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Faculty of Engineering & the Built Environment
Civil Engineering department
Project Management PJM721S
Lesson 6 Project Cost Management
Office E3/4/2.14 New Engineering Building +264 61 207 2375
Learning Objectives
• Understand the importance of project cost management
• Explain basic project cost management principles,
concepts, and terms
• Discuss different types of cost estimates and methods for
preparing them
• Understand the processes involved in cost budgeting and
preparing a cost estimate and budget
• Understand the benefits of earned value management and
project portfolio management to assist in cost control
• Describe how project management software can assist in
project cost management
2
The Importance of Project Cost Management
• Engineering projects have a poor track record for meeting
budget goals
• The CHAOS studies found the average cost overrun (the
additional percentage or dollar amount by which actual
costs exceed estimates) ranged from 180 percent in 1994
to 56 percent in 2004; other studies found overruns to be
33-34 percent
3
What went Wrong?
• The U.S. government, especially the Internal Revenue
Service (IRS), continues to provide examples of how not to
manage costs
• A series of project failures by the IRS in the 1990s cost
taxpayers more than $50 billion a year
• ◦In 2006, the IRS was in the news for a botched
upgrade to its fraud-detection software, costing $318
million in fraudulent refunds that didn’t get caught
• ◦A 2008 Government Accountability Office (GAO) report
stated that more than 400 U.S. government agency IT
projects, worth an estimated $25 billion, suffer from
poor planning and underperformance
4
What is Cost and Project Management?
• Cost is a resource sacrificed or foregone to achieve a
specific objective or something given up in exchange
• Costs are usually measured in monetary units like dollars
• Project cost management includes the processes
required to ensure that the project is completed within an
approved budget
5
Project Cost Management Processes
1. Resource planning: plan, allocate, and schedule the
resources needed
2. Estimating costs: developing an approximation or
estimate of the costs of the resources needed to
complete a project
3. Determining the budget: allocating the overall cost
estimate to individual work items to establish a baseline
for measuring performance
4. Controlling costs: controlling changes to the project
budget
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Project Cost Management Summary
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Basic Principles of Cost Management
• Most members of an executive board better understand
and are more interested in financial terms than
Engineering terms, so Engineering project managers must
speak their language
• Profits are revenues minus expenditures
• Profit margin is the ratio of revenues to profits
• Life cycle costing considers the total cost of
ownership, or development plus support costs, for a
project
• Cash flow analysis determines the estimated annual
costs and benefits for a project and the resulting annual
cash flow
8
Basic Principles of Cost Management
• Tangible costs or benefits are those costs or benefits
that an organization can easily measure in dollars
• Intangible costs or benefits are costs or benefits that are
difficult to measure in monetary terms
• Direct costs are costs that can be directly related to
producing the products and services of the project
• Indirect costs are costs that are not directly related to the
products or services of the project, but are indirectly
related to performing the project
• Sunk cost is money that has been spent in the past; when
deciding what projects to invest in or continue, you should
not include sunk costs
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Basic Principles of Cost Management
• 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
• Reserves are dollars included in a cost estimate to
mitigate cost risk by allowing for future situations that are
difficult to predict
• Contingency reserves allow for future situations that
may be partially planned for (sometimes called known
unknowns) and are included in the project cost baseline
• Management reserves allow for future situations that
are unpredictable (sometimes called unknown
unknowns)
10
Estimating Cost
• Project managers must take cost estimates seriously if
they want to complete projects within budget constraints
• It’s important to know the types of cost estimates, how to
prepare cost estimates, and typical problems associated
with Engineering cost estimates
• Types of Cost Estimates
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Cost Management Plan
A cost management plan is a document that describes how the
organization will manage cost variances on the project
A large percentage of total project costs are often labor costs, so project
managers must develop and track estimates for labor
Cost Estimation Tools and Techniques
• Basic tools and techniques for cost estimates:
• Analogous or top-down estimates: use the actual cost of a
previous, similar project as the basis for estimating the cost of the
current project (consider external expert input)
• Bottom-up estimates: involve estimating individual work items or
activities and summing them to get a project total
• Parametric modeling uses project characteristics (parameters) in
a mathematical model to estimate project costs
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Typical Problems with Cost Estimated
• Estimates are done too quickly
• Lack of estimating experience
• Human beings are biased toward underestimation
• Management desires accuracy
• Order of Magnitude or Budgetary estimates carried over
