COST

While managing cost the project manager is primarily concerned with estimating
and earned value management. Do you create a budget for your projects? Do you
have practical experience managing and controlling costs? The questions on the
exam are written to test whether you have such experience. If these efforts are not
part of how you manage your real-world projects, make sure you read this chapter
carefully and fully understand the concepts discussed.

On the exam, there is a strong connection between cost management and schedule
management. Some topics covered in this chapter also apply to the "Schedule"
chapter. The "Schedule" chapter includes information on estimating techniques that
can be used for both schedule and cost estimating. Earned value analysis is
discussed later in this chapter and is another example of a technique that can be
used for both cost and schedule management.

The "Schedule chapter also describes the decomposition of work packages into
smaller components, or activities. For many projects, cost estimates are created at
the activity level. On some large projects, however, it might be more practical to
estimate and control costs at a higher level, called a control account (defined in the
"Scope" chapter).

The following should help you understand how each part of cost management fits
into the overall project management process:

The cost planning and control processes from the PMBOK• Guide are put
collectively into the Examination Content Outline (ECO) as Plan and Manage
Budget and Resources (domain II, task 5).

While thinking about the process these tables represent, it is worth pointing out
again that many of the same estimating and earned value measurement (EVM) tools
are also used for schedule management.

Estimating is initially done during planning while EVM is used to control costs and
possibly resources and procurement throughout the project. As you balance project
constraints to manage costs you will also do activities related to domain I tasks 1
and 8 Manage Conflict and Negotiate Project Agreements.

Another area of overlap is promoting team performance through training (domain I,

task 5) and the use of emotional intelligence (domain I, task 14). These support
value-driven delivery and cost savings. Can you add to this list of interactions
between processes and ECO tasks?
Think about how decisions around funding and financing resources might affect
project risks and other project constraints.

These decisions will influence how you plan the project across all knowledge areas
and how work will be completed.
If you haven't had to deal with these concerns on your own projects, it's easy to miss
questions on the exam about how cost-related decisions could impact the rest of the
project.

As you read through this chapter, make sure you truly understand what project
management efforts you should be doing when it comes to cost management and
what those efforts mean to the project.

Plan and Estimate Project Costs PAGE 235

Besides having a plan for how you will manage costs, you also need to estimate
costs and determine the budget. The Plan Cost Management process involves
answering questions such as "How will I go about planning cost for the project and
who needs to be involved?" and "How will I effectively manage the project to the
cost baseline and manage variances?"

The project charter includes a high-level cost constraint as well as other

requirements regarding cost management on the project. Organizational process
assets used in this process include cost data and lessons learned from previous
projects as well as organizational standards and policies for estimating and
budgeting.

Plan Cost Management

In some organizations, cost planning may involve determining whether the project
will be paid for with the organization's existing funds or will be funded through
equity or debt. It can also include decisions about how to finance project resources-
such as choosing whether to purchase or lease equipment. As we get detailed
estimates and develop the budget, we will use calculations created for project
selection (like net present value, return on investment, payback period, and
discounted cash flow) to evaluate whether the project is still feasible within the
charter and whether the measurable project objectives can be achieved.

The cost management plan can be formal or informal, but it is part of the project
management plan. It may include the following:

• Specifications for how estimates should be stated (in what currency)

• Levels of accuracy and precision needed for estimates
• Approved estimating techniques
• Reporting formats
• Rules for measuring cost performance
• Guidance regarding whether costs will include indirect costs (costs not directly
attributable to any one project, such as overhead)
• Guidelines for the establishment of a cost baseline for measuring against
• Control thresholds
• Cost change control procedures
• Information on control accounts or other ways to monitor spending

Notice the inclusion of control thresholds. These are the amount of variation
allowed before you need to act. For example, if an actual cost comes in higher than
expected, will you need to act? What if it's a two-dollar difference?

Estimate Project Cost

This process involves coming up with cost estimates for all project activities and
resources required to complete them, to combine into one time-phased spending
plan detailed next in the Determine Budget process.

In the "Schedule" chapter, we included some Tricks of the Trade" titled, "Things to
Know about Estimating for the Exam." As noted in that chapter, those concepts
apply to both cost and schedule estimating. Take some time now to review that list.
It is helpful to have those concepts fresh in your mind before continuing.

