project cost management

Project Cost Management

PCM

PROJECT COST MANAGEMENT


PCM

PROJECT COST MANAGEMENT

1) Project Cost Management for EPC/Construction Project:

Includes the processes required to ensure that the project is completed within the

approved budget.

Is primarily concerned with the cost of the resources required to complete project

activities. The necessary data and the essential tools of cost management activities

include the current and updated WBS, cash flow constraints, details of current estimates

and budgets, timely progress reports, accurate change reports, and cost management

software responsive to the specific needs of that particular project.

Should consider the effect of project decisions on the cost of using the project’s product.

For example: limiting the number of design reviews may reduce the cost of the project

at the expense of an increase in service costs and an increase in the customer’s operating

costs.

A broader view of project cost management is often referred to as life-cycle costing.

It involves including in-house making, out sourcing, and disposal costs when evaluating

various project alternatives. For example fabrication and installation ctc.

A creative approach used to optimize life cycle costs, save time, increase profits, improve

quality, expand market share, use resources more effectively, and solve problems is

called value engineering. For example pre-casting at yard and erecting at site in bridge

construction work.

Life cycle costing and value engineering techniques are used together to reduce cost and

time, improve quality and performance, and optimize the decision-making.

In many application areas, predicting and analysing the prospective financial

performance of the project’s product is done outside the project.

In some areas such as capital facilities projects, project cost management includes

predicting and analyzing the prospective financial performance of the project’s product.

In these situations, project cost management will include general management

techniques such as:

o Return on investment

o Discounted cash flow

o Payback analysis

Should consider the information needs of the project stakeholders and the different ways

and times stakeholders measure project cost. For example, the cost of a procurement item

may be measured when committed, ordered, delivered, incurred, of recorded for

accounting purposes.

When project costs are used as a component of a reward and recognition system,

controllable and uncontrollable costs should be estimated and budgeted separately to

ensure that rewards reflect actual performance.

The ability to influence cost is greatest at the early stages of the project. Early scope

definition and requirements identification are critical to reducing costs in a project.

The project must have a proactive and comprehensive risk management plan in place to

mitigate the impact of unexpected events.


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2) Cost estimating techniques being used in EPC/Construction Project:

Methods used during cost estimating are:-

Analogous estimating: (top down estimating)

Uses the actual cost of a previous similar project as the basis for estimating the cost of

the current project

Is frequently used to estimate total project costs when there is a limited amount of

detailed information about the project. (e.g., in the early project phases)

Generally less costly than other estimating techniques, but it is also generally less

accurate. Most reliable when 1) the previous projects are similar in fact and not just in

appearance, 2) the individuals or groups preparing estimates have the needed expertise

Considered a form of expert judgment.

Parametric modelling:

Uses project characteristics (parameters) in a mathematical model to predict project cost

Models may be simple or complex. Simple example: Model the cost of constructing a

residential home based on square footage of living space. Complex example: Model

software development costs using thirteen adjustment factors, each of which has five to

seven points.

Most reliable when 1) the historical information used to develop the model was accurate,

2) the parameters used in the model are readily quantifiable, and 3) the model is scalable.

Bottom-up estimating:

Involves estimating the cost of individual activities or work packages, then summarizing

or rolling-up the individual estimates to get a project total

The cost and accuracy is driven by the size and complexity of the individual activity or

work package: smaller items increase both cost and accuracy of the estimating process.

The project management team must weigh the additional accuracy against the additional

cost.

Computerized tools:

Project management software spreadsheets and simulation/statistical tools are widely

used to assist with cost estimation.

Can simplify the use of the techniques described earlier and facilitate more rapid

consideration of costing alternatives.

. Other cost estimating methods such as vendor bid analysis.

3) Cost baseline estimation and Cost control in EPC/Construction Project

Considering the cost estimating inputs, Cost estimating relies on several project components

from the Initiation and planning process groups. This process also relies on historical

information and policies from the performing organization.


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Using the Work Breakdown Structure

Of course the WBS is included—it’s an input to five major planning processes: cost estimating,

cost budgeting, resource planning, risk management planning, and activity definition.

Relying on the Resource Requirements

The only output of resource planning serves as a key input to cost estimating. The project will

have some requirement for resources—the skills of the labour, the ability of materials, or the

function of equipment must all be accounted for.

Calculating Resource Rates

The estimator has to know how much each resource costs. The cost should be in some unit of

time or measure—such as cost per hour, cost per metric ton, or cost per use. If the rates of the

resources are not known, the rates themselves may also have to be estimated. Of course, skewed

rates on the estimates will result in a skewed estimate for the project. There are four categories

of cost:

■ Direct costs- These costs are attributed directly to the project work and cannot be shared

among projects (airfare, hotels, and long distance phone charges, and so on).

