Project Cost Management: Basics, Planning Steps & Benefits

Benefits of Cost Management in Project Management

Project cost management offers numerous benefits:

• Enhances cost efficiency.
• Facilitates informed decision-making through cost estimates and budget tracking.
• Improves resource allocation.
• Increases accountability by tracking and auditing project expenses.
• Ensures project delivery within budget.

Challenges in Project Cost Management

Proper cost management in project management comes with its own set of challenges, such as:

• Accurate forecasting of expenses of unforeseen events.
• Market volatility.
• Indirect costs cannot be estimated easily like direct costs.
• Ensuring high quality within a budget needs hard work and dedication.

Project Cost Management Steps

The key project cost management steps are to be taken for the successful completion of project within the given budget. These steps are:

Step-1: Cost Estimation

a. Project cost can be estimated using the following five (5) ways

• Analogous Estimating uses historical data from similar projects in the past.
• Parametric Estimating uses the historical relationship between historical data and other present variables.
• Bottom-up Estimating breaks the project down into smaller components and estimates by doing an analysis of the data.
• Three Point Estimating considers the weighted average for realistic cost estimation.
• Earned Value Analysis forecasts future performance by considering the present work situation.

b. Factors to Consider in Cost Estimation

Project cost estimation is influenced by the following factors:

• Scope of Project Work.
• Resource Availability.
• Project Scale.
• Market Conditions.

Step-2: Cost Budgeting

The cost estimates are used to develop a detailed budget so stakeholders can understand and fund. It involves:

• Creating a Project Budget.
• Allocating Resources and Expenses.

Step-3: Cost Control

Cost control is an ongoing exercise and needs the following steps to be taken regularly:

• Monitoring Project Costs.
• Managing Cost Variances.

Step-4: Cost Reporting

Proper cost reporting ensures that all relevant parties have a clear view of the finances, no matter where they are in the management project lifecycle. The role of project manager includes the following:

• Communicating Project Costs to Stakeholders
• Analyzing and Interpreting Cost Reports.

Project Cost Management Processes

Two of the most important documents you’ll prepare for any project are the project schedule and project budget. You’ll use the schedule and budget documents throughout the Executing, Monitoring, and Controlling processes to measure progress and determine if the project is on track.

There are two processes in the Planning group we’ll perform that will lead us to the cost performance baseline output, which is the authorized budget. They are:

• Estimate Costs and
• Determine Budget.

These processes cover several tools and techniques. One process in the Monitoring and controlling group, Control Costs, is used to manage changes in the cost baseline.

A brief overview of processes for cost management in project management are as follows:

• Estimate Costs—The process of approximating the monetary resources needed to complete project activities.
• Determine Budget—The process of aggregating the estimated costs of individual activities or work packages to establish an authorized cost baseline.
• Control Costs—The process of monitoring the project status to update the project costs and manage changes to the cost baseline.

1st Process: Estimate Project Cost

The Estimate Costs process in project cost management develops a cost estimate for the resources (human and material) required for each schedule activity. This includes weighing alternative options and examining risks and trade-offs. Some alternatives you may consider are make-versus-buy, buy-versus-lease, and sharing resources across either projects or departments.

Estimate Project Cost Example

Let’s look at an example of trade-offs. Many times, software development projects take on a life of their own. The requested project completion dates are unrealistic; however, the project team commits to completing the project on time and budget anyway. How do they do this? They do this by cutting things such as design, analysis, and documentation. Ultimately, the project might get completed on time and on budget, but was it really?

• The costs associated with the extended support period because of a lack of design and documentation and the hours needed by the software programmers to fix the reported bugs weren’t included in the project’s original cost (but they should have been).
• Therefore, the costs exceed what was budgeted. You should examine trade-offs such as these when determining cost estimates. The project management office is important in estimating cost management in project management.

1. Estimate Costs Inputs

Many of the Estimate Costs process inputs are already familiar to you. However, we’ll look briefly at each so you can see the key elements to consider when creating the project budget. Cost management in project management explains the inputs to this process, are as follows:

• Project baseline.
• Project schedule.
• Human resource plan.
• Risk register.
• Enterprise environmental factors.
• Organizational process assets.

2. Tools and Techniques to Estimate Costs:

Estimate Costs has nine tools and techniques used to derive estimates:

• Expert judgment.
• Analogous estimating.
• Parametric estimating.
• Bottom-up estimating.
• Three-point estimate.
• Reserve analysis.
• Cost of quality.
• Project management software to estimate cost.
• Vendor bid analysis.

