AS PROMISED IN THE PREVIOUS ARTICLE, we will look at four different stages in project cost management which will help project managers to overcome their issues in managing the cost of their projects. This management scope is essential to the success of their projects as project capital is needed for every single project and the cost accuracy has to be thoroughly analyzed before the project can be executed
Each of the stage consists of THREE different ingredients to help project managers to run through each stage. These are:
- Key Inputs
- Tools and Techniques
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Planning Cost Management
Planning cost management is the first stage that needs to be done by project manager in project cost management. What is planning cost management? It is basically a set processes in which a project manager establishes different procedures, policies and documentation for planning, managing, expending and controlling project cost. This has to be done in order for project manager to get a clear view of the direction of the project in terms of how the project costs will be managed throughout the project.
1. KEY INPUTS
There are some inputs which are needed by project manager in order to develop a cost management plan by the end of this planning stage. Some of them include:
- PROJECT MANAGEMENT PLAN: documents such as scope baseline (scope statement, project Work Breakdown Structure (WBS) and WBS dictionary),
- SCHEDULE BASELINE: an approved project schedule that points when the project cost will be incurred
- PROJECT CHARTER: shows estimated project budget and other information which might affect the estimation and managing process of the project costs.
These documents are crucial as they will show list of activities that will be done throughout the project life cycle as well as the resources that are needed for the project. For example, if a project manager handles a project about building a house and under WBS it is stated that one of the activities is to hire a contractor, he will definitely take that into consideration of the project cost as hiring a contractor requires a certain amount of budget. Also, the project manager will also be able to identify how much cost he will need for the project given the early budget from project charter.
Besides the main three key inputs, environmental factors that surround the organization has to be taken into account. These factors are often overlooked by project managers, but they are just as crucial as the main inputs. These factors might include things such as:
- CURRENCY EXCHANGE RATE for multi-national projects or imported resources
- MARKET CONDITION of the product or services that the organization wishes to enter
- CULTURE AND STRUCTURE of the organization itself (eg. high salary for employees, rapid spending on basic necessities, etc)
Furthermore, organizational assets such as financial databases, existing documentation such as cost estimate and budget related policies and guidelines from other projects done by the organization can help project manager to develop a thorough cost management plan.
2. TOOLS AND TECHNIQUES
Once the key inputs are determined and identified, project manager has to decide on the tools and technique that will be needed to analyze the estimated cost, ways to collect the budget for the project as well as to inform stakeholders of the project regarding the project cost.
- EXPERT JUDGMENT: project manager will be able to seek guidance from individuals or groups who are expert in the area of field related to the organization’s project due to their previous experience in handling similar projects. According to Louis Alderman’s article for Velociteach project management consultancy firm, an expert can be anyone who has knowledge in the project and he does not have to be a paid consultant. This tool is highly favored by many project managers as they will be able to learn more about the project they are handling from someone who has more knowledge about it.
- ANALYTICAL TECHNIQUE: technique that can be used by project manager to choose strategic option on how he will fund the project (equity, debt, etc). Also, this technique involves calculation of various cost related documents such as Net Present Value (NPV), Return of Investment (ROI), payback period and others. This technique mainly helps project manager to make a calculative decision whether a project is worth pursuing or not in terms of how fast can the organization recoup the expenses spent on a project.
- PROJECT MEETING: arranged by project manager to gather project members, stakeholders, sponsor and other individuals who are responsible towards the project cost and all of them can work together to discuss and develop the cost management plan.
At the end of the planning cost management stage, a COST MANAGEMENT PLAN will be developed by the project manager. This consists of documentation on how the project cost will be planned, estimated and controlled. All the different technique and tools that are used by the project manager will be documented as well. Some measurements will be included in cost management plan as policies and standard that will be followed throughout the project execution. These establish:
- UNITS OF MEASURE: universal time measurement (week, hour) and quantity measurement (meters, kilograms) for each resource involved in the project
- PRECISION AND ACCURACY: rounding up of cost (eg. $99.5 will be rounded to $100) and acceptable range of different cost estimates for each activity (eg. ±10%) which might be needed for unforeseen / contingency costs
- ORGANIZATIONAL PROCEDURES LINKS: WBS that is provided early on will serve as a standard to enable the consistency with cost estimates, budgets and control of cost.
