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Cost Management

Chapter 7


Chapter 7Objectives

Understand the different Cost Management Processes

Their Inputs, Tools and Techniques, Outputs

This chapter entails one to understand the various Cost Management aspects required to understand the customer monetary dimensions.

What and how the project will be funded for expenditure, what will be needed to complete the project and finally brought to the satisfactory need of the customer within defined budget – making the project successful!


Project Cost Management includes processes to ensure the Cost is defined (estimated, budgeted), managed, controlled to arrive on the Cost baseline used for further reference on the project.

Project Cost Management is largely associated with establishing the cost to be incurred on the project and keeping the cost well within the stipulated cost ranges.

In most organizations, the cost management is a function performed largely by the finance or administration team specialized in financial control.

Knowledge Area: Cost Management


There are 4 Cost Management processes:

1. Plan Cost ManagementEstablishing Project Policies, procedures and the controls to ensure the project costs are managed well.

2. Estimate CostsIdentifying the costs associated with the resource needs in order to accomplish the project activities

3. Determine BudgetsOnce the cost estimates are available a planned budget is authorized as the Cost Baseline to maintain a reference for the project

4. Control CostsProcess of managing the project activities to control costs with reference to the Cost baseline

Knowledge Area: Cost Management


7.1 Plan Cost Management

Inputs

• Project Management Plan

• Project Charter• Enterprise

Environmental Factors

• Organizational Process Assets

Tools & Techniques

• Expert Judgment• Analytical

Techniques• Meetings

Outputs

• Cost Management Plan

•Integration•Develop Project Management Plan

•Scope•Plan Scope Management•Collect Requirements•Define Scope•Create WBS

•Time•Plan Schedule Management•Define Activities•Sequence Activities•Estimate Activity Resources•Estimate Activity Duration•Develop Schedule

•Cost•Plan Cost Management•Estimate Costs•Determine Budget

•Quality•Plan Quality Management

•Human Resource•Plan HR Management

•Communications•Plan Communications Management

•Risk•Plan Risk Management•Identify Risks•Perform Qualitative Risk Analysis•Perform Quantitative Risk Analysis•Plan Risk Responses

•Procurement•Plan Procurement Management

•Stakeholder•Plan Stakeholder Management

Planning Process

Define and establish policies, procedures and governance models to ensure the cost of the activities and eventually the Project are planned, managed, expended and controlled in line with the expectations defined.

Key benefit of this process is, It provides the guidance and direction on how the cost need to be managed through out the project.

This process is detailed from a high-level Project Charter and the preliminary project management plan.


Cost Management Plan output describes how project costs will be planned, managed and controlled. It establishes the following:

Units of Measure → Each resource unit of measure will be defined. For example: Staff Hours, Liters, Kilometers..

Level of Precision → The degree to which the activity cost will be rounded up or down. ( INR 449 to Round up of INR 500 or INR 449 to Round down to INR 400)

Level of Accuracy → The activity estimate accuracy level with tolerance range.(+/- 5%)

Organizational Procedure Links → In order to control costs on the project activities, WBS has options to include Control account and Control account codes. These organization procedure links ensure the continuous cost monitoring.

Control Thresholds → Defined thresholds on each activity or at project level ensure any variances beyond the thresholds are acted and informed to the stakeholders.

Rules of Performance Management. EVM rules of performance are set.

Suppose for every INR 10 Lakh, the performance review and the EAC(Estimate at completion) of the project may be reviewed.Suppose for every completion of 10 tasks, the AC(Actual Cost) may be reviewed and further actions defined.Suppose for every CPI variation of more than 20%, a review may be enforced.

Reporting formats → Formats & Frequency of Cost Reports circulated.

Process Description → Other cost processes involved in the project are defined and documented.

Cost Management Plan


7.2 Estimate Costs

Inputs

•Cost Management Plan•HR Management Plan•Scope Baseline•Project Schedule•Risk Register•Enterprise Environmental Factors

•Organizational Process Assets

Tools & Techniques

•Expert Judgment•Analogous•Parametric•Bottom Up•3-point•Reserve Analysis•Cost Of Quality•Project Management Software

•Vendor Bid Analysis•Group Decision Making

Outputs

•Activity Cost Estimates

•Basis Of Estimates•Project Documents Updates

Planning Process

• Integration• Develop Project Management Plan

• Scope• Plan Scope Management• Collect Requirements• Define Scope• Create WBS

• Time• Plan Schedule Management• Define Activities• Sequence Activities• Estimate Activity Resources• Estimate Activity Duration• Develop Schedule

• Cost• Plan Cost Management• Estimate Costs• Determine Budget

• Quality• Plan Quality Management

• Human Resource• Plan HR Management

• Communications• Plan Communications Management

• Risk• Plan Risk Management• Identify Risks• Perform Qualitative Risk Analysis• Perform Quantitative Risk Analysis• Plan Risk Responses

• Procurement• Plan Procurement Management

• Stakeholder• Plan Stakeholder Management

It is the process of estimating (approximation) the financial value needed to ensure the project activities are completed.

