Managing Costs on Your Project
Cost management is perhaps one of the most difficult aspects of project management. As project managers we are well practiced at acquiring resources, assigning work, tracking progress and completing projects. But since there's a cost associated with nearly everything our job becomes much more complex and difficult. We need to be sure the cost of the project is estimated accurately at the beginning, budgets are assigned for various parts of the project and we have the tools to control costs throughout the lifecycle of the project.
As a Project Manager, managing costs on our projects can be quite difficult. Cost management is perhaps one of the most difficult aspects of project management. How often do project managers know how much a project will cost before it begins? How often do stakeholders try to add requirements or deliverables to an already approved project? How do project managers track and report costs in order to determine if the project will over or under run its budget? These are some of the questions we, as project managers, face when dealing with managing costs on a project. There is no single right answer to any of these or other cost management questions. Managing costs, as well as other project attributes that contribute to cost, is a significant challenge faced by project managers every day. Fortunately project managers have various tools available that can be used to effectively manage project costs while successfully accomplishing all project tasks and deliverables. The challenge is to understand all of the factors that contribute to project costs and using the tools available at the right times and for the right reasons. In order to better understand this we will discuss the cost management approach in its component parts and explore each in more detail.
In very few situations do we know exactly what a project will cost before it is completed. There are simply too many variables and contributing factors to realistically expect an exact cost figure when beginning a project. This is where project managers must understand and utilize the cost management component of estimating costs. The estimating costs process is conducted during the project’s planning phase and relies on several inputs:
Input 1: Scope Baseline – The scope baseline consists of the project scope statement, the work breakdown structure (WBS), and the WBS dictionary. The components of the scope baseline provide the detail of what is being estimated; what is in and out of scope; any constraints placed on the project; and the activities that must be accomplished to complete the project.
Input 2: Project Schedule – The project schedule provides the quantities and types of resources needed to accomplish the project as well as when the work for each activity will occur. A project cannot be estimated without a project schedule because timing of purchases or resources may affect their cost and the project team will need to establish a budget which determines expenditures for specific periods of time throughout the project.
Input 3: Human Resource Plan – All labor rates for project members and any costs for a reward system must be known in order to develop project cost estimates.
Input 4: Risk Register – There are always costs associated with risk management efforts. Understanding project risks and estimating the costs of managing those risks are integral parts of cost estimating. The risk register is also an important part of estimating the amount of reserves a project will need. By analyzing the risks and understanding the costs of these risks if they occur, the project team can establish the risk reserve amount required to deal with these known risks if they happen.
Input 5: Existing Organizational Policies, Culture, Systems, and Lessons Learned – Many organizations have a more standardized approach to cost management. Additionally, it is wise for project managers to consider established methodologies and lessons learned to ensure mistakes in estimating are not repeated and that best practices are utilized for more accurate estimating.
The estimating costs process must consider all of these inputs, understand the costs involved with each, and estimate the costs of all activities involved. There may be various types of cost involved including variable, fixed, direct, or indirect costs. There are also various methods for estimating costs which include:
1) One-point Estimates – uses expert judgment or historical information to develop one estimate per activity and is simple and fast but can encourage padding, be inaccurate, and fail to gain buy-in from team members
2) Three-point Estimates – much like for time management this approach uses pessimistic, most likely, and optimistic costs to develop the estimate. This method’s accuracy is dependent on known costs, expert judgment, and historical information.
3) Analogous Estimating – uses expert judgment and historical information to estimate costs. While this is a simplified approach it requires vast experience to achieve an accurate estimate and it is very difficult to account for risks or uncertainties.
4) Parametric Estimating – uses historical information to compare different variables in order to estimate cost per unit measure (cost per installation, cost per unit complete, cost per widget).