- REPORTING FORMAT: frequency and document format for various cost related documentations
- PROCESS DESCRIPTION: explanation of other processes in project cost management will be documented
- ADDITIONAL DETAILS: choice of funding, how to account changes in cost due to external factors, technique to record project cost etc
An example of cost management plan document can be viewed from this example provided by PMdocs.com
Estimating costs of of a project as precise and accurate as possible is crucial for project managers as it will help the project manager to complete the project within the given budget. Cost estimate acts as a prediction based on known information from different documentation from previous stage which help to identify cost of different resources and their alternatives in order to complete the project.
There are many types of cost estimates that need to be taken into consideration by project managers before start estimating their costs. Different cost estimate can be done as the project progresses over time. By having different cost estimate, the accuracy of cost estimate will become more accurate. These are:
- ROUGH ORDER OF MAGNITUDE (ROM): ROM estimate has an accuracy of roughly -25% to +75% as per PMBOK. This estimate is usually done very early in the project life cycle when information about the project is still limited . This estimate is done early in project initiation phase in order to provide project managers time to look for alternatives and selections which can help to reduce the project cost. Do note that ROM estimate is NOT very accurate in estimating cost of a project due to its early development. Katie Jensen of Chron.com provides reasons why ROM estimate should not be relied too much through this article
- BUDGETARY: this budget estimate is often done during planning stage of a project. It increases the accuracy of cost estimate to -10% to +25%. In this stage, some documentation such as project charter and early financial analysis is available for viewing. This helps to narrow down the accuracy of the cost estimate and project manager can start putting currency (in dollars, euro, etc) value in the activity plan.
- DEFINITIVE: definitive estimate has an accuracy of -5% to +10% and this estimate is more detailed compared to ROM estimate. This is done later in the project towards its completion (usually during user acceptance testing) and when a lot of information related to the project are available for viewing. Definitive estimate provides different details for resource purchases or labor wage which are closer to the actual cost of the project.
Cost estimate provides a quantitative measurement of how much a project will cost an organization. These costs include different cost for labors, materials, resources, services, facilities, unforeseen cost and other costs which need to be covered by the budget given.
1. KEY INPUTS
Some inputs which are needed to develop activity cost estimates at the end of this stage includes:
- COST MANAGEMENT PLAN: this document is the deliverable from previous stage
- HUMAN RESOURCE MANAGEMENT PLAN: this document explains to project manager about different position and rate for employees, how much each of them should be paid and any related bonuses which they get after project completion. This attributes to the total cost that needs to be covered for the project
- SCOPE BASELINE: same documents used on previous stage
- PROJECT SCHEDULE: this document presents project manager with quantitative time and quantity of resource which are needed to complete the project. It also includes activity schedule and duration in which the duration of each activity is explained. This is important to calculate the wage for man power based on the time stated (per hour, per week, etc). Activity schedule also helps to determine cost for materials which are time sensitive (eg. item which has expiry or seasonal date)
- RISK REGISTER: risk register is document which lists down different risks that are possessed by the current project and it is crucial towards the cost estimate of the project. As risk can be either positive or negative, this will impact the overall cost and time completion of the project for better or worse. A negative risk will increase cost and project duration while a positive risk will decrease cost and project duration.
2. TOOLS AND TECHNIQUES
Various tools and technique can be used to aid project managers in developing cost estimate. Some of them are:
- EXPERT JUDGMENT: similar to the previous expert judgment on planning cost management, project managers can seek out for experts on the project or can even count themselves as experts as they have thoroughly develop the cost management plan. Some experts might try to combine other technique for cost estimates.
- ANALOGOUS ESTIMATING: this cost estimate technique uses the actual cost of a previous, similar project that was done by the organization and use it as the gross estimate cost for the current project. It includes using different values on scope, cost, budget and duration of the previous project. This technique is useful when the current project is limited in terms of detailed information at the early stage. However, this technique is not the most accurate and it is only recommended to be used if the current project is very similar to previous project, externally and internally.
- PARAMETRIC ESTIMATING: this technique uses detailed statistical relationship between historical data and metric unit value to calculate cost estimate. Parametric estimating uses mathematical calculation and summarize the cost to a higher level cost documentation. For example, in a previous project, the cost of hiring one constructor to build a room is $100, thus; in the current project, the cost of hiring two constructors to build two rooms would be $200.
