4. project cost management

By: Mohamed Salah ElDien Mohamed Aly, MSc, PMP®, DIT, MCAD

4. Project Cost Management

- Cost is one of 3 Triple constraints of the project. Managing costs of the project is

very crucial and hardest part of the project. It spans across all phases of the project

right from conception to closure of the project.

- Cost Management is not just controlling “Costs”; it involves definitive planning and

preparing budgets. Collecting cost associated data. Comparing the data to prepared

budgets and taking appropriate actions when needed.

- The process involved in estimating, budgeting, and controlling cost so that the project can be completed within approved budget.

- Value analysis (value engineering)

Looking at less costly way to do the same work within the same scope - Following table lists all 3 Processes in this Knowledge Area, spread across '2 out of 5

Process Groups'

5 Process

Groups Initiation Planning

Executi

on

Monitoring and

control Closing

Processes

4.1. Cost Estimating

4.2. Cost Budgeting

4.3. Cost Control

4.1 Estimate Cost

- The process of developing approximation of the monetary resources needed to complete

project activities

Cost trade-offs & risk must be considered

Cost estimates should be refined

Inputs Tools Outputs

- Scope baseline

- Project schedule

- Human resource plan

- Risk register

- Enterprise

environmental

factors

- Organizational

process assets

- Expert judgment

- Analogous estimating

- Parametric estimating

- Bottom-up estimating

- Three-point estimates

- Reserve analysis

- Cost of quality

- Project management

estimating software

- Vendor bid analysis

- Activity cost estimates

- Basis of estimates

- Project document updates


There are 3 different types of estimation techniques listed over here under Tools section of Cost

Estimation.

- Analogous Estimation techniques

- Bottom-up approach technique

- Parametric approach technique

Analogous estimation

-It is mainly based on Expert Judgment or based on similar previous Projects. This approach is very useful in early stages of the project where WBS and work packets are completely defined. The expert judgment success factor depends on similarity of previous projects too. The main disadvantage is that it is good for ball-park figures but not for precise project cost.

Parametric Estimation

- It considers different project characteristics to calculate total costs of the project. For example,

in the Telephone wire digging project, if we know cost per meter we can estimate it to whole

project. For a house construction, if we know cost to construct per square feet, we can estimate

total house project. For complex projects there will be multi dimensional parameters involved.

When historic information is available these parametric estimation will be more accurate.

Bottom-up approach

- It is elaborative estimation technique. We start estimating from the bottom most part of WBS

hierarchy which is work package. Work packages are divided into activities. Summing up work

packages to modules or groups, summing up different modules to stages, summing up different

stages to project is the bottom-up approach method. The people who will actually do this work

should create the estimates.

Types of Cost;

- Variable Costs

Change with the amount of production/work

e.g. material, supplies, wages

- Fixed Costs

Do not change as production change

e.g. set-up, rental

- Direct Costs

Directly attributable to the work of project

e.g. team travel, recognition, team wages

- Indirect Costs

overhead or cost incurred for benefit of more than one project

e.g. taxes, fringe benefit, janitorial services


- It is very important to understand “Cost Variability” that focuses on changing of

cost over time as well as over volume;

Inflation; cost of some items increase over time.

Deflation; cost of technology items decrease over time.

Direct Costs vs. Indirect Costs

- when talking about “a new project team member”, the direct cost will be his salary

while the indirect costs may be the insurance premiums given to him, the paid pill

for his telephone calls, computer internet access cost, his disk or disk space that have

been given to him.

- When talking about “a specific material needed”, the direct cost will be its price

while the indirect cost will be the transportation cost paid to receive such material as

well as the storing cost...etc.

Fixed Costs vs. Variable Costs

- A fixed cost is like the cost of a unit has a certain nature which maybe a resource

such as a specific material or equipment used for the project. If you need to buy a

piece of equipment to allow the project to continue, that is simply a fixed cost

regardless it will be used for once or hundreds of times.

- Variable costs are directly related to the level of work with each and every element

of the WBS. It is like the cost of water needed to drink or Gasoline needed to some

machinery.