So what costs should you estimate?

To put it simply, you need to estimate the costs of all the efforts to complete the
project. This includes labor, equipment, materials, and training for the project, as
well as the following:
• Quality efforts
• Physical spaces used directly for the project
• Risk efforts
• Project management activities
• Overhead costs, as applicable (management salaries, general office expenses)

Types of Cost
In the past, the exam has included questions regarding types of cost. A cost can be
either variable or fixed, direct or indirect. Notice a variable or fixed cost may also
be a direct or indirect cost.
• Variable costs change with the amount of production work. Examples include
materials, supplies, and wages.
• Fixed costs do not change as production changes. Examples include setup, rent,
utilities, etc.
• Direct costs are directly attributable to the work on the project. Examples are team
wages, team travel and recognition expenses, and costs of material used on the
project.
• Indirect costs are overhead items or costs incurred for the benefit of more than one
project. Examples include taxes, fringe benefits, and janitorial services.

Inputs to Estimating Costs

Imagine having access to a repository containing all the previous WBSs for projects
similar to yours, along with the estimates and actual costs for each activity.

Can you see how that might be helpful in creating more accurate estimates on your
own project? Having highly accurate estimates will help you better control the
project later and, therefore, save you effort.

Project management plan inputs to cost estimates include the cost and quality
management plans and the scope and schedule baselines.

Useful project documents include the lessons learned register, risk register, and
resource requirements documentation. Organizational process assets include
policies and historical records related to estimating, templates and processes
including those from past projects, while enterprise environmental factors include
corporate governance, marketplace conditions, commercial cost databases,
exchange rates, inflation, and supply sources.

How Is Estimating Done?

As described in the "Schedule" chapter, estimates should be in a range as it is very
unlikely an activity will be completed for the exact amount estimated. It is done
using specific tools like analogous estimating, parametric estimating, and three-
point estimating. From a more general perspective, you have top-down and bottom-
up estimating.

Accuracy of Estimates
Think about someone walking into your office and asking you to estimate the total
cost of a new project. The first question you would probably ask is, "How accurate
do you want me to be?" In the early part of the project, during initiating, estimates
are likely to be top-down. Over time, as you break down project deliverables during
planning, you narrow the estimate range as you do bottom-up estimating.

Estimate Ranges
The standard ranges of the order of magnitude estimate, budget estimate, and
definitive estimate are shown below:
• Rough order of magnitude (ROM) Estimate Usually made during project
initiating, a typical range for ROM estimates is -25 to +75 percent. It varies
depending on how much is known about the project.
• Budget estimate a budget estimate is in the range of-10 to + 25 percent. A best
practice is to narrow the range (from ROM) before you begin re-iterating the
budget.
• Definitive estimate as project planning progresses, the estimate will become even
more refined. Some project managers use the range of +/-10 percent, while others
use -5 to+ 10 percent.

The concept of ranges often appears on the exam. Make sure you understand that
estimates become more detailed as project planning progresses. Remember that
organizations have different rules for the acceptable range of estimate for an activity
or the project and that what you see here may be different than your experience. It is
wise to estimate in a range, based on the level of uncertainty remaining in the
estimate. Even the approved baseline may be expressed as a range, for example:
$1,000,000 (-5 to+ 10 percent).

Determining Resource Cost Rates

Although many project managers do not have access to this information on their
projects, the exam assumes a project manager knows the actual cost of labor when
performing detailed cost estimating.
Resources are not limited to internal human resources.
The work of estimating resource costs might also involve estimating the work of
consultants, sellers, and suppliers.
Other tools and techniques particular to cost estimating are estimating spreadsheets
and software within the PMIS that can speed up calculation and analysis and
integrate finance and accounting.
Quality risk and scheduling tools are useful here as well.
Alternatives analysis, resources analysis, and decision making (all discussed in the
"Schedule" chapter) may also be used as part of the Estimate Costs process.
The Estimate Costs process results in cost estimates and an explanation of how
those estimates were derived (the basis of estimates).
It can also result in project document updates, such as the risk register, assumption
log, and lessons learned register.

Determine Budget
In this part of cost management, the project manager calculates the total cost of the
project to determine the budget. Meeting the cost baseline will be a measure of
project success, so the budget should be in a form the project manager can use to
control costs while the work is being done.

