Topic 4: Project cost management

Project Cost Management - An Overview

Project cost management is about estimating, obtaining and controlling the monetary resources needed by a project required to achieve its outcome. Accurately estimating costs within a project is critical to project success. We need cost estimates so that we:
* can determine whether the economic benefit of the project outweighs its cost, i.e. whether the project should proceed or not
* monitor expenditure (once you have decided to move forward with the project) to ensure our estimates were accurate and, if not, what corrective action needs to be taken.

The cost estimating process begins with the project WBS which identifies the work packages to be undertaken. With the aid of the project plan and the schedule, we then enter these estimates into a time-phased budget for the project. We submit this budget to the organisation for funding and for authority to spend against this budget.

Cost control is the process to approve and monitor expenditure throughout the project. We have to identify variances as they arise to enable us to take appropriate corrective action. It is important that we clearly differentiate in our minds the three cost-related terms— estimate, cost and budget.
* An estimate is basically just someone's opinion, a rough judgement.
* Cost is an accounting fact. It can only be determined after the event.
* A budget is neither an estimate, nor a known cost. It is an agreed expenditure allowance.

Project Cost Management Tools and Techniques

The two main approaches to estimating are often referred to as:
1. top-down—high-level estimates of cost are obtained by splitting the project into large components that we can then use to create an estimate by applying historical data and/or judgement
2. bottom-up—building up a cost profile by adding together individual WBS element costs.

Top-down estimates apply a formula or by compare with previous similar projects. Also known as 'analogous estimate'. The top-down approach is a faster and cheaper way of estimating costs than the bottom-up approach. A bottom-up estimate is based on costing the activities and materials identified in each WBS item or work package. This is labour intensive and time consuming. The increased granularity (i.e. lower down the WBS) of the estimates leads to a better understanding of costs and greater accuracy than top-dow estimates.

Another estimating technique project managers we discussed in the last topic is the threepoint estimate technique. We can improve the accuracy of our cost estimates if we consider the uncertainty and risk in our estimates of activity and work package costs. We ask the project's estimating team to provide the most likely, the most optimistic and most pessimistic costs. We then follow the PERT process to develop our cost estimate.

To calculate the expected activity cost estimate you can use the following formula: CE = (CO + 4CM + CP) / 6
CE—the expected activity cost estimate
CM—most likely cost estimate
CO—optimistic cost estimate
CP—pessimistic cost estimate

A number of factors are likely to affect project estimates, these include:
* variations in labour–material cost ratios
* the effects of distance from supply centres on cost
* variations in exchange rates between countries over a period of time
* significant changes in technology over a period of time
* changes in environmental and social factors over a period of time
* changes in costs affected by time series

Project budgets are the authorised funds that we can spend executing a project, or if you prefer, the approved estimates that we can spend against. We measure project cost performance against this authorised budget. There is a difference between a cost estimate and a cost budget. A cost estimate shows cost by category, whereas a cost budget aggregates these estimates and displays them across time—it's the cost part of a cash flow statement. The management reserve is the funding set aside for unplanned changes to project scope and cost.

Controlling cost is about ensuring a project successfully comes in under budget. The most useful cost control tool for project managers is earned value analysis (EVA) (although it is sometimes called earned value management, EVM). To conduct EVA at any given time (t), within the schedule, we need to know four key pieces of information:

1. BAC—budget at completion—the project's originally planned duration and budget.
2. PV—planned value—the dollar value of budgeted work, or spending plan, that should have been performed multiplied by time (t). Burke also uses the term—BCWS— budgeted cost of work scheduled. This is the S-curve we identified earlier.
3. EV—earned value—the dollar value (budgeted value) of work actually completed multiplied by time (t), the measure of technical accomplishment. Sometimes referred to as the BCWP—budgeted cost of work performed.
4. AC—actual cost—the actual dollars paid or spending at time (t) for the work actually completed. Also known as the ACWP actual cost of work performed.

Armed with these pieces of information we are able to determine a project's performance (e.g., Schedule performance index (SPI) SPI = EV/PV, Cost performance index (CPI) CPI = EV/AC & etc).

Schedule Analysis and Forecast Formula
Schedule variance (SV), SV = EV – PV or SV(%) = SV/PV
Schedule performance index (SPI), SPI = EV/PV
Estimate at completion, time (EACt) EACt = Duration/SPI

Cost Analysis and Forecast Forumula
Cost variance (CV), CV = EV – AC or CV(%) = CV/EV
Cost performance index (CPI), CPI = EV/AC
To-complete performance index (TCPI), TCPI = (BAC – EV)/(BAC – AC)
Estimate at completion1 (EAC), EAC = BAC/CPI = AC + (BAC – EV)/CPI
Variance at completion (VAC), VAC = BAC – EAC or VAC(%) = VAC/BAC
Estimate to complete (ETC), ETC = EAC – AC or ETC = (BAC –EV)/CPI