Quality/Accuracy of Cost Estimation


4.2 Determine Budget

- Process of aggregating the estimated cost of individual activities or work packages to

establish an authorized cost baseline.


- Activity cost estimates

- Basis of estimates

- Scope baselines

- Project schedule

- Resource calendars

- Contracts

- Organizational process

assets

- Cost aggregation

- Reserve analysis

- Expert judgment

- Historical relationship

- Funding limit

reconciliation

- Cost performance

baseline

- Project funding

requirements

- Project document

updates

- The main goal of this process is to develop Cost Baseline. At the starting point of this Process,

you should have finished Project Cost Estimation and have a complete list of estimates of

individual activities.

Cost Aggregation;

- We use Cost Aggregation tools to sum up those low level activity costs to Work package to

higher levels of WBS hierarchy.

- Reserves & risk management are important while estimating!

Contingency reserves/Cost Baseline (the cost impacts of the remaining risk)

Management reserves/Cost Budget (extra fund to cover surprising risks or

changes to the project).

The cost baseline

- It is a reference point for the project to compare time to time. You will monitor and control

project costs comparing to the baseline and report any variations. Costs at work package

level are tied to financial systems using Chart of Accounts. Chart of accounts show cost

allocation categories.

Project manager is allowed to allocate extra resources (time or money) as a buffer for known

unknowns; we call it as Contingency Reserve.

Determines Budget: Other considerations


- High level parametric estimate as a rule of thumb

E.g. testing cost 50% of development cost

- Funding limit reconciliation = checking cash flow

When the money will be available?

- Reconciliation needed before proposed cost baseline and cost budget become final

Such reconciliation is part of integration management

4.3 Control Cost

- The process of monitoring the status of the project to update the project budget and

managing changes to the cost baseline.

Cost control:

Once you estimate Project costs as well as cost baseline and prepare a Budget, you will

be on cruise mode to control the costs. That doesn’t mean it is easy thereafter. No not at

all. You have to monitor your cost so closely. Your work performance information is key

input for this process. You should have clear set templates to report the work progress.

Otherwise all unwanted junk data might ruin the soup.

How to control cost?

- Follow the cost management plan

- Look at any organizational process asset that are available

- Manage change

Recording all appropriate change



plan

- Project funding

requirement

- Work performance

information


assets

- Earned value

management

- Forecasting

- To-complete

performance index

- Performance reviews

- Variance analysis


software

- Work performance

measurement

- Budget forecast


updates

- Change requests

- Project management plan

updates

- Project document updates


Preventing incorrect change

Ensuring requested changes are agreed upon

Managing the actual changes when and as they occur - Measure and measure and measure (monitoring)

Project performance review is another Tools & Techniques provided. You will review

project progress with your baseline plans and will provide what you’ve earned against

what you have planned. This is known as Earned Value Analysis and helps you to track

your day to day progress. 3 possible scenarios are: you are progressing ahead of plan that

means you are getting more than what you have planned, or progress is as per the plan or

not getting enough worth for your investment. Based on these 3 scenarios you can take

according corrective actions. Corrective actions are what you are supposed to do in this

process.

You can use Project Management software of your choice to help you in this regard. MS

Project is popular one or even you can simply use well planned out Excel sheets to track

those costs.

First you will find variances and report those using Variance analysis. The terms you use

over here are Cost Variance (CV) and Schedule Variance (SV). From that point you

might required to forecast rest of the project. This involves estimating rest of the work.

You use terms like Estimation to Completion (ETC) and Estimate at Complete (EAC).

Those names are telling what you have to Estimate.

Other terms you use here are Cost Performance Index (CPI) and SPI (Schedule

Performance Index)


Earned Value Technique

Ex;

Cont. Earned Value Technique


Earned Value Management

- Method to measure project performance against scope, schedule and cost baseline

(performance measurement baseline).

- Interpretation of basic EVM performance measures

Cost Performance Index (CPI)

Schedule Performance Index (SPI)

Exercise;

- You have a project to build a box. The box is six sided. Each side is to take one day to

build and is budgeted for $1000 per side. The sides are planned to be completed one

after the other. Today is the end of day three.

