"This film cost $31 million. With that kind of money, I could have invaded some country.” - Clint Eastwood

Well, now we know how Clint Eastwood feels about controlling movie production costs. For project managers, too, cost management is a primary job function, one that remains a focus through every stage of a project lifecycle. Along with scope, quality and time management, it forms one of the three core functions of Project Management.

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For those aspiring to pass the popular Project Management Professional (PMP)® certification, understanding the difference between types of project costs is critical. In this article, we’ve created an overview of project cost types and how they apply is various sample questions that will help you prepare for the PMP certification exam.

Read more: Here's what you should know about the PMP Exam Changes

What Is Project Cost Management?

Project cost management is a process that ensures that the project's budget is used efficiently.

The project manager's role in this process is to ensure that the project's budget is used efficiently, ensuring that the project is within its allocated budget to avoid spending money on items or activities which are not necessary for the completion of the project.

A project manager is responsible for the life cycle of a project from start to finish. Project cost management is an essential aspect of the job that needs to be done well to avoid complications.

The cost management process is not just about estimating and monitoring costs; it includes other aspects like risk analysis, budgeting, and forecasting.

What Is Cost Management in Project Management?

Cost management is a crucial aspect of project management that helps control a project's budget. By understanding the project cost elements, how they relate to each other, and how they change over time, cost management can help ensure that a project stays within its budget. There are three main cost management processes: cost estimation, cost control, and cost reporting.

To understand what cost management is, it is first essential to understand what a project is. A project can be defined as a temporary endeavor with a definite beginning and end designed to produce a unique product, service, or result. Cost management is a part of project management that deals with controlling the project's cost.

Types of Costs

  • Fixed Costs: 

    Fixed costs stay the same and do not change throughout the project lifecycle. Examples of fixed costs include setup costs, rental costs, and other related costs.
  • Variable Costs: 

    Variable costs are costs that change with the amount of work involved with a project. Examples of variable costs are hourly labor, the cost of material, the cost of supply, fuel for bulldozers, etc.
  • Direct Costs:

    Direct costs are expenses that are billed directly to the project. Examples of direct costs are team travel expenses, team wages, costs incurred for recognition and awards for employees, etc.
  • Indirect Costs:

    Indirect costs are costs that are shared and allocated among several or all projects. Examples include fringe benefits and taxes. Another example of indirect costs would be the salary of an architect or a project manager who is partially allocated across many projects. Their team members' salaries would be direct costs since each of them is directly working on a particular project and their salary is a direct cost to the project. But since the project manager is allocated to several projects, the costs incurred on his salary are indirect costs to the project.
  • Sunk Costs: 

    Sunk costs are costs that have been incurred on a project but have not produced value towards the project objectives. Think of sunk costs as spilled milk. If they are unrecoverable, they are to be treated as if they are irrelevant. For instance, let's assume that you hire a freelance developer to develop your website in Java. However, after working on the job for some time, the developer quits for a personal reason. When you hire another developer for the job, he convinces you that he could do a better job using .NET technologies, and you follow his advice to develop the website with NET. In such a case, the costs that you have incurred on the freelance Java developer could be treated as sunk costs.

Read more: How to Manage Your Time During the PMP® Exam

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How to Manage Project Costs? 

1. Resource Planning

Resource planning is one of the most important aspects of cost management. To control costs, it is crucial to clearly understand what resources are needed and how much they will cost. Many different types of resources can be used in a project, each with its own cost. For example, labor costs can vary depending on the kind of work that needs to be done.

There are many ways to control the cost of a project, but one of the most important is resource planning. By understanding the worth of the project's resources and by planning how those resources will be used, cost managers can help keep the project within its budget. Several steps can be taken to manage project costs in resource planning:

  • Identify all of the project's resources and understand their costs.
  • Determine how those resources will be used throughout the project.
  • Create a resource plan that details how and when the resources will be used.
  • Monitor and adjust the resource plan as needed to ensure the project stays within budget.

2. Cost Estimation

 It is essential to understand the cost estimation process to manage project costs. Cost estimation is the process of predicting the cost of a project based on its scope and complexity. Several methods can be used to estimate project costs, and each has advantages and disadvantages. The most important thing to remember when estimating project costs is to be as accurate as possible.

3. Cost Budgeting 

There are several factors to consider when managing project costs. The first is to develop a cost budget. This budget will include all of the expenses associated with the project, from materials to labour. It is essential to be as accurate as possible when creating the budget, as this will ensure that the project stays on track and within budget.

Managing project costs is a critical part of successful cost budgeting. There are several ways to do this, but the most important thing is to clearly understand all the costs involved in the project from the outset. This includes the direct costs of materials and labour and the indirect costs of overhead and other expenses. Once these costs are known, it is much easier to control them and keep the project on track.

