Project Cost Management Tutorial

7.1 Lesson 07—Project Cost Management

Hello and welcome to PMP Certification Course offered by Simplilearn! In this lesson, we will focus on Project Cost Management. Let us begin with the objectives of this lesson.

7.2 Objectives

After completing this lesson, you will be able to: ?Define Project Cost Management ?Differentiate between cost estimation and cost budgeting ?Explain control accounts ?Describe the Project Cost Management processes ?Apply earned value management technique to track project performance ?Identify key terminologies used in Project Cost Management In the next screen, let us take a quick look at the project management process map.

7.3 Project Management Process Map

There are 47 processes in project management grouped into ten Knowledge Areas, and mapped to five Process Groups. In this lesson, we will look at the fourth knowledge area, i.e., (Pronounce that is) Project Cost Management and its processes. In the next screen, let us understand the concept of Project Cost Management.

7.4 Project Cost Management

Project cost management involves activities like estimating the cost of each of the project activities, adding the cost estimates of the related activities to arrive at the cost budget, and controlling the cost to ensure that project activities are completed within the defined budget. In the next screen, let us discuss Cost Management Plan.

7.5 Cost Management Plan

The cost management plan is a vital step in Project Cost Management. It contains information like planning the project cost, managing and controlling the project in relation to the cost baseline, and managing cost variances. Project cost management plan is a part of the project management plan. The methods used in estimating the cost of each of the project activities are similar to the ones used in estimating project time. For example, time estimation methods like expert judgment, analogous estimating, bottom-up estimating, and reserve analysis are few of the techniques that are also used in estimating activity cost. Let us discuss control account in the next screen.

7.6 Control Account

Control account is an important concept in the project cost management. Project cost is generally estimated at individual activity level. It becomes difficult to manage cost at the activity level in large projects; therefore, the cost is managed at a higher level. This requires related activities to be clubbed and their cost being managed together as one unit. This unit is called control account. While estimating the project time, WBS is created to breakdown the project into smaller deliverables. These deliverables are broken down into work packages and these work packages are in turn, broken into activities. Control account is defined at a level higher than the work packages. For example, if 5 work packages are part of the one control account, the cost of all activities belonging to these 5 work packages are managed as one unit. In the next screen, let us discuss the project cost management processes.

7.7 Project Cost Management Processes

Project Cost Management has four processes. They are Plan Cost Management, Estimate Costs, Determine Budget, and Control Costs. The three processes Plan Cost Management, Estimate Costs, and Determine Budget are a part of planning process group and Control Cost process is a part of monitoring and controlling process group. Let us look at each of these processes in detail. Let us begin with the first process, i.e., plan cost management, in the next screen.

7.8 Plan Cost Management

Managing costs on a project is a critical exercise. If the activities are planned well, it becomes easier to achieve harmony with the overall cost and budget of the project. Plan cost management is the process of establishing the policies, procedures, and documentation for planning, managing, expending, and controlling the project costs. Let us look at the inputs required for this process. The project management plan provides other subsidiary plans and guides the cost planning activities on the project. The project charter provides an overall context, and high-level product and project description, which help determine the approach for cost management. For example, for some projects, budget could be a constraint, whereas for others, budget would not be a constraint, but subject to the other objectives. Enterprise environmental factors provide the organizational context to the project, including the culture of the organization and the infrastructure (for instance, the scheduling systems available, the key personnel, and so on). Organizational process assets provide inputs such as policies and procedures, templates, past performance data and estimates, historical information, and knowledge base. Now, let us look at the tools and techniques employed in this process. Expert judgment refers to input received from knowledgeable and experienced resources. Experts can devise an approach to govern the costs on a project by using their previous experiences. Meetings may be organized to determine the cost management plan. Everyone responsible for the project schedule management, such as the project manager, representatives from the appropriate accounting or financial organization, sponsor, customer, and other stakeholders must attend these meetings. Several analytical techniques may be used to determine the cost management plan. These techniques help to map the impact of various decisions on cost. For example, how do risk management processes impact cost, etc. Cost management plan is the primary output of this process. It establishes the units of measure, levels of precision, organizational process links, control accounts to be used, rules for performance measurement and reporting, frequency and methodology of monitoring the costs, and various other details that lay the overall framework for cost management on a project. In the next screen, let us discuss the second process under project cost management, Estimate Cost.