- BOTTOM-UP ESTIMATING: this cost estimate technique relies on the summed up cost of entire activity in the project. Each activity / work packages cost is estimated and then added up for tracking purposes. The accuracy of this technique is dependent on the size and complexity of each individual work
- RESERVE ANALYSIS: this cost estimate technique include contingency reserve intended to cover the “known-unknowns”. For example, at the start of the project a deliverable needs to be submitted and in later stage of the project this exact deliverable will definitely be tweaked. The project manager knows that the deliverable will be tweaked at some point but the amount of work needs to be done is unknown. The contingency reserve is then used to cover this unknown amount of work. Besides that, management reserve can also be added to cover the “unknown-unknowns”. This might cover for unforeseen works later on the project. When this reserve is used, it needs to be added to the cost baseline.
- VENDOR BID ANALYSIS: this cost estimate technique is used to find out how much a resource for a project will cost based from different vendors who offer different cost for the resource. This way, project manager will get a rough idea on how much the resource is priced on the market
Once the analysis for cost estimate is done, project manager can then develop the deliverable of this stage.
- ACTIVITY COST ESTIMATES: this document is a estimation of the costs required to complete the project work. This includes all the resources that are needed for each activity shown in WBS or work items list such as labor (cost per hour, week, etc), materials, equipment, tools as well as special resources such as exchange rate or contingency reserve.
- BASIS OF ESTIMATES: this document explain details such as assumptions that are made during cost estimate, constraints of the project and range of difference for the cost estimate
- PROJECT DOCUMENTS UPDATE: some documents need to be updated after cost estimate is developed such as risk register
By the end of this stage, project manager will be able to develop a cost estimate with cost for each activity and resource listed such as the one below:
Once a cost estimate is developed, project managers can then proceed to the next stage. Determining budget is the process of dispersing the cost estimate from previous stage to individual work items stated mainly on WBS and this will be arranged in timely order according to the project duration (yearly divided into months, months divided into weeks, etc). This is done in order to produce a COST BASELINE, a document which helps project managers in order to monitor and control project performance against the cost incurred throughout the development phase in timely basis.
1. KEY INPUTS
Key inputs that are needed for this stage are:
- COST MANAGEMENT PLAN: this document should be developed during the first phase, planning cost management
- SCOPE BASELINE: same document from previous stage
- ACTIVITY COST ESTIMATE: this document is the deliverable from the previous stage stating the cost for each activity that needs to be done throughout the project
- BASIS OF ESTIMATES: assumptions, constraints and other project details documented previously
- PROJECT SCHEDULE: same document from previous stage in which the project start and end date can be used to determine how the budget will be divided according to the time
- RISK REGISTER: same document as previous stage
- RESOURCE CALENDAR: this document highlights the timing of resource allocation for the project. This can be used to monitor resource costs throughout the project duration.
- AGREEMENT: this document contains information regarding agreement on different resources, materials, tools, equipment and services that will be purchased by the organization for the development of the project and the costs will be added to the budget.
2. TOOLS AND TECHNIQUES
Different tools and techniques can be applied in this stage in order to develop the cost baseline output. Some of them are:
- COST AGGREGATION: this technique sums up the costs for each unit of work in the WBS and summarize them for the entire project
- RESERVE ANALYSIS: same technique as previous stage whereby amount that is allocated for contingency reserve is added to the budget. However, management reserve cannot be added in the budget just yet as this budget might not be used whereas contingency reserve will definitely be used.
- FUNDING LIMIT RECONCILIATION: using this technique, project managers have to look at the difference between the planned costs and funding limit given for the project. This difference sometimes forces project manager to reschedule the project work in order to minimize the difference between the two. For example, some works can be made shorter in order to reduce the duration of the project, thus; reducing the cost of paying labor wage.
The output of this stage is important in determining the final budget of the project. Some of them are:
- COST BASELINE: cost baseline is a document which shows the summation of all the approved budget for all the activities listed on WBS. As it is a time-phased budgeting, it can be used by project managers to look at the cost of the project at different time of the week or month throughout the project development
- PROJECT FUNDING REQUIREMENT: this is a periodic funding requirement that are obtained from cost baseline. This document in form of a graph shows when the next funding for the project will be distributed during the project execution
- PROJECT DOCUMENTS UPDATES: some documents such as risk register, activity cost estimates and project schedule might need to be updated when the cost baseline is developed as new risks might be identified or activity duration might be shortened.