PMI Performance analysis matrix

SV>0, SPI>1.0 SV=0, SPI=0 SV<0, SPI<0
CV>0, CPI>1 Ahead of schedule, Under budget On schedule, Under budget Behind schedule, Under budget
CV=0, CPI=1 Ahead of schedule, On budget On schedule, On budget Behind schedule, On budget
CV<0, CPI<1 Ahead schedule, Over budget On schedule, Over budget Behind schedule, Over budget

Project activities may be classified into three groups:
1. measurable efforts (ME)—discrete increments of work with a predefined schedule for accomplishment, whose completion produce tangible results
2. level of effort (LOE) —work that does not lend itself to subdivision into discrete schedule increments of work, such as project planning and control, product assurance, and configuration management support
3. apportioned effort (AE)—work that does not lend itself to subdivision into discrete schedule increments of work but that can be accounted in proportion to some measurable efforts activity . This is rarely used.

Project managers report progress using one of the following measurement techniques:

* percentage (%) complete
* 50/50 rule—a task is considered 50% complete when it begins and the remaining 50% is credited only when the task is fully complete
* 20/80 rule (or 80/20)—a task is considered 20% complete when it begins and the remaining 80% is credited only when the task is fully complete
* 0/100 rule—a task earns 100% only when the task is fully complete
* milestone achievement—progress is only recognised when a defined milestone is reached.

Project cost management artefacts

The inputs for estimating costs include:

* the project scope baseline
* project schedules
* the human resource plan
* the risk register

To develop a time-phased budget, project managers require the following inputs:
* activity cost estimates—the output from the estimating cost process, these are the basis of the budget
* basis of estimates—the justification of the cost estimates are needed to support the requests for funding from the organisation, this is often incorporated in the WBS dictionary
* the scope baseline— really we are looking for the higher order detail of what the cost of timeframe constraints placed on the project, the contract or other agencies
* the project schedule—this provides the time sequence of work so that we can apply funds in the budget to the right time period
* resource calendars—detailing when resources will be undertaking work
* contracts—details of what products, services, etc. have be bought for the project.

Control costs
The main inputs for controlling costs are:
* the project management plan — specifically the cost performance baseline and the cost management plan
* project funding requirements—the approved spend pattern for the project
* work performance information —this is the work package and task progress and expenditure information.

Common inputs to all processes are:
* enterprise environmental factors—legal, regulatory, commercial, etc. the external conditions that the organisation must comply with
* organisational process assets—the internal policies, procedures, tools, etc. mandated by the organisation itself rather than by an outside source.

The outputs include:

Cost estimating
* Activity cost estimates. An activity cost estimate is the expected or probable cost to complete a project activity.
* Basis of estimates. The basis of estimate is the supporting detailed document explaining how an activity cost estimate was derived.

Determine budget
* Cost performance baseline. This is the authorised time-phased budget used to measure, monitor and control overall project cost performance.
* Project funding requirements. These are the funding submission for senior management approval that becomes the authorisation for the project manager to expend funds.

Control costs
* Work performance measurements These include the calculated values used to monitor project performance, typically cost variance (CV), cost performance index (CPI), schedule variance (SV) and schedule performance index (SPI).

Budget forecasts
* Forecasted completion is the calculated estimate at completion (EAC) or the estimate to complete (ETC).
* Change requests. Change requests resulting from recommended corrective actions to address project performance issues.

Cost estimate updates
* Approved cost estimate updates, and the supporting basis of estimate, are incorporated into the cost management baseline for future performance management monitoring.

* Project document updates

Project cost management processes

The process for project cost management comprises:
* estimate costs
* determine the budget
* control costs.

To maintain creditability with our stakeholders, we must have repeatable and rigorous cost
estimation methodology that includes:
* standardised processes, tools and techniques
* documented assumptions made in preparing the estimate
* an auditable trail of the estimates and the data sources used
* the robustness (level of confidence) of our estimates
* identifiable contingency (for risks) estimate
* evidence of how the process 'learns' and improves techniques with each iteration.

To ensure that we meet stakeholders' cost expectations, we have to:
* separate the estimating function from the implementation function as those who estimate their own work tend to be optimistic
* quote an estimate range—you should never quote a single figure until the project is complete. Generally speaking, the less you know, the broader your range should be. Initial project estimates have a high margin of error and should correspondingly have a wide range. Later estimates are more certain and can have a smaller range
* qualify the estimates—explain the uncertainties, risks, constraints, assumptions, etc.
* collect actual vs estimation data —to improve estimating performance, you need to know how accurate previous estimates were
* add contingency for unforeseen circumstances.

Determine budget is the process of aggregating the estimates and then allocating costs across the project's timeline. This produces a time-phased spend baseline that project performance can be measured against. This is commonly known as the S-curve for EVA.

Controlling cost is about monitoring and analysing cost using the techniques described in the section on EVA. The key action that results from this is the early intervention that can be taken by the project manager to redress the variations.

Other control activities include:
* establishment of direct linkages to organisational procedures
* definition of control thresholds
* development of the formats for the various cost reports