Project Cost Management Chapter 7

Overview
Take Notes:
Estimating the likely costs of all resources and work effort required to complete the
project is a significant part of the planning process. There are several common
techniques available for use in estimating project costs. These techniques vary in
application, but the objective of the estimating process is to determine, within a desired
degree of accuracy, the total cost to produce a product or project. Estimating is basically
a guess or an approximation of project costs and includes a risk assessment;
assessment and in most
cases an added contingency to address uncertainty. But, But estimates are not based on
luck. They are well-thought-outout decisions based on the best available information,
expert judgment, best practices, and some type of model that is based on previously
previous
collected and validated data.

Pricing is generally the process of determining the appropriate amount to bill or charge
a client, customer, or the receiver of a product or service. One of the most crucial inputs
in the pricing decision is the cost estimate
estim of the proposed project baseline.

Types of Cost There are several ways to look at costs when creating an estimate.

A cost can be variable or fixed:

Variable Costs These costs change with the amount of production or the amount
of work. Examples includee the cost of material, supplies, and wages.
Fixed Costs These costs do not change as production changes. Examples include
set-up, rental, etc.

A cost can be either direct or indirect:

Direct Costs These costs are directly attributable to the work on the project.
Examples are team travel, team wages, recognition, and costs of material used on
the project.
Indirect Costs Indirect costs are overhead items or costs incurred for the benefit of
more than one project. Examples include taxes, fringe benefits, and janitorial
services.

Project Life Cycle Costing:

Concept of life cycle costing emphasizes the cost of the whole life of the product, and not
just the cost of the project. Like maintenance, operations and other costs.

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Chapter 7 Project Cost Management
The following table shows three cost management processes and its process elements.
Take Notes:
Inputs
Scope Baseline
Project Schedule
Human Resource Plan
Risk Register
Enterprise Environmental
7.1 Estimate Costs Factors
Organizational Process Assets
Activity Cost Estimates
Basis of Estimates
Scope Baseline
7.2 Determine
Project Schedule
Budget
Resource Calendars
Contracts
Organizational Process Assets
Project Management Plan
Project Funding Requirements
Work Performance Information
7.3 Control Costs
Organizational Process Assets
Tools & Techniques
Expert Judgment
Analogous Estimating
Parametric Estimating
Bottom-Up Estimating
Three-Point Estimates
Reserve Analysis
Cost of Quality
Project Management
Estimating Software
Vendor Bid Analysis
Cost Aggregation
Reserve Analysis
Expert Judgment
Historical Relationships
Funding Limit Reconciliation
Earned Value Management
Forecasting
To-complete Performance
Index (TCPI)
Performance Reviews
Variance Analysis
Project Management Software
Outputs
Activity Cost Estimates
Basis of Estimates
Project Document Updates
Cost Performance Baseline
Project Funding Requirements
Project Document Updates
Work Performance
Measurements
Budget Forecasts
Organizational Process Assets
Updates
Change Requests
Project Management Plan
Updates
Project Document Updates
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Project Cost Management Chapter 7

Cost Management Plan: Take Notes:

Estimate Costs and Determining the Budget process are governed by a cost
management plan that is created during the Develop Project Management Plan process.
The cost management plan establishes the format and conditions that will be used to
plan for project costs. It also outlines how the Project Manager will estimate, budget,
and control project costs. Like all other management plans, the cost management plan
is a subsidiary of the project management plan.

Some of the elements of this plan include:

Level of Accuracy: The precision level that will be used to round activity estimates—for
example, hundreds, thousands etc…. Level of accuracy is based on the scope and
complexity of the activities and the project itself.

Units of Measure: Units of measure will be used to estimate resources—for example,

hours, days, weeks, or a lump sum amount.

Organizational Procedures Links: Create WBS process outputs, the WBS and the
identifiers associated with each component of the WBS. These identifiers are called the
code of accounts. A control account (CA) is a point where several factors such as actual
cost, schedule, and scope can be used to determine earned value performance
measures. The control account also has a unique identifier that's linked to the
organization's accounting system, sometimes known as a chart of accounts.

Control Thresholds: Most actual project costs do not match the estimate exactly. The
control threshold refers to the amount of variance the sponsor or stakeholders are
willing to allow before action is required. The threshold amount is documented as a
percentage of deviation allowed from the cost performance baseline.

Rules of Performance Measurement: Are how the earned value management

measurements are set. It's here you'll document where the control accounts exist within
the WBS, the earned value management (EVM) techniques you'll use to measure
performance, and the equations you'll use for calculating the estimate at completion
forecast and other measurements. We'll talk about EVM and estimates at completion
forecasts.

Reporting Formats: This refers to the types of cost reports you'll produce for this project
and how often they'll be created.

Process Descriptions: This describes the Estimate Cost, Determines Budgets, and
Control Costs processes and how you'll use these processes to manage project cost.

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Chapter 7 Project Cost Management

7.1 Estimating Costs

Take Notes: Estimating the Cost is the process of calculating the costs of the identified resources
needed to complete the project work. The person or group doing the estimating must
consider the possible fluctuations, conditions, and other causes of variances that could
affect the total cost of the estimate.