7.9 Estimate Cost

Estimate cost is the approximation of the monetary resources required to complete a project activity. Cost of a specific activity is estimated based on the information available at that point of time. As the project team gets more information about the project, the activity cost estimation may change. Let us look at the inputs of this process. Scope baseline is the most important input as it details out the project’s scope of work. Along with that, project schedule is also important. This contains information like when and which resource is required for the project. It is good to remember that the same kind of resources may have different costs at different points of time. Human resource management plan is another important input. Various elements like personnel rates, rewards or recognition programs, etc. are covered in the human resource management plan, which is important in approximating the cost estimate. Human resource management plan will be discussed in detail in the human resource management knowledge area. Risk register is also an input because risk mitigation cost should be considered in cost planning. More information on risk and its affect in the project will be looked at, in detail, in risk management knowledge area. Another input, enterprise environmental factors, provides organizational context to the project. Organization process asset is listed as an input as organizations might have standard set of cost estimation policies or templates. Cost management plan is another important input. The cost management plan lays the framework for the cost management processes in the project. It provides guidelines such as the units of measure, accuracy desired, methodologies and tools to be used, etc. Let us now look at the tools and techniques used in this process. Expert judgment, Reserve analysis Analogous estimating, Cost of quality, Parametric estimating, Project management software, Bottom-up estimating, Three-point estimating, Vendor bid analysis and Group-decision making are the various tools and techniques used in this process. Most of the tools and techniques used here are similar to the ones used in the time management knowledge area. Vendor bid analysis is a technique used to estimate project cost. For e.g., a project requires material procured externally through suppliers. In order to get that, you invite bids from three to four suppliers and assess their quotations. Based on their quotations, you can get an idea of the cost that will be involved in getting the material for the project. Group decision-making technique is another important technique for project cost estimation. Cost estimation is an exercise, which may be carried out by a group or committee in order to gather well-rounded input. Therefore, group decision-making techniques may be used to arrive at a decision that team can work with. The outputs of this process are quite straightforward. Estimates of each of the activities are arrived at. Basis of the estimate includes things like how the estimate was developed, what were the assumptions made in estimating, etc. Project document updates is also one of the outputs because the cost estimates may result in updates to other aspects of the project (e.g., quality, risk, time, etc.). In the next screen, let us discuss the third process under project cost management, Determine Budget.

7.10 Determine Budget

Once the estimate of each of the activities is arrived at, the next project cost management process is to determine budget. It is the process of aggregating the estimated costs of individual activities or work packages to establish an authorized cost baseline. This is where the control account concept comes into picture. The estimated costs of the activities are aggregated to arrive at the cost budget at the control account level. Once approved, this cost budget becomes the cost baseline of the project. Project cost performance is measured against this cost baseline, i.e., how much more would the project cost be compared to the original cost baseline. The cost baseline includes all authorized budgets, but excludes management reserves. The inputs used in determining the project budget are the activity cost estimates and the basis of estimates, which are the output of the previous cost management process. The cost management plan lays the framework for the cost management processes in the project. It provides guidelines such as the budgeting cycle, tools and techniques used to prepare and approve the budget, etc. In addition to these two important inputs, scope baseline, is also looked at. Project schedule provides aggregate cost in a particular calendar period to ensure how much money can be made available during that time. Similarly, resource calendar provides information on the resource, which is assigned to the project at a particular point of time. This information is then used to indicate resource costs over the duration of the project. Risk register gives an understanding of the overall level of risk on the project and, therefore, the level of contingency reserves that need to be built into the budget. Agreements entered into with the suppliers are also required to finalize the budget. Again, organizational process asset is an input because organization may have few policies for reporting the cost budget or there might be some cost budgeting tools being used. There are various tools and techniques used in determining budgets. Cost aggregation technique involves adding up the cost and aggregating them at the control account level, so that the cost can be managed in a better way. In reserve analysis, once the costs are estimated, some extra amount is added to the estimate as a management reserve, to take care of any unplanned activities. Expert judgment is a technique in which an expert’s help is sought to estimate the activity cost. Expert is someone who might have worked on a similar project in the past and has a good idea to estimate the activity cost involved. Historical relationships are used to predict the total project cost using mathematical model. This is similar to analogous estimate or parametric estimate method. Funding limit reconciliation technique is used to ensure that cost on the project is budgeted or spent as per the availability of the fund. For example, if the project can get the funding of only $50,000 a month, the project budget should be planned accordingly. The output of this process is the cost baseline. This is an authorized project budget over a period. This is used to measure, monitor, and control overall cost performance of the project. In addition to this, the project funding requirements are also arrived at. Funding requirements means, how much fund the project requires monthly, quarterly, or yearly for the execution. The last output of this process is project document updates. An understanding of determining budget may be useful when answering questions in the PMP exam. So make a note of the inputs, tools and techniques, and outputs of determining budget. In the next screen, let us discuss the last process of project cost management, i.e., control cost.