Cost estimates also provide the details on alternate options such as make versus buy, buy versus lease, shared resources and so on.

Cost estimates are generally represented in the format of staff hours, staff days and/or staff years instead of currencies due to the currency fluctuations.

These estimates evolve over a period from the range of, -25% to +75%(Rough order of magnitude ROM) to -5% to +10%(definitive estimate).


Human Resource Management Plan

HR Management Plan defines allocation, engagement and finally release of resources for project. This plan may include following:

Roles and ResponsibilitiesRole – function of job role has to be defined with clear boundaries.Authority – In the function of job, Authority resource exercisesResponsibility – nature of responsibilities resource performCompetency – level of skill the resource has. For any gaps identified, proactive planning to up skill competency.

Project Organization ChartsEach staff member of the project has to report their duties to the respective function or authority for the defined project. This being represented in graphical tree structure is known as Project organization chart. Example: Imagine a Satellite Development Project with Thousands of Staff.

As a component of HR Management plan, it has to be defined when and how the resources will be allocated, engaged for how long and when will be finally released. Such plan may include:

Staff Acquisition

Resource Calendars – use visual tools Resource Histogram

Staff Release Plan – Smooth transition of resources during the release to another project increases Morale of the staff

Training Needs

Recognition and Rewards – Key aspect of motivating staff. Definite plan should exist to ensure the performing resources achieve their project objectives.

Staffing Management Plan


Cost of quality includes all costs incurred over the life of product by investment in preventing non-conformance to requirements, appraising the product or service for conformance to requirements, and failing to meet requirements.

Failure to meet requirements is known as Rework. Any rework has to be completely eliminated with refinements in the process or avoided in the first place.

Failure costs are also called Cost of Poor Quality and are categorized into:

Internally found by StaffExternally found by Customers

Cost of Quality - COQ

Cost of Conformance

•Prevention Costs (build Quality product)•Training•Document Processes•Equipment•Time to do it right

•Appraisal Costs (assess the Quality)•Testing•Destructive testing loss•Inspections

Cost of Non-Conformance

•Internal Failure Cost•Rework•Scrap

•External Failure Cost•Liabilities•Warranty Work•Lost Business

Mon

ey S

pent

to A

void

Failu

res

Mon

ey S

pent

dur

ing

& af

ter d

ue to

Failu

res


For Large Projects, it is very fruitful to have bidding mechanisms wherein the qualified vendors engage and define the cost of such a work at hand.

This largely saves huge upfront estimation costs for performing organization and also gain advantage of multiple competing bids.

At the same time, wherever the performing organization intends to have better control on the overall cost incurred, the organization performs due diligence to award such work to contractors. This may result in additional overhead of detailing project with due-diligence.

Vendor Bid Analysis


Arriving at Cost Estimates should also detail the approach and the mechanisms adopted to arrive at the cost in a clear and complete manner.

Based on the nature of the projects, the basis of estimation for such industry or function may completely alter.

Such cost estimates may include the :

Basis of estimationRisks & AssumptionsConstraints & BoundariesRange of possible estimatesIndication of confidence level of the final estimate

Basis of Estimates


7.3 Determine Budget

Inputs

• Cost Management Plan

• Scope Baseline

• Activity Cost Estimate

• Basis Of Estimate

• Project Schedule

• Resource Calendars

• Risk Register• Agreements• Organizationa

l Process Assets

Tools & Techniques

• Cost Aggregation

• Reserve Analysis

• Expert Judgment

• Historical Relationships

• Funding Limit Reconciliation

Planning Process

• Integration• Develop Project Management Plan

• Scope• Plan Scope Management• Collect Requirements• Define Scope• Create WBS

• Time• Plan Schedule Management• Define Activities• Sequence Activities• Estimate Activity Resources• Estimate Activity Duration• Develop Schedule

• Cost• Plan Cost Management• Estimate Costs• Determine Budget

• Quality• Plan Quality Management

• Human Resource• Plan HR Management

• Communications• Plan Communications Management

• Risk• Plan Risk Management• Identify Risks• Perform Qualitative Risk Analysis• Perform Quantitative Risk Analysis• Plan Risk Responses

• Procurement• Plan Procurement Management

• Stakeholder• Plan Stakeholder Management

It is the process of aggregating the estimated costs and to establish an authorized budget for the project + define the cost baseline.

Key benefit is a ready cost baseline reference for monitoring and controlling the costs on the project duration.