There is a distinct difference between cost estimating and pricing. A cost estimate
is the cost of the resources required to complete the project work. Pricing, however,
includes a profit margin. In other words, a company performing projects for other
organizations may do a cost estimate to see how much the project is going to cost to
complete.

Estimating Costs: Management, customers, and other interested stakeholders are all
going to be interested in what the project is going to cost to complete. Several
approaches to cost estimating exist and are defined in PMBOK. The more accurate the
information, the better the cost estimate will be.

Analogous Estimating: This relies on historical information to predict the cost of the
current project. It is also known as top-down estimating. The process of analogous
estimating takes the actual cost of a historical project as a basis for the current project.
The cost of the historical project is applied to the cost of the current project, taking into
account the scope and size of the current project as well as other known variables.
Analogous estimating is a form of expert judgment. This estimating approach takes less
time to complete than other estimating models, but is also less accurate. This top-down
approach is good for fast estimates to get a general idea of what the project may cost.

Bottom-Up Estimating: This starts from zero, accounts for each component of the WBS,
and arrives at a sum for the project. It is completed with the project team and can be
one of the most time-consuming methods used to predict project costs. While this
method is more expensive, because of the time invested to create the estimate, it is also
one of the most accurate. A fringe benefit of completing a bottom-up estimate is that
the project team may buy into the project work since they see the cost and value of
each cost within the project.

Parametric Estimating: Will use a mathematical model based on known parameters to

predict the cost of a project. The parameters in the model can vary based on the type of
work being completed and can be measured by cost per cubic yard, cost per unit etc…. A
complex parameter can be the cost per unit with adjustment factors based on the
conditions of the project. In addition, the adjustment factors may have additional
modifying factors depending on additional conditions. To use parametric modeling, the
factors the model is based on must be accurate. The factors within the model are
quantifiable and don’t vary much based on the effort applied to the activity. And finally,
the model must be scalable between project sizes.
There are Two Types of Parametric Estimating:
Regression Analysis: This is a statistical approach to predict what future values may be
based on historical values. This form of estimating relies solely on pure statistical math
to reveal relationships between variables and predict future values.

Learning Curve: This approach is simple as the cost per unit decreases, the more units’
workers complete—this is because workers learn as they complete the required work.

Reserve Funds:

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This reserve is sometimes called contingency reserve and is traditionally set aside for
cost overruns due to risks that have impacted the project’s cost baseline. Contingency Take Notes:
reserves can also be allotted to deal with th
those pesky “unknowns” that practically every
project has to deal with. The “unknowns”
“unknown are essentially risks that are lurking within the
project but that haven’t been specifically identified by name, source, or probability.
The output of cost estimating is the actual cost estimates of the resources required to
complete the project work. The estimate is typically quantitative and can be presented
in detail against the WBS components, summarized in terms of a grand total according
to various phases of the project,
ect, or its major deliverables. Each resource in the project
must be accounted for and assigned to a cost category. Categories include the following:
 Labor Costs
 Material Costs
 Travel Costs
 Supplies
 Hardware Costs
 Software Costs
 Special Categories (inflation, cost reserve, etc…)

Refining Cost Estimates:

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

Determining Resource Cost Rates: Many project managers

manag do not have access to this
information on their projects, but detailed cost estimat
estimates require the knowledge of the
actual cost of labor. Remember that resources are not just human resources. This work
might also involve getting pricing from consultants,
consultants vendors, and suppliers. Work
provided by sellers may also require bid analysis. Further cost estimates
estimat may then be
necessary before finalizing an agreement.
agreement
Cost of Quality: The cost of work added to the project to accommodate quality planning
should be added to the project estimate
When completed, the estimate costsosts process should result in activity cost estimates and
what the basis for those estimates is.
is It can also result in changes or updates to the risk
register and other parts of the project manage
management plan and project documents in
order to decrease the project costs.

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Chapter 7 Project Cost Management

7.2 Determine the Budget

Take Notes:
Cost budgeting is the process of assigning a cost to an individual work package. The goal
of this process is to assign costs to the work in the project so it can be measured for
performance. This is the creation of the cost baseline.
Cost budgeting and cost estimates may go hand-in-hand, but estimates should be
completed before a budget is requested—or assigned. Cost budgeting applies the cost
estimates over time. This results in a time-phased estimate for cost, allowing an
organization to predict cash flow needs. The difference between cost estimates and cost
budgeting is that cost estimates show costs by category, whereas a cost budget shows
costs across time.

Many of the tools and techniques used to create the project cost estimates are also used
to create the project budget.

Cost Aggregation: Costs are parallel to each WBS work package. The costs of each work
package are aggregated to their corresponding control accounts. Each control account
then is aggregated to the sum of the project costs.
Reserve Analysis: Cost reserves are for the unknowns within a project.