■ Variable costs- These costs vary depending on the conditions applied in the project (number

of meeting participants, supply and demand of materials, and so on).

■ Fixed costs- These costs remain constant throughout the project (the cost of a piece of rented

equipment for the project, the cost of a consultant brought onto the project, and so on).

■ In-direct costs- These costs are representative of more than one project (utilities for the

performing organization, access to a training room, project management software license, and

so on)

Estimating Activity Durations

Estimate of the duration of the activities, which predict the length of the project, are needed for

decisions on financing the project. The length of the activities will help the performing

organization calculate what the total cost of the project will be, including the finance charges.

Recall the formula for present value? It’s PV= FV/(1+R)n; PV is the present value, FV is the

future value, R is the interest rate, and n is the number of time periods. The future value of the

monies the project will earn may need to be measured against the present value to determine if

the project is worth financing, as shown here:

Finance charges

Future Value 1.46cr Present Value 1.0cr

Calculations of the duration of activities are needed in order to extrapolate the total cost of the

work packages. For example, if an activity is estimated to last 14 hours and Excavator’s cost

per hour is Rs.2000, then the cost of the work package is Rs.28000. The duration shows

management how long the project is expected to last and which activities will cost the most and

provides the opportunity to re-sequence activities to shorten the project duration—which

consequently shortens the finance period for the project.


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Another aspect the project manager and management may have to determine is the long-term

worth of a product in regard to tax deductions. There are three approaches to deduct product’s

cost:

■ Straight-line depreciation allows the organization to write off the same amount each year.

The formula for straight-line depreciation is Purchase Value minus Salvage Value divided by

Number of Years in Use. For example, if the purchase price of a crane is 3cr and the salvage

value of the crane in 10 years is Rs1cr, the formula would read: (3-1)/10= Rs0.2cr

■ Double-declining balance is considered accelerated depreciation. This method allows the

organization to double the percentage written off in the first year. In our above example, a single

deduction was Rs0.2cr per year, which is 10 percent of the total deduction across the ten years.

With double-declining, the customer would subtract 20 percent the first year, and then 20

percent of the remaining value each subsequent year. In our example, the deducted amount for

year one would be Rs0.4cr. For year two it’d be Rs0.36cr, and year three it would be Rs0.152cr.

This is a great method for equipment that you don’t anticipate to have around for a very long

time—such as computer equipment.

■ Sum of the year’s depreciation is like a magic trick. It works by writing out the number of

years the equipment is in production and adding each year to the year before. In our example it

was 10 years, so we’d do this: 10+9+8+7+6+5+4+3+2+1=55 (note the largest to smallest). The

sum of the years, 55, becomes our denominator; the five, for the first year, is our numerator. So

for the first year, we’d deduct 10/55 of the crane cost after the salvage amount

Using Estimating Publications

There are, for different industries, commercial estimating publications. These references can

help the project estimator confirm and predict the accuracy of estimates. If a project manager

elects to use one of these commercial databases, the estimate should include a pointer to this

document for future reference and verification.

Using Historical Information

Historical information is proven information and can come from several places:

■ Project files- Past projects within the performing organization can be used as a reference to

predict costs and time. Caution must be taken that the records referenced are accurate,

somewhat current, and reflective of what was actually experienced in the historical project.

■ Commercial cost-estimating databases These databases provide estimates of what the

project should cost based on the variables of the project, resources, and other conditions.

■ Team members Team members may have specific experience with the project costs or

estimates. Recollections may be useful, but are highly unreliable when compared to

documented results.

Referencing the Chart of Accounts

This is a coding system used by the performing organization’s accounting system to account

for the project work. Estimates within the project must be mapped to the correct code of


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accounts so that the organization’s ledger reflects the actual work performed, the cost of the

work performed, and any billing (internal or external) that was charged to the customer for the

completed work.

Acknowledging the Cost of Risk

The impact of risks, for positive or negative effect, must be evaluated and considered in the cost

estimates. For example, should a risk come into play, the mitigation of the risk may require

adding several activities to squelch the risk. The expense of the activities would add cost to the

project.

4) Application of Cost Estimating Techniques in EPC/Construction Project Analyzing

Cost Estimating Results

The output of cost estimating is the actual cost estimates of the resources required to the

complete the project work. The estimate is typically quantitative and can be presented in detail

against the WBS components or summarized in terms of a grand total, by phases of the project,

or by major deliverables. Each resource in the project must be accounted for and assigned to a

cost category. Categories include the following:

■ Labour costs

■ Material costs

■ Travel costs

■ Supplies

■ Hardware costs

■ Software costs

■ Special categories (inflation, cost reserve, and so on)

The cost of the project is expressed in monetary terms, such as rupees, dollars, euros, or yen,

so management can compare projects based on costs. It may be acceptable, depending on the

demands of the performing organization, to provide estimates in staffing hours or days of work

to complete the project along with the estimated costs. As projects have risks, the cost of the

risks should be identified along with the cost of the risk responses.

