Once the project team has settled on an operating range, they should improve throughout its lifecycle to ensure that the CPI stays within limits. When the CPI deviates outside the limit, it is a red flag for the team.

Can cost performance fall outside of the operating range? 

Price fluctuations over time lead to a lot of deviations in the Cost Performance Index. As much as this is perfectly natural in construction projects when the changes push the CPI outside the operating range, it should be a cause of concern. When the CPI is outside the range, it is a crucial indicator of inefficiencies in a project.

On most occasions, a low CPI indicates an increased scope of work in the project, reduced labor efficiency, or increased cost of materials. However, a low CPI does not always mean that the project is inefficient. Sometimes the excess spending that drives the CPI low might be crucial and necessary for a company. Money spent on servicing and maintaining equipment might push the CPI below the operating range, but it is significant as it extends the equipment life.

On the other hand, when the CPI is higher than the top of the range, it does not necessarily mean that the project performs exceptionally. This might mean that the project team poorly evaluated an aspect in the project leading to overachievement for every monetary unit spent. For example, if a company casts concrete in place when it is missing half the rebar, it would reflect a high CPI, but the extensive scope of work has been overlooked in the real sense. The cast concrete will have to be demolished and reconstructed, which will cost more in the long run. In other cases, a company might spend little money on project aspects such as customer service and employee training. This will lower the expenditure costs and increase the CPI, but it is detrimental to the company and project success. If a construction company does not miss the scope but always ends up with overperforming projects, it will have a bad rapport with the clients. This is because the clients will think that the contractor inflated budgeted costs beyond the real expected value.

What to do if CPI falls outside the operating range?

Overruns in project CPI are familiar in construction. Keeping projects within the operating range is essential for a project's profitability and employee morale. There are several measures one can assess to rectify overruns in the operating range.

The main reason why CPI moves beyond the operating range is scope creep. Scope creep refers to uncontrolled changes in a project's scope. The project manager should create a framework to assess the project's size while keeping the end goal in mind. The project team should rectify any discrepancies in the scope to steer the project's CPI within the operating range.

The project's staff is the most valuable asset. However, assessing a project’s profitability isn’t easy if the staff's working hours are not closely monitored. Once the project's CPI steps outside the acceptable range, it is necessary to track the staff's working hours. With the right tracking software, it is easy to follow the staff's working hours.

Another way to bring projects back on track within the operating range is using software solutions. Software solutions provide great insights into project management and accounting. These software solutions pinpoint when a project is rolling over budget and give the project managers strategic remedies to bring back the CPI within the acceptable range.

Sometimes, small decisions over time cause a significant impact on a project's budget and a deviation of the CPI from the acceptable range. This can be rectified using project accounting practices. Project accounting practices collect vital data such as expenses and information on a project. This gives the construction company financial insights on what they need to rectify to thrive.

performance index

Cost Performance Index vs. Schedule Performance Index

Many people confuse the term Cost Performance Index and use it interchangeably with Schedule Performance index. However, they refer to different things. The CPI, as discussed earlier, is the measure of the budgeted work to the actual incurred costs. The Schedule Performance Index is the ratio between the current time you expected to be in a project at that time. It is a measure of the project's efficiency against the schedule.

We denote the Schedule Performance Index by the formula below:

Schedule Performance Index = Earned Value/ Planned Value.

Like in the CPI, when the SPI is equal to one, the project has been completed right on schedule. If the SPI is less than one, the finished work is far less than earlier planned. An SPI of above one means that the completed work is far beyond the work that this point had planned for in time.

You may want to exclusively use the SPI and ignore the CPI to determine a project's success. However, these numbers are necessary when deciding whether a project is lagging or performing well in budget and time. It is easier to implement changes when you know where exactly you are dragging.

Conclusion

It is crucial to have an allocated budget and time before starting a project. However, sticking to the budget and projected time always appears challenging. Therefore, it is necessary to track whether a project's spending is in line with the budget.

The CPI and SPI are key performance indicators for tracking whether the project is on the right track. They help you know how far ahead or behind you are in your project. Project management professionals can develop systems that record the project's progress at different stages of construction. When one is equipped with such information, it is easy to account for differences and rectify any issues throwing the project off-course. It is easy for the project control team to identify discrepancies on time. This, therefore, easier to make decisions that positively influence the successful delivery of a project on time.