3. Estimate Costs Process Outputs

Activity Cost Estimates

Activity cost estimates in project cost management are quantitative assessments of the probable costs required to complete project work. Cost estimates can be presented in summary form or detail. Costs are estimated for all resources applied to the activity cost estimate. This includes but is not limited to, direct labor, materials, equipment, services, facilities, information technology, and special categories such as cost of financing (including interest charges), an inflation allowance, exchange rates, or a cost contingency reserve.

Basis of Estimates

The basis of estimates is the supporting detail for the activity cost estimates. It includes any information that describes how the estimates were developed, what assumptions were made during the Estimate Costs process, and any other details you think are needed. According to the PMBOK® Guide, students study for a project management certification, a postgraduate diploma in project management, and a master’s in project management. The basis of estimates should include at least the following:

• A description of how the estimate was developed or the basis for the estimate.
• A description of the assumptions made about the estimates or the method used to determine them.
• A description of the constraints.
• There is a range of possible results. You should state the cost estimates within ranges such as $5000 ± 10%.
• The confidence level regarding the final estimates.

2nd Process: Estimate Project Budget Baseline

The next process in the project cost management concerns determining the cost performance baseline, which is the primary output of the Determine Budget process. The Determine Budget process aggregates the cost estimates of activities. It establishes a cost performance baseline for the project that is used to measure the project’s performance throughout the remaining process groups. An important goal of cost baseline is to provide info for project funding requirements –at what point(s) in time will the money be needed? Only the costs associated with the project become part of the authorized project budget. For example, future period operating costs are not project costs and aren’t included in the budget.

1. Determine Budget Inputs

In order to understand what is project cost management, let us first explain the budget inputs. Outputs from other Planning processes, including the Create WBS, Schedule Development, and Estimate Costs processes, must be completed before working on Determine Budget because some of their outputs become the inputs to this process. The inputs for Determine Budget are as follows:

a. ACTIVITY COST ESTIMATES

These are an output of the Estimate Costs process. Activity cost estimates are determined for each activity within a work package and then summed to determine the total estimate for a work package.

b. BASIS OF ESTIMATES

This is also an output of the Estimate Costs process and contains all the supporting detail regarding the estimates. You should consider assumptions regarding indirect costs and whether they will be included in the project budget. Indirect costs cannot be directly linked to any one project. They are allocated among several projects, usually within the department or division in which the project is being performed. Indirect costs can include items like building leases, management and administrative salaries (those not directly assigned full time to a specific project), and so on.

c. SCOPE BASELINE

Scope baseline includes the scope statement, WBS, and WBS dictionary. The scope statement describes the constraints of the project you should consider when developing the budget. The WBS shows how the project deliverables are related to their components, and the work package level typically contains control account information (although control accounts can be assigned at any level of the WBS).

d. PROJECT SCHEDULE

Project cost management schedule contains information that helps develop the budget, such as start and end dates for activities, milestones, and so on. Based on the information in the schedule, you can determine budget expenditures for calendar periods.

e. RESOURCE CALENDERS

Resource calendars help you determine costs in calendar periods and over the length of the project because they describe what resources are needed when on the project.

f. CONTRACTS

Contracts include cost information you should include in the overall project budget. We’ll talk more about contracts in Procurement Management. Organizational process assets: The organization process assets that will assist you with the work of this process include cost budgeting tools, the policies and procedures your organization (or PMO) may have regarding budgeting exercises, and reporting methods.

2. Determine Budget Tools and Techniques

The Determine Budget process has five tools and techniques, including two you haven’t seen before:

• Cost aggregation.
• Reserve analysis.
• Expert judgment.
• Historical relationships.
• Funding limit reconciliation.

3. Determine Budget: Outputs

In the context of cost management in project management, the goal of Determine Budget is to develop a cost performance baseline for the project that you can use in the Executing and Monitoring Controlling processes to measure performance. You now have all the information you need to create the cost performance baseline. In addition, you’ll establish the project funding requirements.

The following are the outputs of the Determine Budget process:

• Cost performance baseline.
• Project funding requirements.
• Project document updates.

We have covered the project cost management document updates in other processes. For Determine Budget, you may need to update the risk register, cost estimates, and/or the project schedule.

3rd Process: Control Costs

Control Costs is the process of monitoring the project status to update the project costs and manage changes to the cost baseline. The key benefit of this process is that it provides the means to recognize variance from the plan, take corrective action, and minimize risk.