7.11 Control Costs

Control costs is the process of monitoring the status of the project to update the project budget and managing changes to the cost baseline. Updating the budget involves recording actual costs spent until date. Any increase to the authorized budget can only be approved through the “perform integrated change control process.” Some of the typical activities that happen as part of the control costs process are ensuring that cost expenditure does not exceed the authorized funding; monitor the cost performance to understand variance; and, monitoring the work performance against the funds expended. The inputs to the process are Project management plan, Organizational process assets, Project funding requirements, and work performance data. Work performance data contains the information about the project progress. The important tools and techniques used in controlling cost are earned value analysis management, forecasting, to-complete performance index. Other important aspects of controlling costs are to review the performance, analyze the reserves to make sure the project has enough budgetary reserves to meet the expenses and project management software, which helps in tracking and managing costs. Now, let us look at the output of this process. The key outputs of this process are work performance information in terms of cost variance (CV), schedule variance (SV), and earned value (EV) and forecasts about the cost performance. This process may also result in change requests arising out of cost control measures, as well as updates to project documents, the project management plan, and organizational process assets. Business scenario based questions on project cost control can be expected in the exam. So if you have questions on these concepts, get them cleared as that will help you score higher. In the next screen, let us learn about Earned Value Management and its related terms.

7.12 Earned Value Management

Earned value technique is an excellent way to track the project progress against the project plan. It is a method of measuring the project performance objectively and comparing it against the project baseline. Results from an earned value analysis indicate deviation of the project from cost and schedule baselines. Baseline is the initial approved value along with approved changes. Therefore, schedule baseline is the first approved project schedule along with approved changes. There are various terms used in earned value technique. Planned value is the authorized budget assigned to the scheduled work. Earned value is the work performed in terms of budget authorized for that work. Actual cost is the cost incurred in work performed. Budget at completion is the budgeted amount for the total work. Estimate at completion is the expected total cost for the project. Estimate to complete is the expected cost to finish all the remaining project work. Variance at completion is the projected budget surplus or deficit at the end of the project. All the parameters displayed on the screen are measured in terms of cost. You may come across business scenario based questions on earned value management, in the PMP exam. So ensure that you develop a clear understanding of this topic. Let us look at an example of a planned value, in the next screen.

7.13 Planned Value—Example

Planned value is the estimated value of the work planned. This value is measured in terms of currency, say dollar. If the planned value is $340, then the work planned is worth $340. How do you calculate earned value? The solution is: add the budget allocated to each of the activities that have been completed at that point of time. The resulting value is the earned value. In the next screen, let us look at the formulae used to calculate earned value.

7.14 Earned Value Formulae

In cost variance, negative means the project is over budget, positive means the project is under budget. Similarly, in schedule variance, negative means the project is behind schedule whereas positive means the project is ahead of schedule. The value of the next two parameters, cost performance index (CPI) and schedule performance index (SPI) values vary between 0 and 1. For example, a CPI of 0.8 implies that 80 cents of work is obtained for every dollar spent in the project. Similarly, if SPI is 0.9, it implies that project is progressing at only 90% of the speed originally planned. The next parameter is estimate at completion or EAC. There are different ways of calculating the EAC value; the method used depends on how the cost and schedule variances are expected to play for the rest of the project. BAC/CPI (pronounce as “B-A-C-by-C-P-I”) is used if you expect that the current cost performance will continue until the end of the project. AC + (BAC – EV) (pronounce as “A-C-plus-B-A-C-minus-E-V”) is used if you expect that the rest of the project will be managed at the budgeted rate. AC + [(BAC – EV)/(CPI * SPI)] (pronounce as “A-C-plus-B-A-C-minus-E-V-by-the-product-of-C-P-I-and-S-P-I”) is used if you want to factor in the impact of the cost as well as schedule variances. AC + ETC (pronounce as “A-C-plus-E-T-C”) is used if you want to re-evaluate the project based on a forecast value for the estimated cost of the remainder of the project. The next parameter is estimate to complete or ETC (pronounce as E-T-C), which is the cost of project from this point to the end. This is calculated by subtracting the actual cost from the estimate at completion. In addition, variance at completion can be calculated by subtracting the estimate at completion from the budget at completion. Variance at completion is the cost estimation whether it is over or under budget. Another parameter is the to-complete performance index or TCPI (pronounce as T-C-P-I). This is the cost performance needed to achieve a desired outcome. For example, if the project needs to be managed to the original budget (BAC), then TCPI i.e., the CPI that must be maintained for the rest of the project, is calculated as (BAC – EV)/(BAC – AC) (pronounce as “B-A-C-minus E-V - by B-A-C minus A-C”). Similarly, if it has to be managed within a revised target (say EAC), then TCPI is calculated as (BAC – EV)/(EAC – AC) (pronounce as “B-A-C-minus-E-V-by-E-A-C-minus-A-C”). Before the start of the PMP exam, please make a note of the formulas of earned value technique. In the next screen, let us look into a business scenario to understand this concept better. After reading the problem statement, click the solution button to look at a possible answer.

