COST MANAGEMENT

Cost management is the process of planning and controlling the costs associated

with running project.

This topic describes important concepts in project cost management, particularly

planning cost management, creating good estimates, and using earned value

management (EVM) to assist in cost control.

Notice two crucial phrases in this definition: “a project” and “approved budget.”

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There are four processes for project cost management:

1.Planning cost management:
The first step in project cost management is planning how the costs will be

managed throughout the life of the project.
It involves determining the policies, procedures, and documentation that
will be used for planning, executing, and controlling project cost.
The project manager and other stakeholders use expert judgment, analytical

techniques, and meetings to produce the cost management plan.
The main output of this process is a cost management plan.

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In general, a cost management plan includes the following
information:
1. Level of accuracy:
2. Units of measure
3. Organizational procedures links
4. Control thresholds
5. Rules of performance measurement
6. Reporting formats
7. Process descriptions:

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2. Estimating costs.
 Involves developing an approximation or estimate of the costs of the resources

needed to complete a project.

 The main outputs of the cost estimating process are activity cost estimates, basis

of estimates, and project documents updates.

3. Determining the budget.

 Determining the budget involves allocating the project cost estimate to

individual material resources or individual work items over time to establish a

baseline for measuring performance.
 These material resources or work items are based on the activities in the work

breakdown structure for the project.

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It's the sum of the cost estimates for all the tasks on your project schedule.
The main outputs of the cost budgeting process are a cost baseline, project
funding requirements, and project documents update. project documents
updates, such as items being added, removed, or modified in the scope
statement or project schedule.
A cost baseline is the budget that has been approved for the project, broken
down into a list of salaries, materials, equipment and more.
cost baseline for measuring project performance and to determine project
funding requirements.
The cost management plan, scope baseline, activity cost estimates, basis of
estimates, project schedule, resource calendars, risk register, agreements,
and organizational process assets are all inputs for determining the budget.

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4. Controlling costs
 Controlling project costs includes monitoring cost performance,

ensuring that only appropriate project changes are included in a revised

cost baseline, and informing project stakeholders of authorized changes
to the project that will affect costs.
 The main outputs of the cost control process are work performance

information, cost forecasts, change requests, project management plan

updates, project documents updates, and organizational process assets
updates.
 The cost forecast is a process you can use to adapt cost planning to

constantly changing circumstances.

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 Change request is a formal proposal for an alteration to some product
or system.
 E.g. In project management, a change request often arises when the
client wants an addition or alteration to the agreed-upon deliverables
for a project. This would change the cost, schedule and resources of the
project.
 The project management plan, project funding requirements, work
performance data, and organizational process assets are inputs for
controlling costs.
 Outputs of this process are work performance information, cost
forecasts, change requests, project management plan updates, project
documents updates, and organizational process asset updates.

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 Basic Principles Of Cost Management
 Many IT projects are never initiated because IT professionals do not

understand the importance of basic accounting and finance principles.

 Therefore, IT project managers need to be able to present and discuss

project information both in financial terms and technical terms.

 In addition to net present value analysis, return on investment, and

payback analysis, project managers must understand several other cost

management principles, concepts, and terms.

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 profits are revenues minus expenditures. To increase

profits, a company can increase revenues, decrease

expenses, or try to do both.
 Life cycle costing allows you to see a big-picture view of

the cost of a project throughout its life

cycle.
 Cash flow analysis is a method for determining the

estimated annual costs and benefits for a project and the

resulting annual cash flow.
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 Tangible and intangible costs and benefits are categories
for determining how well an organization can define the
estimated costs and benefits for a project.
 Direct costs can be directly related to creating the
products and services of the project. You can attribute
direct costs to a certain project.
 For example, direct costs include the salaries of people
working full time on the project and the cost of hardware
and software purchased specifically for the project.
 Project managers should focus on direct costs because
they can be controlled.

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 Indirect costs are not directly related to the products or
services of the project, but are indirectly related to
performing the project.
 For example, indirect costs would include the cost of
electricity, paper towels, and other necessities in a large
building that houses 1,000 employees who work on many
projects.
 Sunk cost is money that has been spent in the past.
Consider it gone, like a sunken ship that can never be
raised.
 When deciding what projects to invest in or continue, you
should not include sunk costs.
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 Learning curve theory states that when many items are produced repetitively,

the unit cost of those items decreases in a regular pattern as more units are
produced.
 The basic concept of unit theory is that as the quantity of units produced

doubles, the cost of producing a unit is decreased by a constant percentage.

 For example, suppose that a Surveyor Pro project would potentially produce

1,000 handheld devices that could run the new software and access
information via satellite.
 The cost of the first handheld unit would be much higher than the cost of the

thousandth unit.

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 Reserves are dollar amounts included in a cost

estimate to mitigate cost risk by allowing for future

situations that are difficult to predict.
 Contingency reserves are the finance for the project

cost estimates by the project manager to deal with

uncertain events/risks that may happen

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 Earned Value Management(EVM).
 Earned value (EV) is a way to measure and monitor the level of work completed on a project

against the plan.