The key to effective cost control is the management of the approved cost baseline and the changes to that baseline. Project cost control includes:

• Influencing the factors that create changes to the authorized cost baseline.
• Ensuring that all change requests are acted on in a timely manner.
• Ensuring that cost expenditures do not exceed the authorized funding.
• Monitoring cost performance to isolate and understand variances from the approved cost baseline.
• Monitoring work performance against funds expended.
• Bringing expected cost overruns within acceptable limits.

1. Control Costs: Inputs:

a. COST BASELINE:

The cost baseline is compared with actual results to determine if a change, corrective action, or preventive action is necessary.

b. PROJECT FUNDING REQUIREMENTS:

The project funding requirements include projected expenditures plus anticipated liabilities.

c. WORK PERFORMANCE DATA:

Work performance data includes information about project progress, such as which activities have started, their progress, and which deliverables have finished. Information also includes costs that have been authorized and incurred.

d. ORGANIZATIONAL PROCESS ASSETS:

Existing formal and informal cost control-related policies, procedures, and guidelines; Cost control tools; and Monitoring and reporting methods to be used.

2. Control Costs: Tools and Techniques:

The tools and techniques of the Control Costs process are as follows:

• Earned value measurement (EVM).
• Forecasting.
• To-complete performance index (TCPI).
• Performance reviews.
• Variance analysis.
• Project management software.

a. Earned Value Management

You can accomplish performance measurement analysis using a technique called earned value measurement (EVM). Simply stated, EVM compares what you’ve received or produced to what you’ve spent. The EVM continuously monitors the planned value, earned value, and actual costs expended to produce the work of the project. When variances that result in cost changes are discovered (including schedule variances and cost variances), those changes are managed using the project change control system. The primary function of this analysis technique is to determine and document the cause of the variance, to determine the impact of the variance, and to determine whether a corrective action should be implemented as a result.

b. Forecasting

Forecasting uses the information you’ve gathered to date and estimates the future conditions or performance of the project based on what you know when the calculation is performed. Forecasts are based on work performance information (an output from the Executing process group) and your predictions of future performance.

3. Control Costs: Outputs

a. WORK PERFORMANCE INFORMATION

The calculated CV, SV, CPI, SPI, TCPI, and VAC values for WBS components, in particular the work packages and control accounts, are documented and communicated to stakeholders.

b. COST FORECASTS

Either a calculated EAC value or a bottom-up EAC value is documented and communicated to stakeholders.

c. CHANGE REQUESTS

Analysis of project performance may result in a change request to the cost baseline or other components of the project cost management plan. Project change management requests may include preventive or corrective actions and are processed for review and disposition through the Perform Integrated Change Control process.

d. PROJECT MANAGEMENT PLAN UPDATES

Elements of the project management plan that may be updated include, but are not limited to; Changes to the cost baseline are incorporated in response to approved changes in project scope, activity resources, or cost estimates. Changes to the cost management plan, such as changes to control thresholds or specified levels of accuracy.

e. PROJECT DOCUMENT UPDATES

Project cost management documents that may be updated include, but are not limited to, Cost estimates and Basis of estimates.

6 Important Terms in Project Cost Management

1. Time/Cost Relationship in Project Management

The Time-Cost Relationship is also referred as project management triangle or the triple constraint. This concept posits that changes to one side of the triangle invariably affect the other sides. For example, extending a deadline through the project time management process may reduce project costs.

2. Appraisal Cost in Project Management

Appraisal cost in project management refers to the expenses associated with project quality expectations and standards. These costs are incurred through inspections, testing, audits, and reviews. Appraisal costs are integral to quality management in project management .

3. Benefit-Cost Ratio in Project Management:

The Benefit-Cost Ratio (BCR) is a financial metric used in project management to assess the relative profitability of a project. It is calculated by dividing “the present value of all expected benefits” by “the present value of all associated costs”.

• BCR greater than 1 means project’s benefits outweigh the costs.
• BCR less than 1 means project costs are greater than the benefits.

4. Cost Slope in Project Management:

The cost slope in project management refers to the rate at which the project cost will change with respect to time. It means, it it illustrates the cost impact of accelerating or delaying project activities. It helps project managers decided, where and when to allocate additional resources to recover delays.

5. Direct Costs in Project Management:

Direct costs in project management are those expenses that can be directly attributed to the project, such as: labor, materials, equipment, etc.

6. Actual Cost in Project Management:

The Actual Cost (AC), also known as the Actual Cost of Work Performed (ACWP), represents the total amount spent on a project to date. It includes all costs incurred, including direct and indirect costs.