COST OF PROJECT

DEFINITION:
Project cost management is the process of estimating, budgeting and controlling
costs throughout the project life cycle, with the objective of keeping expenditures
within the approved budget.

For a project to be called successful, it’s necessary that

 it delivers on the requirements and scope

 its execution quality is of a high standard

 it’s completed within schedule and

 it’s completed within budget.

Hence, project cost management is one of the key pillars of project management
and is relevant regardless of the domain, be it manufacturing, retail, technology,
construction and so on. It helps to create a financial baseline against which project
managers can benchmark the current status of their project costs and realign the
direction if needed.

Why is Project Cost Management Important?

The importance of cost management is easy to understand. To take a simple, real-
life example, if you decide to build a house, the first thing to do is set the budget.
When you have a sense of how much to spend on the project, the next step is to
divide the high-level budget into expenses for sub-tasks and smaller line items.

The budget will determine critical decision points such as: which designer to hire
—a high-end one who will construct and deliver the project end-to-end, or
someone who can help with a few elements and be able to work for a smaller
budget? How many stories should the house have? What quality of materials
should be used?
Without a predefined budget, not only is it difficult to answer these questions, but
it becomes impossible to assess whether you are progressing in the right direction
once the project is underway. In large organizations, the scale of this problem is
further magnified due to concurrent running of multiple projects, change in initial
assumptions and the addition of unexpected costs. That’s where cost management
can help.

By implementing efficient cost management practices, project managers can:

 Set clear expectations with stakeholders

 Control scope creep due to transparencies established with the customer

 Track progress and respond with corrective action at a quick pace

 Maintain expected margin, increase ROI, and avoid losing money on the
project

 Generate data to benchmark for future projects and track long-term cost
trends

The Four Steps in Project Cost Management:

While cost management is viewed as a continuous process, it helps to split the
function into four steps: resource planning, estimation, budgeting and control.
They are mostly sequential, but it’s possible that some resource changes happen
midway through the project, forcing the budgets to be adjusted. Or, the variances
observed during the control process can call for estimate revisions.

Let us look at each of these four steps in detail.

1. Project Resource Planning

Resource planning is the process of identifying the resources required to execute a

project and take it to completion. Examples of resources are people (such as
employees and contractors) and equipment (such as infrastructure, large
construction vehicles and other specialized equipment in limited supply).
Resource planning is done at the beginning of a project, before any actual work
begins.

To get started, project managers first need to have the work-breakdown structure
(WBS) ready. They need to look at each subtask in the WBS and ask how many
people, with what kind of skills are needed to finish this task, and what sort of
equipment or material is required to finish this task?

By adopting this task-level approach, it becomes possible for project managers to

come up with an accurate and complete inventory of all resources, which is then
fed as an input into the next step of estimating costs.

A few tips to consider during the process:

 Consider historical data—past schedules and effort—before determining

sub-tasks and the corresponding resources.

 Take feedback from SMEs and team members—a collaborative approach

works well especially in projects that do not have past data to use

 Assess the impact of time on resource requirements. For instance, a resource

may be available only after a few months, dragging the project’s schedule.
This could have an impact on cost estimation.

 Although this step happens at the planning stage, project managers need to
account for ground realities. For example, you may identify the need for a
resource with certain expertise, but if such a resource is not available within
the organization, you have to consider hiring a contractor or training your
team to get them up to speed. All these real variables impact cost
management.

2. Cost Estimation

Cost estimation is the process of quantifying the costs associated with all the
resources required to execute the project. To perform cost calculations, we need
the following information:

 Resource requirements (output from the previous step)

  Price of each resource (e.g., staffing cost per hour, vendor hiring costs,
server procurement costs, material rates per unit, etc.)

 Duration that each resource is required

 List of assumptions

 Potential risks

 Past project costs and industry benchmarks, if any

 Insight into the company’s financial health and reporting structures

Estimation is arguably the most difficult of the steps involved in cost management
as accuracy is the key here. Also, project managers have to consider factors such as
fixed and variable costs, overheads, inflation and the time value of money.

The greater the deviation between estimation and actual costs, the less likely it is
for a project to succeed. However, there are many estimation models to choose
from. Analogous estimation is a good choice if you have plenty of historical cost
data from similar projects. Some organizations prefer mathematical approaches
such as parametric modeling or program evaluation and review technique (PERT).