Cost baseline includes all the funds required to execute the project till completion. Management reserves are beyond the Cost baseline and are not part of the funds for execution of the project.


Cost AggregationCosts are aggregated (summed up) at above levels. Usually the costs are attached to each work package, which are then aggregated at Control Accounts and then aggregated at the entire Project level.

Total Project Costs can be arrived using the historical relationships of using the parametric or analogous estimates.

This depends on the actual costs of the previous projects. Helpful in the early phase of the project when limited information is known.

Historical Relationships

Expenditure of funds should be reconciled based on the funding limits on the commitment of funds for the project by the customer or the organization.

This may necessitate and/or trigger changes to the schedule and cost expenditure patterns as the project would progress.

In order to ensure the expenditures are inline with the funds by necessitating constraint dates into project schedule.

As the project progresses, all expenditures are supposed to be accounted and readjusted as per the reconciliation of the project expenses in to project schedule.

Funding Limit Reconciliation


Project BudgetLet us take a sample example to understand what and how Project Budgets are arrived at and what are the Funding Limits.

For a New Wooden House Construction Project in an Amazon forest of 4 Months.

Vendor is charging the Project USD 3,50,000. Based on the agreement, Vendor has agreed to start work immediately upon 10% received funds in 1st Month, 30% in 2nd Month and rest in subsequent 2 months. Project staff working on the Project would need an upfront USD 45,000 for their travel expenditure. During the 3rd Month staff needs USD 20,000 for the final travel settlements. Project also needs Machines which is estimated to be USD 30,000 in 1st Month and thereafter every month USD 10,000 till Project completion.

What will be Total Project Budget and how is it reconciled for every month? Also draw an S-Curve for the Project.Category Sum 1st Month 2nd Month 3rd Month 4th Month

Vendor 350000 10% 30% 30% 30%

Staff Travel 45000 20000

Machines 30000 10000 10000 10000

Total Budget

Cumulative Cost


Category Sum 1st Month 2nd Month 3rd Month 4th Month

Vendor 350000 35000 105000 105000 105000

Staff Travel 65000 45000 - 20000 -

Machines 60000 30000 10000 10000 10000

Total Budget 475000 110000 115000 135000 115000

Cumulative Cost 110000 225000 360000 475000

M1 M2 M3 M40

50000100000150000200000250000300000350000400000450000500000

0

110000

225000

360000

475000

Cost Baseline (S-Curve)

Cum

ulati

ve C

ost o

f Pro

ject


Cost baseline is the approved time-phased project budget, excluding any management reserves.

In order to use the management reserve, the change control board has to approve the required funds.

Project Funding Requirements are periodic funding requirements derived from the cost baseline.

Activity Cost

Estimates

Work Package

Cost Estimates

Control Accounts

Cost Baseline

Project Budget

Tota

l Am

ount

Time

Cum

ulati

ve V

alue

s

Management Reserve

Project Budget

expenditures

Cost Baseline (S-Curve)

Funding Requirements

Cost Baseline(S-Curve) Project Funding Requirements

ActivityContingency

Reserve

Contingency Reserve

Management Reserve


7.4 Control Costs

Inputs

•Project Management Plan•Project Funding Requirements

•Work Performance Data•Organizational Process Assets

Tools & Techniques

•Earned Value Management•Forecasting•TCPI (To-complete Performance Index)

•Performance Reviews•Project Management Software

•Reserve Analysis

Outputs

•Work Performance Information

•Cost Forecasts•Change Requests•Project Management Plan Updates

•Project Document Updates•Organizational Process Assets Updates

Monitoring & Controlling Process

• Integration• Monitor and Control Project Work• Perform Integrated Change Control

• Scope• Validate Scope• Control Scope

• Time• Control Schedule

• Cost• Control Costs

• Quality• Control Quality

• Human Resource• Communications

• Control Communications• Risk

• Monitor & Control Risks• Procurement

• Control Procurements• Stakeholder

• Control Stakeholder Management

It is the process of managing project cost and controlling project costs to ensure, “project is delivered” with in planned cost baseline.

Key benefit includes the project cost is well within the planned cost baseline and minimize the project risks.

Using “control costs” the project can be put back in to track by corrective and preventive actions.

Effective management of Control costs is performed by ensuring the Projects Costs are controlled with Control Accounts and approved by the Authorized Personnel along with the reviews.


Earned Value Management Technique is a Performance Measurement and Project health status check technique with visual & statistical representation on Scope,

Cost, Schedule, Resources.EVM combines an integrated view of both Scope Baseline and Cost Baseline based on which the Performance Baseline is established.