Refining the Cost Estimates

Cost estimates can also pass through progress elaboration. As more details are acquired as the

project progresses, the estimates are refined. Industry guidelines and organizational policies

may define how the estimates are refined, but there are three generally accepted categories of

estimating accuracy:

■ Rough order of magnitude- This estimate is “rough” and is used during the Initiating

processes and in top-down estimates. The range of variance for the estimate can be –25 percent

to +75 percent.

■ Budget estimate- This estimate is also somewhat broad and is used early in the Planning

processes and also in top-down estimates. The range of variance for the estimate can be –10

percent to +25 percent.


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■ Definitive estimates- This estimate type is one of the most accurate. It is used late in the

Planning processes and is associated with bottom-up estimating.

The range of variance for the estimate can be –5 percent to +10 percent.

Considering the Supporting Detail

Once the estimates have been completed, supporting detail must be organized and documented

to show how the estimates were created. This material, even the notes that contributed to the

estimates, may provide valuable information later in the project. Specifically, the supporting

detail includes the following:

■ Information on the project scope work- This may be provided by referencing the WBS.

■ Information on the approach used in developing the cost estimates

This can include how the estimate was accomplished and the parties involved with the estimate.

■ Information on the range of variance in the estimate For example, based on the estimating

method used, the project cost may be Rs 220,000 ± Rs15, 000.

This project cost may be as low as Rs205, 000 or as high as Rs235, 000.

5) Use of Project Reserves (Contingency Reserve & Management Reserve) in

EPC/Construction Project

Contingency Reserve:

The allocation of extra funds to cover uncertainties and improve the chances of finishing on

time.

Specific provision(s) to mitigate random or unknown project risks from causing project failure

or frequent baseline changes.

Reserves (2 Types): Provision in project plan to mitigate cost and/or schedule risk.

Contingencies are needed because

• Project scope may change

• Cost estimation must anticipate interaction costs

• Normal conditions are rarely encountered

• Global Economic Slowdown

• Commodity Price Volatility

Reserves–Known Unknowns

Cost Estimating Tool

Contingency allowance

Discretion of PM

Anticipated but not certain events


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Potentially overstates costs

Part of project scope and baseline

e.g. weather, productivity…

Budgeting Tool -Mgmt. Contingency

Unplanned but potentially required changes to scope & baseline

Approval needed for PM to spend

May result from risk register

NOT part of project baseline

NOT part of EVA

e.g. risks, approved changes…

6) Application of Project Cost Budget in EPC/Construction Project

The process of allocating the overall cost estimates to individual activities or work

packages to establish a cost baseline for measuring project performance.

Inputs include: cost estimates, WBS, project schedule, and risk management plan.

Methods used during cost budgeting include: cost budgeting tools and techniques which

are the same tools used for cost estimating.

Outputs include: Cost baseline

A time-phased budget used to measure and monitor project cost performance.

It is developed by summing estimated costs by period and is usually displayed in the

form of an S-curve.

Many projects, especially larger ones, may have multiple cost baselines to measure

different aspects of cost performance. For example, a spending plan or cash-flow forecast

is a cost baseline for measuring disbursements.

7) Project Cost Monitoring and Control in EPC/Construction Project

The process of:

Influencing the factors that create changes to the cost baseline to ensure that changes

are beneficial

Determining that the cost baseline has changed

Managing the actual changes when and as they occur.

Cost control includes:

Monitoring cost performance to detect and understand variances from plan.

Ensuring that all appropriate changes are recorded accurately in the cost baseline.

Preventing incorrect, inappropriate, or unauthorized changes from being included in the

cost baseline.

Informing appropriate stakeholders of authorized changes.

Acting to bring expected costs within acceptable limits.

Inputs include: cost baseline, performance reports, change requests, and cost management plan


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Performance reports:

Provide information on project scope and cost performance such as which budgets have

been met and which have not.

May also alert the project team to issues that may cause problems in the future.

The methods used in cost control include:

Cost change control system:

Defines the procedures by which the cost baseline may be changed.

Includes the paperwork, tracking system and approval levels necessary for authorizing

changes.

Should be integrated with the integrated change control system.

Performance measurements: Used to access the magnitude of any variations which do

occur.