Then there is the choice between employing a top-down versus bottom-up

approach. Top-down typically works when past costing data are available. In this,
project managers usually have experience executing similar projects and can
therefore take a good call. Bottom-up works for projects in which organizations do
not have a lot of experience with, and, therefore, it makes sense to calculate a cost
estimate at a task-level and then roll it up to the top.

Cost Estimation as a Decision Enabler

It’s useful to remember that cost estimation is done at the planning stage and,
therefore, everything is not yet set in stone. In many cases, project teams come up
with multiple solutions for a project, and cost estimation helps them decide which
way to go. There are many costing methodologies, such as activity-based costing,
job costing, and lifecycle costing that help perform this comparative analysis.
Lifecycle costing, for instance, considers the complete end-to-end lifecycle of a
project. In IT projects, for example, maintenance costs are often ignored, but
lifecycle costing looks long-term and accounts for resource usage until the end of
the cycle. Similarly, in manufacturing projects, the goal is to minimize future
service costs and replacement charges.

Sometimes the estimation process also allows teams to evaluate and reduce costs.
Value engineering, for example, helps to gain the optimal value from a project
while bringing costs down.

3. Cost Budgeting

Cost budgeting can be viewed as part of estimation or as its own separate process.
Budgeting is the process of allocating costs to a certain chunk of the project, such
as individual tasks or modules, for a specific time period. Budgets include
contingency reserves allocated to manage unexpected costs.

For example, let’s say the total costs estimated for a project that runs over three
years is $2 million. However, since the budget allocation is a function of time, the
project manager decides to consider just the first two quarters for now. They
identify the work items to be completed and allocate a budget of, say, $35,000 for
this time period, and these work items. The project manager uses the WBS and
some of the estimation methods discussed in the previous section to arrive at this
number.

Budgeting creates a cost baseline against which we can continue to measure and
evaluate the project cost performance. If not for the budget, the total estimated cost
would remain an abstract figure, and it would be difficult to measure midway.
Evaluation of project performance gives an opportunity to assess how much budget
needs to be released for future phases of the project.

Another reason to firm up budgets is that organizations often rely on expected

future cash flows for their funding. During the initial phases, the project manager
has a limited financial pool and has to set targets accordingly. It’s similar to
building the foundation and one floor of the house in the initial few months and
later completing the rest of the project, as you save more.

4. Cost Control
Cost control is the process of measuring cost variances from the baseline and
taking appropriate action, such as increasing the budget allocated or reducing the
scope of work, to correct that gap. Cost control is a continuous process done
throughout the project lifecycle. The emphasis here is as much on timely and clear
reporting as measuring.

Along with the cost baseline, the cost management plan is an essential input for
cost control. This plan contains details such as how project performance will be
measured, what is the threshold for deviations, what actions will be done if the
threshold is breached, and the list of people and roles who have the executive
authority to make decisions.

Earned value management (EVM) is one of the most popular approaches to

measuring cost performance. Let’s take an example.

At the end of a week, you measure the progress of task X and find that it’s 25%
complete. Now, how do you assess if you are on track to meet the task budget?

First, a project manager calculates the planned value for this task (at the planning
stage). Let’s say, Task X has a budget of $4000 and is expected to be 50%
complete by the week.

Planned value (PV) of task X by the week = $4000 * .5 = $2000

Earned value (EV) of task X by the week = $4000 * .25 = $1000

Now, you also determine the actual cost (AC) of the work, which involves other
variables such as equipment and material costs (say, $800).

Schedule variance = EV – PV = $1000 – $2000 = -$1000.

Cost variance = EV – AC = $1000 – $800 = $200.

The negative schedule variance indicates that the task is falling behind, but the
positive cost variance indicates that it’s under budget.

While dealing with hundreds of tasks in huge projects, cost control can provide the
level of transparency that decision makers require to respond quickly to the
situation.

Project Cost Software:

Cost management, similar to other aspects of project management, gets complex
with many variables in play. The process itself is elaborate, needing attention to
detail along with a rigorous approach. The use of project management software can
simplify this process considerably.

Let’s look at a few advantages of using project cost management software:

 Automation of cumbersome quantitative analysis during estimation and

measurements.