 Simply put, it's a quick way to tell if you're behind schedule or over budget on your project. You
can calculate the EV of a project by multiplying the percentage complete by the total project
budget.

 EVM is a project management methodology that integrates schedule, costs, and scope to measure

project performance which is called Project management triangle.

 Given a cost performance baseline, project managers and their teams can determine how well the

project is meeting scope, time, and cost goals by entering actual information and then comparing
it to the baseline.

 A baseline: in project management is a clearly defined starting point for your project plan which

is the figure in the original project plan plus approved changes.

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EVM is considered by Insight to be one of the “critical few” best practice
areas for monitoring project performance from both a cost and schedule
perspective.
which means ,it is common to think about projects with binary thinking:
1. Ahead of schedule vs behind schedule
2. Over budget vs under budget
Under budget (=using less money than planned) If you come in under budget,
everyone will be very to create a favorable.
Over budget (=using more money than planned) Feature movies always run
over budget.
Ahead of schedule (=doing or finishing something earlier than planned
Behind schedule (=later than planned or expected.

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 Both project performance factors have a direct impact on
the total project cost.
 What will be the total cost of my project if I'm ahead of
schedule but my costs are higher than expected? If I'm
behind schedule but my costs are lower?
 EVM provides great information to help with these
questions.
 Calculating earned value
 Software packages such as Microsoft Project can perform
earned value calculations automatically, and they’re
simple calculations that can quickly be performed
manually as needed.
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Earned
 value management involves calculating three

values for each activity or summary activity from a

project’s WBS.

1. The planned value (PV)

2. The actual cost (AC)

3. The earned value (EV)

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 1. The planned value(pv)
 (PV) also known as Budgeted Cost of Work Scheduled (BCWS).
It is the portion of the approved total cost estimate planned to be spent on an

activity during a given period.

The approved budget allocated to complete a project deliverable (or Work

Breakdown Structure) within a specific time period

2. The actual cost (AC):

 It is the total direct and indirect costs incurred in accomplishing work on an

activity during a given period.
Also known as Actual Cost of Work Performed (ACWP) is the actual amount

of money that has been spent for the work completed by a specific date.

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 3. The earned value (EV)
 EV is based on the original planned costs for the project or

activity and the rate at which the team is completing work

on the project or activity to date.
 Earned value represents the amount of the work that's

actually completed and the value the project has produced.

 It will allow you to compare the work that has been

completed with the planned costs of your project.

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 EV
 This calculation will allow you to objectively and quantitatively

measure the success of your project.

 The formula is total project budget multiplied by the % of
project completion.
 EV = Percent complete (actual) x Task Budget.

 The rate of performance (RP) is the ratio of actual work

completed to the percentage of work planned to have been

completed at any given time during the life of the project or
activity.

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 example
 Let’s take a look at an example. Assume we’re halfway

through a year-long project that has a total budget of

$100,000.

 The amount budgeted through this six-month mark is

$55,000.

 The actual cost through this six-month mark is $45,000.

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 Therefore, in summary:
Planned Value (PV) = $55,000

Actual Cost (AC) = $45,000

Earned Value = % of completed work X BAC

(Budget at Completion).

Earned Value (EV) = ($100,000 * 0.5) = $50,000.

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 With these available numbers, we're ready to do some
calculations.
1. Schedule Performance Index (SPI)
 SPI measures progress achieved against progress planned.
 (SPI) calculation: SPI = EV/PV
 An SPI value <1.0 indicates less work was completed than was
planned.
 SPI >1.0 indicates more work was completed than was planned.
 So ,Schedule Performance Index (SPI) = EV/PV =
$50,000/$55,000 = 0.91 (bad because <1)

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2. Cost Performance Index (CPI):
 CPI measures the value of work completed against the actual

cost.
 (CPI) calculation: CPI = EV/AC

 A CPI value <1.0 indicates costs were higher than budgeted.

CPI >1.0 indicates costs were less than budgeted.

 For both SPI and CPI, >1 is good, and <1 is bad.

 So , Cost Performance Index (CPI) = EV/AC =

$50,000/$45,000 = 1.11 (good because >1).

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3. Schedule Variance (SV) :

 It is typically used within earned value management (EVM) to

provide a progress update for project managers at the point of

analysis.

 The Earned Value (EV) minus the Planned Value (PV)... It is the

value of the money spent, based upon the schedule.

 So EV–PV = $50,000-$55,000 = -$5,000 (bad because <0)

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4. Cost Variance (CV) :
 Cost variance (CV), also known as budget variance.

 It is the difference between the actual cost and the budgeted

cost, or what you expected to spend versus what you

actually spent.
 This formula helps project managers figure out if they are

over or under budget.

 So, EV–AC = $50,000-$45,000 = $5,000 (good because

>0)

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5. Estimated at Completion (EAC) :
 Estimate at Completion (EAC) is the current expectation of total

cost at the end of a project.

 EAC is a forecast/prediction of how much the total project will

cost.
 The EAC represents the final project cost given the costs

incurred to date and the expected costs to complete the project.

(Total Project Budget)/CPI ).
 (EAC) = (Total Project Budget)/CPI = $100,000/1.11 = $90,000

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 The end
 Question?

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