Earned value management (EVM): All EVM Control Account Plans (CAPs) must

continuously measure project performance by relating and comparing three independent

variables:

Planned Value (PV): the physical work scheduled to be performed including the estimated

value of this work (BCWS).

Earned Value (EV): the physical work actually accomplished including the estimated value of

this work (BCWP),

Actual Cost (AC): the costs incurred to accomplish the earned value.

Additional planning: Prospective changes may require new or revised cost estimates or

analysis of alternative approaches.

Computerized tools: project management software and spreadsheets are often used to track

planned costs versus actual costs and to forecast the effects of cost change.

Outputs from cost control: revised cost estimates, budget updates, corrective action, estimate

at completion (EAC), project closeout, and lessons learned.

Revised cost estimates:

Modifications to the cost information used to manage the project.

Appropriate stakeholders must be notified as needed.

Revised cost estimates may or may not require adjustments to other aspects of the

project plan.

Budget updates:

A special category of revised cost estimates.

Involve changes to an approved cost baseline.

Estimate at completion (EAC): A forecast of the most likely total project costs based on project

performance and risk quantification.


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Project closeout:

Processes and procedures should be developed for the closing or cancelling of projects.

Example: Statement of Position (SOP 98-1 issued by the America Institute of Certified

Public Accountants) requires that all the costs for a failed information technology

project be written off in the quarter that the project is cancelled.

8) Application of EVM (Earned Value Management) method in EPC/Construction

Projects for Project control and monitoring

The problem of reporting work completed without the associated cost is resolved by Earned

Value (EV). EV combines effort and time into a single rupees schedule. Financial data is

important to a project manager because it can help manage a project to a successful completion.

Earned Value Analysis:

PV (BCWS)

Planned value or budgeted cost of work scheduled. Equates to the physical work scheduled and

the associated budget for the scheduled work. What was the planned spending for a given period

of time?

EV (BCWP)

Earned value or budgeted cost of work performed. Equates to the physical work accomplished

and the associated budget for this accomplished work. What work has been completed and what

measurement is used to establish the accomplished value of these items? EV is the bridge

between PV and AC. It is the key to relating three independent variables which can be used to

measure the performance of the project and obtain a forecast for the future.

AC (ACWP)

Actual Cost or Actual Cost of Work Performed. Equates to the physical work accomplished

and the actual cost of this accomplished work. What has been completed and what is the actual

cost of these items?

BAC

Budget at Completion = Total Budgeted Costs. What is the project’s budget?

EAC

Estimate at Completion (Estimated Costs at Completion)

Depending on the situation, EAC may be calculated by different means.

1) EAC = AC + ETC when original assumptions are flawed

2) EAC = AC + (BAC - EV) when variances are considered to be atypical and not expected to

occur again.


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3) EAC = AC + (BAC-EV)/CPI where CPI is a cumulative. Used when variances are considered

typical.

4) EAC = BAC/CPI This is the old formula used by PMI.

Know this one and use it if the only information you have is BAC and CPI and you are asked

to calculate EAC. What is the total project expected to cost? How much will the project cost at

completion?

ETC

Estimate to Complete (Estimate of the additional funds needed to complete the project). ETC

ETC= EAC - AC

What is the estimate of additional funds needed to complete the project?

VAC

Variance at Completion. The difference between the total amount the project was supposed to

cost (BAC) and the amount the project is now expected to cost (EAC).

VAC = BAC – EAC

CPI

Cost Performance Index (cost performance factor, measures efficiency)

CPI = EV/AC, a value of less than 1.0 indicates less productivity than expected. This is a

measure of the financial wellbeing of the project. How efficient is the project? How fast are

things getting done from a financial point of view?

CV

Cost Variance (valued in rupees). This is a measure of the financial wellbeing of the project.

CV = EV - AC, a value of zero indicates that the project is on budget.

How far off are the scheduled cost of things to be completed from the actual amount spent?

SPI

Schedule Performance Index (schedule performance factor, measures effectiveness). Indicates

which portion of the planned schedule was actually accomplished.

SPI = EV/PV, a value of less than 1.0 indicates less has been completed than was scheduled.

How well is the project progressing in comparison to the expected progression?

SV

Schedule Variance (valued in rupees).

SV = EV - PV, a value of zero indicates that the project is on schedule.

How far off schedule is the project from a financial point of view?


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PC

Percent Complete (real value of work accomplished). Tells the PM how much of the project

has been completed.

PC = EV/BAC

How much of the project has been completed?

TCPI

To-Complete Performance Index (verification factor)

TCPI = (BAC-EV)/BAC-AC) (a cost index). Values for the TCPI index of less than 1.0 is good

because it indicates the efficiency to complete is less than planned.

How efficient must the project team be to complete the remaining work with the remaining

money?

project cost management

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