To begin the Determine Budget process, it's important to review the business case
and the benefits management plan. The business case may be expressed in financial
terms, such as expected return on investment. The benefits management plan can be
used to finalize the budget and compare it to the economic benefits expected from
the project.

On adaptive projects, project teams help determine the budget based on the project
scope. This typically requires the team to break down the scope using techniques
such as T-shirt sizing, planning poker, and affinity estimating, for example. The
team will then plan releases using story maps.

Refer to the "Schedule" chapter for a review of these concepts, if necessary. Teams
on adaptive projects may also use retrospectives to determine the accuracy of
budget estimates, and if any adjustments should be made to the budget. For
instance, if a team's retrospective uncovers a recurring pattern of underestimating
costs, the team may decide to try more analysis before they ultimately determine the
budget.

Two outputs from Estimate Costs-cost estimates and the basis of estimates-are
essential inputs to this process. Many of the inputs to Estimate Costs are used here
as well: the cost management plan, the scope baseline, the project schedule, the risk
register, existing policies on cost control and cost budgeting, and resource
requirements documentation (for how long and at what rates for particular
resources, for example).

Agreements regarding the purchase of services or products for the project are also
inputs. To create a budget, activity cost estimates are rolled up to work package cost
estimates. Work package costs are then rolled up to control account costs and
finally to project costs.

This process is called cost aggregation. After risk management planning,

contingency reserves are added to determine the cost baseline. These are shown at
the project level, as described here and depicted in figure 7.1, but note it is also
possible to add contingency reserves at the activity level.

In the final step, the management reserves are added. Note that it is the management
reserves that make the difference between the cost baseline and the budget.

After the cost baseline and budget are estimated, the project manager may compare
these numbers to parametric estimates or to expert judgment, or perform an
historical information review, comparing their estimates to those of past, similar
projects.
For example, a general rule for a high-level parametric estimate in some industries
is that design should be 15 percent of the cost of construction. Other industries
estimate the cost of design to be 60 percent of the project budget.

The project manager needs to investigate and justify any significant differences
between the project estimates and the reference data to ensure the estimates are
reasonable and as accurate as possible. The next thing to check is cash flow (part of
funding limit reconciliation2). For example, if equipment costing $500,000 is
scheduled to be purchased on June 1 but the money for the purchase is not available
until July 1, the activities dependent on that equipment will have to be moved to
later points in the schedule.

The cost baseline, therefore, is time-phased. A special note on the term "financing,"
as it relates to project management. Financing refers to obtaining the needed funds
for a project. This means all funds, both internal and external.

External funds are obtained from sources outside the performing organization
(through loans) and are typically needed for major long-term projects.

As we discussed in the "Schedule" chapter, agile teams use velocity to help create a
project schedule based on story point estimates, but ve1ocity can help anticipate
future budgetary issues as well. For instance, let's say the team is averaging 50 story
points per month and there are 500 story points left in the backlog.

You would need 10 more months to complete the project. Here, the project manager
can look at the budget and decide if they have correctly estimated a budget for 10
months of the team's monthly bum rate.

Are you familiar with the term "burn rate"? Did you know that on adaptive projects,
teams are often stable and consistent as more value is placed on retaining project
knowledge and developing stable working relationships? This leads to consistent
burn rates for teams and simplified cost estimating.

If the burn rate for a team is $50,000 per month, you can quickly estimate the cost
for the next six months is likely to be 6x $50,000 =$300,000. Project managers on
adaptive projects do the majority of their cost estimating for

projections and estimates at completion based on extrapolation of burn rates.

The project budget must be reconciled with any-cost constraints in the charter.
If the project estimate exceeds the constraints, the project manager must meet with
management, explain why their cost requirement cannot be met, and propose
options to decrease costs.

Pay particular attention to that last sentence. As with the schedule, project managers
have a professional responsibility to reconcile the budget in this way. When the
Determine Budget process is complete, the cost baseline, including all funding
requirements, is established. Naturally, many of the inputs to the process will be
updated, such as the cost estimates, the risk register, and the project schedule.