 Integration of data across planning, estimation, budgeting, and control

enables continuous monitoring and quick, proactive responses, rather than
one-off interventions

 Decision-making is made easier as cost software helps evaluate alternate

solutions using scenario forecasting and what-if analysis

 Clear and easy reporting in the form of dashboards and other rich UIs

 The complexity of multicurrency management in projects across different

geographical locations is simplified with project cost software

 Many project cost solutions allow third-party integrations, so data can be

pooled and analyzed

 Benchmarking and standardization are possible with the availability of

performance data across multiple projects

Cost Management and Enterprise Project Performance:

In the 2018 PMI Pulse of the Profession Report, 41% of respondents said that their
projects are of high complexity. It’s no surprise then that 40% of the survey
participants consider “investing in technology to better enable project success” as
their top priority.

Cost management is closely tied to the capability of an organization to succeed in

current as well as future projects. Investing in reliable cost management software
can result in huge savings. A good solution to cost management will not treat it as
a siloed function but leverage it as integral to project and portfolio performance,
and correlate data across projects.
 MEANS OF FINANCING

DEFINITION:
Project financing is a means of obtaining funds for industrial projects, long-term
infrastructure, and public services. Many businesses use this funding method to
take care of major projects using a non-recourse or limited financial structure.
There are several ways to secure project finance, such as investor, loans, private
finance, equity, funds, grants, etc. The repayment is managed from the cash-flow
generated off the project.

It is a secured form of lending, accepting the project’s rights, assets, and interests
as collateral. Project loans are useful in more than one way. It can help expand the
manufacturing capacity, rent a workstation, upgrade technology, handle
unexpected expenses, experimentation for a new service or a product, create a cash
pool, etc.

The financing of long-term infrastructure, industrial projects and public services

based upon a non-recourse or limited recourse financial structure where project
debt and equity used to finance the project are paid back from the cash flow
generated by the project. Following are the means that an organization can use for
financing a project:

(1) Share capital: Share capital is the fund raised by issuing shares in return for
cash on other considerations. Also known as “equity financing”. The amount of
share capital a company has can change over time because each time a business
sells new shares to the public in exchange for cash, the amount of share capital will
increase. Share capital can be composed of both –

 Common share and,

 Preferred shares.

(2) Term loan: It is a loan from a bank for o specific amount that has a specified
repayment schedule and a floating interest rate. Term loans almost always mature
between one and 10 years but it is a costly one for financing.
 (3) Bond: A debt investment in which an investor loans money to an entity
(corporate or governmental) that borrows the funds for a defined period of time at
a fixed interest rate. Bonds are used by companies, municipalities, states and U.S.
and foreign governments to finance a variety of projects and activities.

Bonds are commonly referred to as fixed-income securities and are one of the three
main asset classes along with stocks and cash equivalents.

(4) Debenture capital: A type of debt instrument that is not secured by physical
assets or collateral Debentures are backed only by the general creditworthiness and
reputation of the issuer. Both corporations and governments frequently issue this
type of bond in order to secure capital. Like other types of bonds, debentures arc
documented in an indenture

(5) Deferred credit: Income that is received by a business but not immediately

reported as income is known as deferred credit. Typically, this is done on income
that is not fully earned and. consequently, has yet to be matched with a related
expense. Such items include consulting fees, subscription lees tend any other
revenue stream that is intricately tied to future promises. For example, a book club
might defer income from a two-year membership plan until all the costs of
procurement and shipping arc assessed. Also known as deferred revenue or
deferred income.

(6) Other sources:

 Personal loan,
 Unsecured loan,
 Public deposit,
 Leasing, etc.

These are the ways an organization can collect the funds and finance for a given
project.

CONCLUSION:
Project Financing is a long-term, non-recourse or limited recourse financing
scheme that is used to fund massive projects which can be repaid using the project
cash flow obtained after the completion of the project. This scheme offers financial
aid off balance sheet, therefore, the credit of the shareholder and Government
contracting authority does not get affected. In Project Financing, multiple
participants are allowed to handle the project while the ownership of the project is
entitled according to the terms of the loan only after the project is completed. This
financial scheme offers better credit margin to lenders while shifting some of the
risk from the sponsors to the lenders.

As the Indian Government continues to investment on the infrastructure of the

country, it is expected that there will be massive developments in future in terms of
power, transportation, bridges, dams etc. Most of these projects will be using the
Public Private Partnership (PPP) method indicating a rise in Project Financing
during the upcoming years. This entire cycle will further help improve the
economic condition of India.