Time

Cum

ulat

ive

Cost

Management Reserve

Project Budget

Planned Value(PV)

Earned Value(EV)

Present Day

Actual Cost (AC)

Estimate to Complete(ET

C)

Budg

et A

t Com

plet

ion

(BAC

)

Estim

ate

At C

ompl

etio

n (E

AC)

Project Start

Earned Value Management


Planned Value (PV)The charted out planned value for the project is referred to as the PV and is commonly thought as Authorized budget for the Scheduled Work.At any given point in time, it is supposed to be the accomplished value which can be treated as the baseline. This baseline may be used to make comparisons against the actual values either cost or schedule.This baseline is also referred to as the Performance Measurement Baseline.The total planned value of the project is also known as BAC(Budget at Completion), which does not include the Management Reserve.

Earned Value (EV)The charted out actual value for the project at that given point in time is known as EV and is commonly thought as the Actual Work Performed measured against the Authorized Budget value.EV actually shows the Project percentage completion.EV is the real time performance data of the project and based on which suitable measures may be adopted incase of deviations of the project parameters.



Actual Cost (AC)AC is the total cost incurred on project till date.Based on past performance, it is possible to estimate future predicted values and arrive at the final actual cost = EAC (Estimate at Completion) giving insights to project management team for appropriate funding on future course of project.AC is the realized cost for the work performed on the project till that point in time.

Schedule Variance (SV) = EV - PVSV is the difference between the Earned value and the Planned value.SV helps to identify whether the project is ahead on the schedule or behind the schedule in comparison to PV.

Cost Variance (CV) = EV - ACCV is the difference between the Earned value and the Actual cost.CV helps to identify whether project is cost overrun or under control.

Variance at Completion (VAC) = BAC – EACEstimated variance cost to completion of the project.



Schedule Performance Index (SPI) = EV / PVSPI is measure of schedule efficiency of project.

SPI Value = 1Project is trending as per expectation and expected to finish as planned.

SPI Value > 1 (Means Better)Project is ahead of schedule and all work planned has been achieved along with some future work accomplished earlier.

SPI Value < 1Project is behind schedule and not all work planned has been achieved as of date and need to recover lost time.



Cost Performance Index (CPI) = EV / ACCPI is the measure of cost efficiency of project.

CPI Value = 1Project is spending as per expectation and expected to meet cost objectives as planned.

CPI Value > 1 ( Means Better)Project is spent less than planned and is efficient in terms of cost expended.

CPI Value < 1Project is spent more than planned and needs to control cost expenditure to be back on track for cost objectives.

Estimate To Complete (ETC) = EAC – ACIt is the expected cost to complete remaining work.



Project Metrics in EVMFor any project these all constitute a part of the metrics which the project management team may be interested to act and report on frequently.

PV, EV, AC, SV, CV, SPI, CPI, ETC, BAC, EAC and so on..

ForecastingEstimating BAC & EAC are very helpful for the management to get an overview of the funds required for the project to start and bring it to closure.

Based on the AC, the EAC may vary significantly than the planned BAC. This helps the project management team to regularly monitor and ensure the values are continuously monitored for better control during the entire project duration based on the forecasts.



EAC may be forecasted in various manners.

Simplest Way: EAC = AC + Bottom up of ETC

EAC forecast for ETC work performed at budgeted rate:EAC = AC + (BAC – EV)

EAC forecast for ETC work performed at present CPI:EAC = BAC / CPI

EAC forecast for ETC work considering both SPI & CPI:EAC = AC + [(BAC – EV) / (CPI × SPI)]

In the last forecast method both SPI & CPI are considered at the ratio based on the project managers confidence level of future SPI & CPI

levels.To-Complete Performance Index (TCPI)

TCPI is the cost performance index which is to be achieved on the remaining work to meet the specified management goal like BAC or EAC.

TCPI = (BAC – EV) / (BAC – AC) or (EAC – AC)

TCPI = Work Remaining / Funds Left Over



Cost Forecast is the new cost estimated at the completion of the project while the project is in progress.

The new cost is a result of the cost variances(CV) to the original planned value(PV) and is also represented as EAC(Estimate at Completion) value.

Cost Variance may be a result of various actions which has caused either the cost to fluctuate on the upper or lower side of the planned value.

Cost Forecasts


Chapter 7 - Debrief


THIS BRINGS TO “COST MANAGEMENT” COMPLETION.

From what we have understood so far is:

4 Cost Management Knowledge Area Processes Identified their Inputs, Tools & Techniques, Outputs

Chapter 7


Acknowledgements & Disclaimer

PMI, PMBOK, PMP, CAPM, PgMP, PMI-ACP, PMI-RMP, PMI-SP are registered marks of Project Management Institute, Inc.All registered trademarks, symbols, names are marks of their respective owners and acknowledged.

online pmp training material for pmp exam - cost management knowledge area

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