without thorough review
Sample Cost Estimate
Before creating an estimate, know what it will be used for,
gather as much information as possible, and clarify the
ground rules and assumptions for the estimate
If possible, estimate costs by major WBS categories
Create a cost model to make it easy to make changes to and
document the estimate
13
Surveyor Pro Project Cost Estimate
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Determining the Budget
• Cost budgeting involves allocating the project cost
estimate to individual work items over time
• The WBS is a required input to the cost budgeting process
since it defines the work items
• Important goal is to produce a cost baseline
• A time-phased budget that project managers use to
measure and monitor cost performance
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Surveyor Pro Project Cost Baseline
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Controlling Cost
• Project cost control includes:
• Monitoring cost performance
• Ensuring that only appropriate project changes are
included in a revised cost baseline
• Informing project stakeholders of authorized changes to
the project that will affect costs
• Many organizations around the globe have problems with
cost control
17
Earned Value Management (EVM)
• EVM is a project performance measurement technique that integrates scope,
time, and cost data
• Given a baseline (original plan plus approved changes), you can determine
how well the project is meeting its goals
• You must enter actual information periodically to use EVM
• More and more organizations around the world are using EVM to help control
project costs
Earned Value Management Terms
• The planned value (PV), formerly called the budgeted cost of work scheduled
(BCWS), also called the budget, is that portion of the approved total cost
estimate planned to be spent on an activity during a given period
• Actual cost (AC), formerly called actual cost of work performed (ACWP), is
the total of direct and indirect costs incurred in accomplishing work on an
activity during a given period
• The earned value (EV), formerly called the budgeted cost of work performed
(BCWP), is an estimate of the value of the physical work actually completed
• 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
18
Rate of Performance
• 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
• Brenda Taylor, Senior Project Manager in South Africa,
suggests this term and approach for estimating earned
value
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Rules of Thumb for Earned Value Numbers
• Negative numbers for cost and schedule variance indicate
problems in those areas
• CPI and SPI less than 100% indicate problems
• Problems mean the project is costing more than planned
(over budget) or taking longer than planned (behind
schedule)
• The CPI can be used to calculate the estimate at
completion (EAC), an estimate of what it will cost to
complete the project based on performance to date; the
budget at completion (BAC) is the original total budget
for the project
20
Project Portfolio Management
• Many organizations collect and control an entire suite of
projects or investments as one set of interrelated activities
in a portfolio
• Five levels for project portfolio management
1. Put all your projects in one database
2. Prioritize the projects in your database
3. Divide your projects into two or three budgets based on
type of investment
4. Automate the repository
5. Apply modern portfolio theory, including risk-return
tools that map project risk on a curve
21
Benefits of Portfolio Management
• Schlumberger saved $3 million in one year by organizing 120
information technology projects into a portfolio
• Improvements from implementing portfolio management
software by IT departments:
• Savings of 6.5 percent of the average annual IT budget by
the end of year one
• Improved annual average project timeliness by 45.2 percent
• Reduced IT management time spent on project status
reporting by 43 percent and IT labor capitalization reporting
by 55 percent
• Decreased the time to achieve financial sign-off for new IT
projects by 20.4 percent, or 8.4 days
22
Best Practice
• A global survey released by Borland Software in 2006 suggests
that many organizations are still at a low level of maturity in
terms of how they define project goals, allocate resources, and
measure overall success of their information technology
portfolios; some of the findings include the following:
• Only 22 percent of survey respondents reported that their
organization either effectively or very effectively uses a
project plan for managing projects
• Only 17 percent have either rigorous or very rigorous
processes for project plans, which include developing a
baseline and estimating schedule, cost, and business impact
of projects
• Only 20 percent agreed their organizations monitor portfolio
progress and coordinate across inter-dependent projects
23
Using Software to Assist in Cost Management
• Spreadsheets are a common tool for resource planning,
cost estimating, cost budgeting, and cost control
• Many companies use more sophisticated and centralized
financial applications software for cost information
• Project management software has many cost-related
features, especially enterprise PM software
• Portfolio management software can help reduce costs
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Summary
• Project cost management is a traditionally weak area of IT
projects, and project managers must work to improve their
ability to deliver projects within approved budgets
• Main processes include:
• Estimate costs
• Determine the budget
• Control costs
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Thank you
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