7.15 Business Scenario—Problem Statement

In the next screen, let us look at an example for earned value calculation.

7.16 Earned Value Management—Example

Let us take the example of a software development project. There are four phases and each phase takes a month to complete and is expected to cost $10,000. The phases are planned to be completed one after the other. The status of the project at the end of the month 3 is summarized in the table. Requirements definition is completed and actual spending on this is $10,000. Architecture and design is done and actual spending on this is $12,000. Development and unit testing is only 50% done, though it was supposed to be completed by 3rd month. It has cost $9,000 until date. System testing and go live has not yet started. Note, S indicates start time, F indicates finish time, and PF indicates that it is partly finished at the end of the month. Based on the above information, calculate the CV, SV, CPI, and SPI of the project. Let us look at the solution in the next screen.

7.17 Earned Value Management—Example (contd.)

To calculate the planned value, you need to add the amount of work that was supposed to be done by the third month. Three phases were supposed to be completed. The budget to complete each of the three phases was $10,000. So the planned value, is $10,000 + $10,000 + $10,000 = $30,000. However, by the third month, two phases are complete and the third phase is only 50% done. Hence, the earned value is $10,000 + $10,000 + $5,000 = $25,000. The actual cost of the work is $10,000 + $12,000 + $9,000 = $31,000. Cost Variance is Earned Value minus Actual cost which is $25,000 - $31,000 = -$6,000. Schedule Variance is Earned Value minus Planned value which equals to -$5,000. CPI is Earned value by Actual cost which equals to 0.80. SPI is Earned Value by Planned value, which equals to 0.83. Spend some time to interpret each of these values and their implications on the project. Click the icon to view various formulae used for calculations. In the next screen, let us look at the cost related terms that you might encounter in the PMP® exam.

7.18 Key Terms

Before we end this lesson, let us also look at few definitions that might be useful for your PMP examination. Law of diminishing return: This means the more you put into something, the less you get out of it. For example, doubling the number of resources working on a project will not necessarily halve the time. Working capital: The amount of money the company has to invest on the project and the day-to-day company operations. Funding limit reconciliation: The process of comparing the planned expenditure in a given period with the available funding for that period. Large assets purchased by the company lose value time. This is called depreciation. There are two forms of depreciation Straight line and Accelerated: Straight line depreciation: Same amount of depreciation is taken every year. For instance, a car with a price tag of $10,000 and useful life of 10 years is depreciated $1,000 per year. At the end of 10th year, the value of the car is considered zero for all accounting purposes. Accelerated depreciation: Depreciates faster than the straight line depreciation. For instance, a car with a price tag of $10,000 depreciates $3,000 the first year, $1,500 next year, $1,000 the third year, and so on. Let us now check your understanding of the topics covered in this lesson.

7.20 Quiz

A few questions will be presented in the following screens. Select the correct option and click submit to see the feedback.

7.21 Summary

Here is a quick recap of what was covered in this lesson: ?Project cost management includes the processes involved in estimating, budgeting, and controlling costs so that the project can be completed within the approved budget. ?Cost management plan contains details on how to plan, manage and control the project cost in relation to the cost baseline, and manage the cost variances. ?Cost estimate is an educated guess of how much an activity or a project will cost. Budget considers the cost estimate and accordingly sets aside funds for the completion of the project. ?Under control account technique, related activities are clubbed and their costs are managed as one unit. ?The four Project Cost Management processes are Plan cost management, Estimate costs, Determine budget, Control costs. ?Earned Value Management technique indicates potential deviation of the project from the cost and/or schedule baselines.

7.22 Conclusion

With this, we have come to the end of this lesson. In the next lesson, we will discuss Project Quality Management.

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