Manage Costs PAGE 257

Start this section by completing the following exercise and imagine how this would
apply to real-world projects. When completing this exercise, keep in mind that you
need to continuously look for anything that can cause a project to be terminated.
Think of yourself as a detective looking for anything that can get in the way of
project success. This mindset will help you select the best choice when answering
questions that seem to have more than one correct answer.

7.1 Exercise
In your Exercise Notebook, list the actions a project manager may take to control
costs. (This is an important topic, so be sure to take your time to think about this
question.)
Answer
• Follow the cost management plan for how to control costs
• Tailor control activities to the needs of the project
• Consider policies, procedures, tools and reporting templates and formats related to
controlling costs (selected from organizational process assets during planning)

• Measure project performance and compare it against the plan

• Determine if variances require change, including preventive and corrective action

• Request changes
• Implement approved changes
• Prevent unnecessary changes
• Look for the root cause of factors causing costs to rise
• Conduct reserve analysis
• Conduct earned value measurement
• Aggregate data, analyze it, and produce reports
Controlling costs is an important responsibility for project managers, but you must
also understand and plan for potential budget variations. For instance, your team
worked overtime to complete a new feature for an upcoming sponsor demo. While
the new feature was completed on time, the overtime work means your monthly
budget goal for payroll will be missed.
As the project manager, you weighed the value of this through a simple analysis of
benefits and costs. The benefit outweighed the cost, so you approved the overtime,
but you must also keep this decision in mind while forecasting future monthly
budgets.
Was this month's higher payroll atypical or has your team consistently needed
overtime hours to complete the necessary work? Should you adjust the budget for
future months or adjust the schedule to avoid unnecessary overtime?

There can be a lot of unplanned scenarios that impact the overall budget of a
project, and these costs may not be avoidable. As the project manager, you should
look for likely costs, anticipate the potential risks, and plan ahead. You will never
be able to foresee everything, but if you try to imagine the unplanned costs on your
project, you will have a much easier time planning a realistic budget.

Progress Reporting
Progress reports convey information based on data analysis. The project manager
uses information about project progress to help control the schedule and costs and
to assess whether the project is on track through earned value analysis (described
later in this section).
Some project managers use alternative means of determining progress, such as
asking team members to estimate percent complete for deliverables.
Simply asking for percent complete does not result in a realistic estimate of
progress. You can more carefully track progress without using earned value analysis
by accurately measuring deliverable completion at the work package level based on
cost and schedule estimates.
For example, with a WBS, 80 hours is a small enough work increment to track
progress against and still have accurate data. For the exam, remember that projects
using proper project management make use of a WBS, and activities to produce
work packages are broken down to an appropriate level for controlling.

Reserve Analysis
Reserve analysis allows you to identify and apply lessons learned in controlling
costs. Remember the contingency reserves that get factored into the cost baseline to
address known risks? Part of cost control is analyzing where those contingency
reserves are still necessary or where new reserves are required. For example, let's
say a project team identifies a highly ranked risk and sets aside a contingency
reserve to address it.
If the risk does not occur and is no longer a threat, the contingency reserve can be
removed from the cost baseline. Or, a risk review on a project may identify new
risks, which could lead to a decision to increase the contingency reserves. Both of
these examples require a change request being submitted through integrated change
control.
A change request is also required to move management reserve funds into the cost
baseline for a similar purpose. It may also be necessary to reassess the amount of
management reserve that was set aside to address unknown risks.

Earned Value Measurement

Earned value measurement is a data analysis technique used to measure project
performance against the performance measurement baseline (the scope, schedule,
and cost baselines). The resulting measurements indicate whether there are any
potential deviations from the performance measurement baseline.
Many project managers manage project performance by comparing planned to
actual results. With this method, however, you could easily be on time but over
budget. Earned value analysis integrates cost, time, and scope and can be used to
forecast future performance and project completion dates and costs.

Earned value measurement is on the exam and questions often contain formulas.
Are you worried about it? Don't be. We are going to make it easier. First, think
about this:
How valuable would it be to know how your project is really going?
Could you sleep better at night? Would you be able to spend your time in more
productive ways than worrying?
If you currently rely on hope, guesses, or a general percent complete estimate to
assess how your project is faring, you probably know from experience that these
methods do not tell you much, nor are they very accurate.

