CHAPTER ONE: COST MANAGEMENT

What is Project Cost Management?

Processes that help to estimate, budget, and control cost so as to
ensure that the project is completed within the approved budget.
•Processes primarily concerned with the cost of resources required
to complete the project activities.
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Most project managers would agree that cost overruns are the
causes of more frustration than almost any other factor. Clearly,
this is the case with innovative development projects, as the very
nature of innovation makes it nearly impossible to accurately
predict costs. However, even in relatively routine projects (such
as many found in the construction industry), initial cost estimates
are often completely off target from the final outcome.
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overruns are the norm, rather than the exception. The most
significant reasons for this are
• Low initial cost estimates
• Unanticipated technical difficulties
• Lack of or poor scope definition
• Specification changes
• External factors
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• Low initial cost estimates are often the result of

underestimating the magnitude and complexity of the task to
be undertaken. The obvious reason for this is that the
evaluation of project task performance and duration is often
done in isolation, without considering the impact of
surrounding activities.
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• Unanticipated technical difficulties are the second important

cause of cost overruns. The roots of this problem usually rest
in poor initial design, but this is not always the case.
• Lack of or poor scope definition leads to the creation of
projects that have no clear direction, features, goals, or even
purpose. It is important to recognize that when the initial steps
of developing a comprehensive scope statement and work
breakdown structure are done poorly, they effectively turn any
attempt to reasonably estimate project costs into an exercise in
futility.
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• Specification changes, often referred to as ‘‘scope creep,’’ make
initial cost estimates nearly meaningless, and are often the primary
culprits for overruns. Requests for specification changes while the
project is underway sometimes originate internally within the
project organization, but more often than not, the sources for these
requests are external.
• External factors such as inflation, interest rates, environmental
issues, and currency exchange rate fluctuations can also escalate
actual project costs, particularly in the case of projects where
technical problems and other difficulties lead to an increase in
project duration.
Potential for errors in estimates during the various stages of the
project
 1.1. Process of cost management
Processes associated with cost management include:
◦Estimate Costs
◦Determine Budget
◦Control Costs
Cost management process
 1.2.Categories of Project Costs
• Initial cost estimation begins during project proposal
development. At this stage, all relevant costs that are likely to be
incurred in the project should be identified and included in the
initial project proposal. To develop the initial cost estimates, we
need to know the various sources of project costs. These include
1. Cost of labor:This involves hiring costs and wages for the
various human resources associated with the project.
2. Cost of materials: This is the cost of raw materials, supplies, and
other equipment needed to complete project tasks. The actual costs
incurred for materials depend on the nature of the project
3.Cost of equipment and facilities:Many ‘‘off-site’’ projects, such
as mining or construction of large buildings, require project team
members to rent facilities and equipment. In these cases, the rental
costs are legitimate costs that can be charged against the project.
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• Project costs can be classified as direct or indirect, recurring or
nonrecurring, fixed or variable, and normal or expedited.
• Direct costs can be directly charged against the project; for
example, the costs of personnel who are directly involved in the
project, or the costs of materials directly used for project work.
• Indirect costs include overhead, as well as selling and
administrative expenses. Examples of overhead costs include
costs associated with taxes, insurance, utilities, and so forth.
Costs associated with selling and administrative expenses stem
from salaries, commissions, advertising, etc. Tracking and
allocating indirect costs to specific projects is considerably more
difficult than allocating direct costs.
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• Recurring costs, such as labor and materials, are repeatedly
incurred throughout the project life cycle.
• Nonrecurring costs, on the other hand, are one-time costs that
are typically incurred at the beginning or at the end of the
project, such as market research and labor training.
• Fixed costs do not vary with usage. For example, costs
incurred in the purchase of capital equipment remain fixed,
regardless of the extent of equipment use.
• Variable costs, on the other hand, vary directly with usage.
They are typically associated with labor and materials.
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• Normal costs are incurred when project tasks are completed
according to the original planned duration.
• Expedited costs or crash costs are unplanned costs incurred
as a result of steps taken to accelerate project completion. For
example, costs associated with using additional overtime or
hiring additional workers specifically to hasten project
completion can be regarded as expedited costs.
 Linkages of project cost management and budgeting
• Developing a project budget involves estimation of costs,
subsequent analyses, frequent revisions, and, to a certain
extent, intuition. Meaningful budgets are developed through
frequent interaction among concerned parties, and require data
input from a variety of sources.
• The way in which cost data are collected and interpreted is
determined by whether the project organization takes a top-
down or bottom-up approach to budgeting. The two
approaches use radically different methods for collecting
relevant information, which can lead to completely different
results.
 Budgeting Approaches
• Top-down Budgeting
• The top-down approach utilizes the judgment and experience
of top and senior-level managers, as well as past data on
similar activities. It assumes that experience in past projects
will enable senior management to provide guidance on
accurate cost estimates for future projects.
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• The advantage of top-down budgeting is that top
management’s estimates of project costs, in aggregate terms,
often tend to be quite accurate. Furthermore, these aggregate
estimates provide the basis for disaggregation, which in turn
provides important budgetary discipline and cost control. Also,
because senior-level managers are directly involved in
developing the project budget, there is a sense of commitment,
ownership, and support.
• Disadvantages of top-dow: First, lower-level managers may
feel that their share of the project budget doesn’t accurately
reflect the tasks to be accomplished.
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• Second, top-down budgeting creates a potentially conflict-
laden atmosphere as the lower levels of the organization work
to align their specific task budgets with the overall project
budget.
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• Bottom-up Budgeting
• The most important prerequisite for the bottom-up approach is
the availability of a detailed WBS that identifies all elements
in the project, e.g., deliverables, sub deliverables, and work
packages.
• The advantage of bottom-up budgeting, first and foremost, is
that it forces the creation of detailed project plans as an initial
step for creating a budget. Second, the approach facilitates
participative management, because it assumes that the
individuals actually performing the tasks are more likely to
have a clear understanding of resource requirements than their
superiors.
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• The major disadvantage of bottom-up budgeting is the reduced

role played by top management in the initiation and control of
the budgeting process.