Aggregation and reserve analysis is shown below

Funding Limit Reconciliation: Funding limit reconciliation is an organization’s approach

to managing cash flow against the project deliverables based on a schedule, milestone
accomplishment, or data constraints. This helps an organization plan when monies will be
devoted to a project rather than using all of the funds available at the start of a project.
A project’s cost baseline shows what is expected to be spent on the project. It’s usually
shown in an S-curve. The idea of the cost baseline allows the project manager and
management to predict when the project will be spending monies and over what time
period. The purpose of the cost baseline is to measure and predict project performance.
Large projects that have multiple deliverables may have multiple cost baselines to
illustrate the cost within each phase. Additionally, larger projects may have cost baselines
to predict spending plans, cash flows of the project, and overall project performance.

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Take Notes:

The purpose of a cost baseline is to measure performance, and a baseline will predict
the expenses over the life of the project. Any discrepancies early on in the predicted
baseline and the actual costs serve as a signal that the project is slipping.

7.3 Controlling Costs

The Control Costs process is similar to the control part of any other knowledge area,
with a focus on cost.

Progress Reporting: Project managers can use information about project progress to
help control the schedule and costs and to assess whether the project is on track
through earned value measurement. Many project managers determine how much
work has been accomplished by asking team members for an estimate of percent
complete for each work package or activity. Following are few examples to measure %
of completion, no one is better than other it just your organizations practice.

50/50 Rule: An activity is considered 50 percent complete when it begins, and gets
credit for the last 50 percent only when it is completed.

20/80 Rule: An activity is considered 20 percent complete when it begins and gets credit
for the last 80 percent only when it is completed.

0/100 Rule: An activity does not get credit for partial completion; it only gets credit for
full completion.

Earned Value Measurement

This methodology is used to measure project performance against the scope, schedule,
and cost baselines. Earned value technique calls the combination of these three
baselines the performance measurement baseline. Results from an earned value
analysis indicate potential deviation of the project the performance measurement
baseline.

Using earned value measurement integrates cost, time, and the work done (or scope)
and can be used to forecast future performance, project completion dates and costs.

Earned value will lead to budget forecasts, change requests, and other items that will need
to be communicated. The results of earned value measurement should be a major part of
project reporting, which will be used by Communications Management.

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Chapter 7 Project Cost Management

Key Terms:
Take Notes:
Acronym Term Description (As on Status date)

PV Planned Value The Estimated value of the work planned

EV Earned Value Estimated value of the work actually accomplished

AC Actual Cost (total cost) Actual cost incurred for the work accomplished

BAC Budget at Completion The set BUDGET for the TOTAL project effort

EAC Estimate at Completion Forecasted values of TOTAL project to cost

ETC Estimate to Complete Cost to finish the remainder of the work (a forecast)

VAC Variance at Completion Difference between Original Budget (BAC) and

Forecasted Budget (EAC)

Current Performance and Variances:

Name Formula Interpretation

Cost Variance (CV) EV-AC Positive value is good
Schedule Variance (SV-) EV-PV Positive value is good
Cost Performance Index (CPI) EV/AC Greater than 1 is good
Schedule Performance Index (SPI) EV/PV Greater than 1 is good

Forecasting (Estimate at Completion EAC):

Name Formula Interpretation

AC + Estimate of remaining Re-Estimation. (original estimation is completely
work unusable for remaining work)

BAC
Project will continue at the same rate of spending
CPI
(EAC)

AC+(BAC-EV) AC + Remaining work.

AC + BAC - EV AC + cost and schedule performances

CPI * SPI considered for Reaming work

ETC EAC – AC Estimate To Complete. (Forecast for remaining work)

VAC BAC – EAC Variance at Completion

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To Complete Performance Index (TCPI)

There are 2 scenarios needs to be considered:
Take Notes:
1. TCPI based on BAC is the forecast of how efficient future project performance
must be in order to conform to the planned BAC for the project.
 TCPI based on BAC = (BAC – EV) / (BAC – AC)
 Which is ratio between remaining work and remaining funds

2. TCPI based on EAC is the forecast of how efficient future project performance
must be in order to conform to the planned EAC (based on new outcome
predictions) for the project
 TCPI (EAC) will be = (BAC – EV) / (EAC – AC)

Cost control is an ongoing process throughout the project. The project manager must
actively monitor the project for variances to cost. Specifically, the project manager
should always do the following:
 Monitor cost variances and then understand why variances have occurred
 Update the cost baseline as needed based on approved changes
 Work with the conditions and stakeholders to prevent unnecessary changes to
the cost baseline
 Communicate to the appropriate stakeholders cost changes as they occur
 Maintain cost within an acceptable and agreed range

Cost Estimates Revision: As the project progresses and more details become available,
there may be a need to update the cost estimates. A revision to the cost estimates
requires communication with the key stakeholders to share why the cost were revised.
A revision to the cost estimates may have a ripple effect: other parts of the project may
need to be readjusted to account for the changes in cost, the sequence of events may
be reordered, and resources may have to be changed. In some instances, the revision of
the estimates may be expected, as with phased-gate estimating in a long project.

Updating the budget: is slightly different than revising a cost estimate. Budget updates
allow the cost baseline to be changed. The cost baseline is the “before project
snapshot” of what the total project scope and the individual WBS components should
cost. Should the project scope grow, as shown next, the cost will also likely change to be
able to fulfill the new scope?

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