- Using the following project status chart, calculate PV, EV, AC, BAC, CV, CPI, SV,

SPI, EAC, ETC, VAC.

- Describe your interpretation based on the calculation!


Solution;

Hence, based on the result table;

• Over budget, getting 0.88 dollar for every spent dollar,

• Ahead schedule, progressing 101% of the rate planned,

• Probably will spend $6818 at the end (estimation),

• need $3368 to complete,

• Over budget at the end for about $818 (estimation)

Performance Metrics;

- Budget At Completion (BAC) “Total cost of the project.”

- Budgeted Cost for Work Scheduled (BCWS) / Planned Value (PV)

The amount expressed in Pounds (or hours) of work to be performed as

per the schedule plan.

PV = BAC * % of planned work.

- Budgeted Cost for Work Performed (BCWP) / Earned Value (EV)

The amount expressed in Pounds (or hours) on the actual worked

performed.

EV = BAC * % of Actual work

- Actual Cost of Work Performed (ACWP) / Actual Cost (AC)


Cost Forecasting:

- Estimate At Completion (EAC)

- The expected TOTAL cost required to finish complete work.

- EAC = BAC / CPI

= AC + (BAC - EV) (at typical case)

= AC + ((BAC - EV) / CPI) (The same performance will remain)

= AC + (BAC - EV) / (CPI* SPI) (The same performance will remain +

Extra loss due to delay in time)

* Here “typical” means it is assumed that similar variances will not occur in the future.

- Estimate to complete (ETC)

- The expected cost required to finish all the Remaining work.

- ETC = EAC - AC

= (BAC - EV) / CPI

Variances:

Cost Variances (CV)

Determine “How much under or over budget?”

CV = EV-AC

NEGATIVE is over budget, POSITIVE is under budget.

Schedule Variances (SV)

Determine “How much ahead or behind schedule?”.

SV = EV-PV

NEGATIVE is behind schedule, POSITIVE is ahead of schedule.

Variance At Completion (VAC)

Variance of “TOTAL” cost of the work and expected cost.

VAC = BAC - EAC


Performance Indices:

Cost Performance Index

CPI = EV / AC

“Over (< 1) or under (> 1) budget”.

Schedule Performance Index

SPI = EV / PV

“Ahead (> 1) or behind (< 1) schedule”.

To-Complete Performance Index (TCPI)

- Helps the team determine the efficiency that must be achieved on the remaining

work for a project to meet a specified endpoint, such as BAC or the team’s revised

EAC.

TCPI = Remaining Work (BAC – EV) / Funds Remaining (EAC - AC)


Problem: A project has a budget of £10M and schedule for 10 months. It is assumed that

the total budget will be spent equally each month until the 10th month is reached. After 2

months the project manager finds that only 5% of the work is finished and a total of £1M

spent.

Solution:

PV = £2M

EV = £10M * 0.05 = £0.5M

AV = £1M

CV = EV-AC = 0.5-1 = -0.5M

CV% = 100 * (CV/EV) = 100*(-0.5/0.5) = -100% overrun

SV = EV-PV = 0.5-2 = -1.5 months

SV% = 100 * (SV/PV) = 100*(-1.5/2) = -75% behind

CPI = EV/AC = 0.5/1 = 0.5

SPI = EV/PV = 0.5/2 = 0.25

EAC = BAC/CPI = 10/0.5 = £20M

ETC = (BAC-EV) / CPI = (10-0.5)/0.5 = £19M

Time to compete = (10-0.5)/0.25 = 38 Months

This project will take TOTAL £20M (19+1) and 40 (38+2) Months to complete.


Hints to remember;

- EV comes in most of formulas specially regarding “Variance” & “Index”

- If it’s variance, the formula is EV – something.

- If it’s index, EV / something.

- If it relates to cost, use Actual Cost.

- If it relates to schedule, use PV.

- Negative numbers are bad, positive is good.

4. project cost management

Business

project cost management

precise project cost

estimate cost

types of cost

storing cost

transportation cost

cost variability

cost budgeting4