4. Cost Control 

Most project managers use a cost control system to track project expenditures and to ensure that the project stays within its budget. There are several different cost control systems, but they all have one common goal: to keep the project's costs under control. The most common type of cost control system is a cost-plus system. In a cost-plus system, the project manager sets a budget for the project and then reimburses the project's expenses up to that amount.

Why Is Cost Management Important in Project Management?

Cost management is essential in project management because it helps the project manager control the project's costs. A cost control system allows the project manager to track the project's expenses and helps ensure that the project stays within its budget. By keeping the project's costs under control, the project manager can ensure that the project is completed on time and within budget. By tracking the project's fees, the project manager can ensure it is within budget. Cost management is also essential because it helps the project manager to control the project's expenses. By knowing where the project's money is being spent, the project manager can ensure that its costs are within its budget.

Benefits of Project Cost Management 

  1. Prevents overruns: Cost management is critical in project management, and cost management avoids cost overruns and ensures that the project stays within its budget. This, in turn, prevents project delays and ensures that the project is completed on time and within its budget.
  2. Avoids risk: Cost management is critical in project management as it can help prevent troubles. Risks can include cost overruns, leading to project delays and increased costs. Cost management can help keep the project on track and within its budget by avoiding cost overruns.
  3. Aids future planning: There are several benefits to cost management in project management. One advantage is that it aids in future planning. This is because cost management provides information that can help managers predict future project costs. This information can be used to create more accurate budgets and make better decisions about allocating resources.

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Challenges of Project Cost Management

  1. Lack of resources: One of the challenges of cost management is the lack of resources. When a company is trying to save money, it may need more money to invest in new technologies or hire additional staff. This can make it challenging to keep track of all the different factors that go into cost management. Also, cost management can be complex because it requires carefully juggling many other factors.
  2. Inaccurate estimation: The most difficult challenge of cost management is an accurate estimation. This can be difficult for several reasons, but often the root cause is a need for more understanding of what goes into the product or service being delivered. Other times, it is simply a lack of experience on the part of the estimator. Regardless of the reason, an inaccurate estimation can lead to significant cost overruns and schedule delays.
  3. Outdated technology: One of the challenges of cost management is that obsolete technology can lead to inaccurate estimates. This is because outdated technology may need to accurately account for all the factors that go into the product or service delivered. As a result, the estimator may need a complete understanding of what goes into the final product or service, which can lead to significant cost overruns.

Who Is Responsible for Project Cost Management?

The project manager is typically responsible for cost management, but the responsibility may be delegated to a cost engineer or other team member. The project manager ensures that the project stays within its budget and that all costs are accounted for. The project manager may also be responsible for negotiating with vendors and suppliers to get the best possible price for the project.

The responsibility for cost management usually falls to the project manager. The project manager is responsible for ensuring the project stays within the budget. This includes identifying and managing risks that could lead to cost overruns. The project manager also works with the project team to ensure the project is completed on time and within budget.

The project manager is typically responsible for cost management, but the estimator also plays a critical role. The estimator is responsible for creating accurate estimates of the project's costs. This includes understanding all the factors that go into the final product or service. With accurate estimates, the project manager can effectively manage the project budget.

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Sample Question and Answers

1) John works as a project manager with ABD Consultants Pvt. Ltd. He felt a need to arrange special skills training for his team members for this project. What type of cost will he incur on the project for this training?


A.Direct
B.NPV
C.Indirect
D.Fixed

Answer: A. The skills training to upgrade their skillsets is directly related to this specific project, so it is considered a direct cost.

2) Bob needs to analyze project costing to find ways to decrease overall costs for a project. It would be advantageous for Bob to focus on:


A. Variable Cost and Fixed Cost
B. Fixed Costs and Indirect Costs
C. Direct Costs and Variable Costs
D. Indirect Cost and Direct Costs

Answer: C. Direct costs and variable costs are costs that are directly attributable to the project or those that vary with the amount of work accomplished. Therefore Bob could analyze these costs to find ways to be more efficient and reduce them.

3) Various rooms in a building are being rented out to accommodate a group of workers during a project. These room rental costs are an example of:


A. Variable Costs
B. Fixed Costs
C. Overhead Costs
D. Opportunity Costs

Answer: B. Costs incurred on room rental are considered fixed costs.

Conclusion

When creating estimates on a project, project managers must fundamentally understand the types of costs incurred. The PMP® certification exam will be sure to have many questions on the topic, so be sure you have reviewed each type of project cost and be able to determine which type of cost is used in different scenarios.  

PMBOK®, PMP® and PMI® are registered trademarks of the Project Management Institute, Inc.

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Simplilearn is one of the world’s leading providers of online training for Digital Marketing, Cloud Computing, Project Management, Data Science, IT, Software Development, and many other emerging technologies.

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  • *According to Simplilearn survey conducted and subject to terms & conditions with Ernst & Young LLP (EY) as Process Advisors