5) Bottom-Up Estimating – estimates are done for each activity or work package and the costs are rolled up into accounts and an overall project cost. This method is very accurate, achieves buy-in from team members, and establishes a basis for managing costs throughout the project. However, this method requires significant time and effort (greater cost) and very detailed activity definition from the outset.
As the project team develops its cost estimates it should be mindful of the accuracy of the estimates. As we stated earlier, it is unlikely that we will ever know the exact cost of a project before it is completed. Therefore, estimates are provided with a range. The more information and detail the team has for its estimates the narrower the range should be. Ranges may be rough order of magnitude (ROM) with a range of +/- 50%, budget estimate with a range of -10% to +25%, or a definitive estimate with a range of +/- 10%. Upon completion of the estimate costs process, the output should be a cost estimate and range for all project activities and resources.
The determine budget process also occurs in the planning phase and is the process of calculating the total cost of the project and determining the amount of funding the organization needs to make available for the project. This may include a time-phased approach to allocating funds and determining when various levels of funding will be required throughout the project. This is why the project schedule is an integral part of managing costs. In the determine budget process, activity costs are rolled up into work package costs. Work package costs are then rolled up into control account costs. Control account costs are then rolled into an overall project cost.
This is also when the project team must identify the need for management reserves. We have discussed the risk or contingency reserves which are based on the risk register. However, management reserves are often set aside to cover any unidentified risks or possible modifications to the project or its scope. It is important to note that contingency reserves are part of the cost baseline for the project and are managed by the project manager. Management reserves are added to the cost baseline to determine the cost budget which is the total amount the organization needs for the project.
The next step in the determine budget process is to use the project schedule to determine when funding is needed for each purchase or phase of the project. If a major purchase is required in November then funding may not be allocated for the purchase until that time frame. Conversely, if the schedule requires a purchase in November but funds will not be available until December then this results in a situation that needs to be addressed.
The result of the determine budget process is a project budget and time-phased cost baseline which illustrates amounts and funding requirements and allocations. These outputs will be used throughout the project to manage and control costs.
Just like controlling any other part of a project, the foundation of controlling costs is in the tracking, measuring, and reporting of costs during the monitoring and controlling phase of the project. While these are necessary and important functions of controlling costs, what else can be done to ensure costs are controlled for a project? First, the project manager must be in a position where he/she can provide oversight. He/She must be able to prevent unnecessary changes to the project’s scope which may result in higher costs. The project manager must also ensure that any required changes are done through a formal change control process and that the cost impacts are understood by all stakeholders. The ability of a project manager to exert influence on factors which may cause project costs to rise is extremely important in controlling costs.
Most projects use earned value management to measure and control project costs. While the Communications Management Plan and the Cost Management Plan will establish the frequency of measuring and reporting the cost status against the cost baseline, earned value is the methodology used to obtain those measurements. Earned value measures a project’s performance against scope, schedule, and cost baselines. It is an extremely valuable tool in allowing the project manager to measure performance as well as to be proactive in identifying potential issues which may negatively impact scope, schedule, or cost. We can use the progress of project activities to determine what work has been done (scope), how much the work cost against the cost baseline, and how long the work took against the schedule baseline.
Earned value also provides the ability to forecast the project’s future performance as well as to project the completion timeframe and costs at any point during the project. By understanding this information, the project manager can act accordingly to prevent overruns ahead of time and realize a greater likelihood of success.
Managing project costs is always challenging due to the complexities, constraints, uncertainties, and conflicting interests and priorities on projects. We cannot realistically expect to plan a project and develop an exact estimate of costs due to the variables involved with most projects. However, it is generally true that the more work we do in planning and clearly defining the project’s scope baseline, the more effectively we can use one of the available methodologies to achieve an accurate estimate. This also results in more effective project budget development and cost base-lining. With all of these pieces in place, it is then incumbent on the project manager to use the tools at his/her disposal to control the project costs in a manner which meets the constraints and scope of the project and is within the project’s budget.
Be sure to download our Free Cost Management Plan Template.