At the end of this stage, the team should be able to finalize the project budget as cost baseline (plus any management reserve) serves as the closest actual cost that has to be covered by the budget. At this point, the confidence level about the project cost and budget will be high as the project manager should get a much clearer view on both things.
Once project managers have identified and finalized the necessary costs and budget required for the development of the project, it is time for controlling the project cost as the project progresses. According to Neil Kokemuller’s article from Chron.com, this stage can help to boost company’s profitability as through detailed monitoring, cost control can help to minimize the usage of materials, resources, supplies and man power and time cost. It is necessary for project managers to update any relevant document when there are changes to the costs. This step is an important step in the project cost management because it allows them to make correction towards any changes on the costs which differ from the original project plan. In addition, it also helps to minimize any cost related risk which might complicate the funding of the project in the long term. At the end of this stage, project managers are expected to develop important deliverables such as CHANGE REQUESTS, COST FORECASTS and WORK PERFORMANCE INFORMATION in addition to updates to relevant cost related documents which needs to be shown to stakeholders involved.
1. KEY INPUTS
Key inputs that are needed for this stage are:
- COST BASELINE: cost baseline which is developed on previous step is important as it will be used as a comparison with the actual project cost and project managers can use it to record the difference in cost
- COST MANAGEMENT PLAN: this document from the first stage has to be used as it contains list of ways on how the cost will be controlled in this phase.
- WORK PERFORMANCE DATA: this documentation includes details which show progress of activities and deliverables that have been submitted.
2. TOOLS AND TECHNIQUES
Just like the other phases, there are several tools and techniques which can be used to monitor and plan for any changes in the project cost such as:
- EARNED VALUE MANAGEMENT: also known as EVM by many, this technique measure the performance of the project in terms of cost (whether the project is over or under budget) as well as in terms of time (whether the project is behind or ahead of schedule). EVM is very flexible as it can be applied in many projects other than IT related projects. The idea of EVM is that using three different elements, Earned Value (EV), Planned Value (PV) and Actual Cost (AC), project managers will be able to determine the current progress of the project they are handling at that moment. For more explanation regarding the basic of EVM, visit this article written by Wayne Brantley of PMtimes.com
- PROJECT MANAGEMENT SOFTWARE: as the list of software which help to make project management activities easier, this can be used as one of the tools to track cost and project performance. Using software such as EcoSys Project Cost Management Tool or Monitor Mpower Project Cost Management Tool, these software help to automate the projection and calculation of three main key attributes on EVM through web or desktop based software solution to ease the process for project managers.
- RESERVE ANALYSIS: this technique is used in order to manage and control contingency and management reserves. Using this technique, project managers have to monitor and determine whether these reserve budgets are still needed for the project development or not. As the list of risk register might increase, the reserve budgets might or might not be used at all, thus; asking project managers to edit the developed cost baselines and estimates.
Once project managers have monitored and controlled the project cost according to the schedule and budget planned, they will develop these documents as the deliverables of this phase:
- WORK PERFORMANCE INFORMATION: figures such as cost and schedule performance index which show the progress of projects in time and cost perspective can be documented and shown to stakeholders for assessment and review.
- CHANGE REQUEST: this document keeps track of changes in cost (negative or positive) for cost related documents such as cost baseline which include list of actions that had were taken for adjusting the project cost.
- COST MANAGEMENT PLAN: cost management plan might need to be updated should project managers used different ways such as method and accuracy of controlling the cost during the project development and those techniques were not listed on the original plan.
- PROJECT AND ORGANIZATIONAL DOCUMENT UPDATES: this updates include editing values of company’s financial databases, cost estimate as well as list of problems that were faced during the controlling cost phase.
In conclusion, each of the four phases discussed above is crucial for the success of a project financially and thus; project cost management is something which has to be applied and practiced by every project manager regardless of the scope and scale of the project in hand. By having a certain degree of financial control in a project, project manager will be able to track and monitor the progress of the project with little to no financial issue. Early identification and discussion on project cost and budget are important to ensure the success of the project in the long run.