Keep the benefits of earned value as an analysis technique in mind as you read this
section and go through it slowly if it seems confusing.
Using the work performance information gathered through earned value analysis, a
project manager can create reports, including forecasts, and other communications
related to the project's progress. Earned value analysis may also result in change
requests to the project.
Make sure you understand and memorize the following about CV, SV, CPI, and
SPI;
• EV comes first in each of these formulas. Remembering this one fact alone should
help you get about half the earned value questions right.

• If it is a variance (difference), the formula is EV minus AC or PV.

• If it is an index (ratio), the formula is EV divided by AC or PV.
• If the formula relates to cost, use AC.
• If the formula relates to schedule, use PV.
• For variances interpretation: negative is bad and positive is good. Thus a -200 cost
variance means you spent more than planned (over budget). A -200 schedule
variance means you are behind schedule. This also applies to VAC.

• For indices interpretation: greater than one is good and less than one is bad.
Remember, this only applies to CPI and SPI. The opposite is true of TCPI.
People often incorrectly answer questions requiring them to interpret earned value
terms or acronyms because they fail to understand the meanings of the terms. Figure
7.2 illustrates some of the differences.
Notice that planned value (PV; what the value was expected to be at this point in the
project according to the plan) and actual cost (AC; what the cost has actually been
on the project to this point) look backward at the project.
Budget at completion (BAC), estimate to complete (ETC), and estimate at
completion (EAC) look forward. BAC refers to the project's planned budget; it
indicates what the end cost of the project would be if everything went according to
plan. ETC and EAC forecast future performance based on what has actually
occurred on the project, taking into account any variances from the plan the project
has already experienced. ETC is an estimate of how much more the remainder of
the project will cost to complete.

EAC indicates what the total project cost is forecasted to be.

Earned Value in Action

Earned Value in Action Earned value is an effective tool for measuring
performance and determining the need to request changes. The following is a
sample team meeting conversation on this subject
The project manager calls a team meeting and says, "We are six months into this
million-dollar project, and my latest analysis shows a CPT of1.2 and an SPI of0.89.
This means we are getting 1.2 dollars for every dollar we put into the project but
only progressing at 89 percent of the rate originally planned. Let's look for options
to correct this problem.
The network specialist suggest that she could be removed from the project team
and replaced with someone less expensive. The.IT coordinator suggests either
removing the purchase of new computers from the project or telling the customer
the project will be two weeks late.
The project manager looks at the network specialist and says, "It would sadden me
to lose you, and your suggestion would improve costs but not schedule. You are the
company's best network specialist. Someone else would not be as proficient as you
in completing the work." To the IT coordinator's suggestion, they respond that
canceling the new computers would save money but not time. "Let's focus on time."

Another team member suggests that since the project is doing well on cost the
project manager could bring in another programmer from the IT department to
work on the project to get the next two activities completed more quickly.
The project manager says, "That sounds like the most effective choice in this
situation. Let's see if we can find someone who will improve performance, at the
lowest cost. Thanks for your help.

The best way to learn the earned value analysis technique is to use it. The following
exercises are designed to give you a chance to practice both calculations and
interpretation. Earned value questions on the exam have generally required fewer
calculations per question than these exercises.
Understanding the meaning of the results of each calculation is as important as
knowing how to calculate them. Expect questions on the exam such as: "The CPI is
0.9, and the SPI is 0.92. What should you do?" You will need to interpret this and
other data in the question and then determine which choice would address the
issue(s) described. In the fence example, there are both cost and schedule problems.
You may also see questions on the exam that require you to perform multiple
calculations (for example, you need to perform one calculation to come up with a
result that can be used as an input for a second calculation). We have a few
exercises coming up that will help you understand how to answer these questions,
but it's helpful to first consider the following useful tip.

In summary, earned value analysis enables the project manager and team to identify
and analyze trends in performance and variances that may require action to bring
the project in line with what was planned.
It also includes monitoring the use of contingency reserves to ensure the amount of
reserves remaining is adequate. It may identify the need to request additional
reserve funds through integrated change control.

The Control Costs process provides measurements that indicate how the work is
progressing and allow the project manager to create reliable forecasts and take
action to control the project. This process may result in requested changes to the
cost management plan, performance measurement baseline, and other parts of the
project management plan, recommended corrective or preventive actions, and
updates to project documents.