Cost Management

Cost Management and Time Management are closely connected and share many techniques. As discussed in Time Management, work packages are broken down into activities. On many projects, those activities are the basis for cost estimates. Large projects estimate costs at the control-account level, which is at or above the work-package level.

Cost Management Plan

The cost management plan is a required part of the project management plan. In the framework used in this chapter, it is developed through Develop Project Management Plan in Integration Management. The chapter lists this planning step in Integration Management and treats the formal Cost Management processes separately.

The plan explains how to plan project costs, manage the work within those costs, control costs, and handle variances. Decide these details in advance:

• How to express cost estimates.
• What level of accuracy to expect.
• How to identify, track, and report cost performance.
• What reporting formats to use.
• How to define and distinguish direct and indirect costs.
• What spending ceiling to set.
• What change control procedures to follow for cost changes.

The spending ceiling defines how much cost variation the team can allow. Set it during planning. If spending exceeds the ceiling, act to bring it under control.

Life Cycle Costing

Life cycle costing considers costs over the product’s full life, including the costs of the project itself.

Suppose a product costs $50,000 to buy and $5,000 to maintain over its life. An alternative costs $38,000 to buy and $50,000 to maintain over its life. Would you save $12,000 on the purchase and increase the company’s maintenance cost by $45,000? Or would you spend the extra $12,000 now to save the company $45,000 in future maintenance?

Value Analysis

Value analysis aims to reduce project cost while maintaining scope and performance. Identify the functions systematically, assign a value to each, and look for less costly resources and activities that maintain the required performance. Value analysis is aligned with value engineering.

Cost Risk

Procurement risk and cost management risk are examples of cost risk. Address risks related to cost throughout the project, including during risk management.

Estimate Costs

Estimate the cost of each identified project activity. The cost of completing the project includes:

1. Quality work.
2. Risk management work.
3. Project management activities.
4. Resources.
5. Direct and indirect costs.
6. Overhead.
7. Other costs.

Types of Cost

Costs can be classified by whether they vary with the amount of work.

• Variable costs change with the amount of work. Examples include raw materials and labor wages.
• Fixed costs stay constant as the amount of work changes. Examples in this chapter include setup costs, working capital, and leases or rent.

Costs can also be classified by whether they are directly attributable to the work.

• Direct costs can be traced directly to project work. Examples include travel and entertainment expenses, stationery, and labor salaries.
• Indirect costs are shared overhead or other costs that cannot be assigned to a specific project or activity. They can cover multiple projects.

Inputs to Estimating Costs

• Scope baseline. The project scope statement, work breakdown structure (WBS), and WBS dictionary show what is inside and outside project scope.
• Project schedule. Develop a schedule before creating the budget. It lists activities, assigned resources, and when work will occur. Knowing when to make purchases and spreading expenditures across the schedule help control costs. Costs can also affect the schedule. If raw materials will be especially expensive when an activity is scheduled, move the activity earlier or later to account for the price surge.
• Human resource plan. The plan identifies how to reward team members, labor rates, and the number and cost of people needed. It helps the project manager keep people motivated to achieve savings while controlling costs.
• Risk register. Managing risk can save time and money, but it also takes work that costs money. This work can lead to additional risks, including cost risks. In this sense, risk is both an input to and an output of Estimate Costs.
• Historical records and lessons learned. Records from past projects simplify cost calculations and estimates. Templates in those records can speed up the work.
• Project management costs. Project management work has costs, including the project manager’s time, status reporting, change analysis, and execution.

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Estimating Methods

Time Management covers one-point, analogous, parametric, and three-point (PERT) estimating. The same methods can be used to estimate costs. Bottom-up estimating is another option.

Bottom-Up Estimating

Estimate costs for individual activities or work packages. Roll those costs up into control accounts, then combine them into an overall project estimate. This is another reason to build a well-defined WBS with the project team.

Project Management Software

Project management software can speed up cost calculations across several hundred activities, including calculations for direct, indirect, overhead, and fixed costs.

Resource Cost Rates

Know the rates for the resources the project will use. These may include internal staff, vendors, consultants, suppliers, and external technicians.

Reserve Analysis

Identify activities with significant risks and estimate the time and money required to manage those risks if they occur. Contingency reserves cover known risks. Management reserves cover unknown risks. Use analysis to calculate reserves and avoid padding estimates.

Cost of Quality

Quality work is required for the project. The additional costs of that work are called the cost of quality (CoQ).

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Accuracy of Estimates

Cost estimating is iterative. Early estimates are less accurate and should use wider ranges. As the project progresses, the project manager can narrow the ranges. Preliminary, conceptual, feasibility, and final estimates each call for a range appropriate to that stage.

• Rough order of magnitude (ROM) estimate. Usually made during project initiation. A typical range is ±50%, depending on how much the team knows about the project.
• Budget estimate. Made during project planning, with a range of −10% to +25%.
• Definitive estimate. A more refined estimate. Some project managers use ±10% and others use −5% to +10% of actual cost.

Estimate Costs produces activity cost estimates and explains how they were derived. It can also lead to updates to project documents, such as the risk register and change control register.

Determine Budget

Determine Budget calculates the total project cost and the amount the organization should have available. The project manager must perform risk management and include both contingency and management reserves in the total cost estimate. The cost budget is the cost baseline plus management reserves. It shows how much money the organization should allocate.

Use cost aggregation to build the budget. Roll up activity costs into work-package costs, then into control-account costs, then into total project costs. Include contingency reserves in the cost baseline. Add management reserves as the final step to determine the cost budget.

Check the cost baseline and cost budget against parametric estimates, expert judgment, or historical records. Investigate significant differences to make sure the estimates are sound.

Check cash flow next. Funding might be unavailable when the project needs it. Plan activities and funding over time. An S-curve can show the time-phased costs.

Review the constraints in the project charter and reconcile the cost baseline and budget with them as part of Integration Management. If the estimate exceeds those constraints, meet with stakeholders, explain the reasons, and present options for reducing project costs. The project manager is accountable for avoiding an unrealistic budget.

Determine Budget produces the cost baseline and may also lead to updates to other project management documents.

Control Costs

Use the same general approach to control that applies in the other project management knowledge areas. To control project costs:

• Follow the cost management plan.
• Use organizational process assets, such as policies, procedures, tools, and reporting formats for cost control.
• Prevent unnecessary changes by identifying and addressing the root causes of high costs.
• Measure actual costs against the baseline throughout the project life cycle. A variance can trigger corrective or preventive action.

Progress Reporting

Use defined rules to report activity progress and avoid guesswork.

• 50/50 rule. Credit 50% when the activity starts and the remaining 50% when it finishes.
• 20/80 rule. Credit 20% at the start and the remaining 80% at completion.
• 0/100 rule. Credit 0% at the start and 100% at completion.

Earned Value Measurement

Earned value measurement helps the project manager track costs closely, spend time on other productive work, and avoid guesswork in progress reporting.

The performance measurement baseline combines the scope, schedule, and cost baselines. Earned value measures project performance against this combined baseline. By bringing together cost, time, and completed work or scope, it gives the project manager a way to forecast future performance, completion dates, and costs.