Cost management is a crucial aspect of project management that requires considerable expertise and knowledge. Cost is a critical factor in determining a project’s feasibility, as it aids in making the go/no-go decision during the early initiation stages.
Project cost management is also vital to the delivery organization as it ensures that it can accurately estimate and win work and deliver it at a profit.
Despite all this, it is expected to see mega-projects going over budget by multi-millions of dollars, if not billions!
What is Project Cost Management?
Project cost management refers to the processes and activities involved in estimating the cost of a project during its initiating and planning phases, as well as setting the budget baseline.
It also involves controlling the budget during the monitoring and control phase of the project.
Main Areas of Cost Management:
The main areas of cost management are cost planning and control.
A. Cost Planning
Cost planning aims to work out the budget baseline and requires several inputs, such as the scope, time, and risk. If you are a project manager tasked with determining the project budget, you would want to know the project scope, schedule, resource estimate, and risk mitigation plan.
B. Cost Control
Cost control involves monitoring, tracking, and adjusting the project budget during the execution phase to ensure that it stays within the approved budget.
How to Estimate Project Cost?
In the estimate cost section, we will discuss the different types of cost estimates, how they’re used, and the different cost categories.
A. Types of Cost Estimates
Several estimation methods can be used in this process depending on the required level of estimation accuracy, which is dependent on the maturity and completeness of the scope. These methods include:
- Rough Order of Magnitude (ROM): This method is used early in the project when there is not enough scope definition and can be accurate to +/-50%.
- Budget Estimate: This method is typically accurate to +/-20% and can be used to create the first iteration of the project budget as the scope documents become available or to inform the scope variations decisions during the execution phase.
- Definitive Estimate: This method is the most accurate at +/-10% and is used to agree on project costs, sub-contractors, and third-party packages.
A bottom-up estimating technique is best used in both budget and definitive estimates.
B. Types of Cost Categories
There are two main cost categories in estimating the costs: direct cost and indirect cost.
Direct Costs:
These are directly associated with work activity, such as staffing, equipment, material, and sub-contractor costs.
Indirect Costs:
These aren’t related to a specific activity but overlap all project work, such as project management, supervision, mobilization, and insurance costs.
How to Determine the Project Budget?
After estimating the direct and indirect costs, the final step in determining the budget is to combine both types and calculate the cost contingency.
Some organizations use a simple approach by applying a percentage of the project cost as a budget contingency. However, this approach is not very accurate and may not take into account the specific risks of the project.
The best approach is to carry out a full risk assessment by identifying the risks, analyzing them, and developing a mitigation plan that forms the budget contingency.
For instance, if there’s a 20% chance that the project might not meet its completion date and would take extra days or weeks, which would cost $50K extra, then the project team should consider a budget contingency of $10,000 (20% * 50,000).
This way, the budget contingency is based on actual project risks and not just a rough estimate.
What is Cost Control in Project Cost Management?
Cost control is a crucial process in project management. It involves monitoring the project’s cost during the execution phase by comparing the actual costs with the budget baseline, forecasting the project cost at completion, and managing the cash flow.
The main areas of cost control are variance and change management, cost forecasting, cash flow management, and earned value management.
Variance and change management: involves collecting data during the execution phase and updating the baseline to reflect any agreed scope changes.
Cost forecasting: is essential as it allows the management team to look into the future and determine the final project costs, enabling them to take corrective actions to bring the cost back on budget.
The basic equation for forecasting cost is:
Cost at Completion = Cost to Date + Cost to Complete
It’s worth noting that corrective actions are only effective when the balance of the cost to complete is stable, and actual costs can no longer be adjusted.
Cash flow management: aims to balance the project’s cash in and out and forecast the finance requirements during the project’s life
Earned value management: is used to evaluate project progress. The earned value measures how much the project has spent to date, and this can be actual costs, accrued costs, or both. The EV compares the cost at a certain point to the schedule as a performance measure.
The EV measures the cost at a certain point and compares it to the schedule as a performance measure.
It’s worth noting that the EV and cost should be considered collectively, as a project could have a higher EV, but it’s due to a cost overrun rather than good performance.
What are the Different Types of Costs that can be included in a contract?
There are different cost types in a contract, primarily two main types: fixed costs and variable costs.
Fixed Costs:
When the delivery organization commits to a fixed price to deliver a specific scope, it is known as Lump Sum Costs.
Variable Costs:
This type can take various forms, such as Schedule of Rates and Cost Plus.
- Schedule of Rates is generally used for consulting or commissioning services jobs and is based on agreed rates. The final cost is calculated based on the resources’ time spent multiplied by the rates.
- Cost Plus is a flexible model for an open book type agreement, where the client pays for all the delivery organization’s actual costs plus an agreed fee.
In this model, the delivery organization provides a project budget estimate before the contract award. Generally, a pain/gain share percentage is applied based on the delivery organization’s performance against the resources’ estimate.
The main difference between these types is the cost-risk allocation between the client and the delivery organization. Some models allocate the risk to the delivery organization, whereas others allow sharing the risk.
Project Cost Management Tools & Software
There are various tools and software utilized in project cost management, which mostly depend on the project size, type, and complexity. Some of these tools include:
- Spreadsheet: Spreadsheets are commonly used to estimate and track costs and produce reports and dashboards. A good amount of manual work can be involved, which increases the chances of errors.
- Planning and Integrated Project Management Software: As cost management and planning are somehow interlinked, some planning software, such as MS Project, can provide basic functionality to estimate and track resource costs.
- Integrated Project Management Software: For example, SAP Portfolio and Project Management cover a broader spectrum of project management functionality.
- Collaborative Project Management Software: These packages generally have good planning and project team collaboration functionally but offer little in terms of cost management.
In conclusion, combining different packages can provide organizations with a tailored approach to meet their specific needs. With the right combination, teams can work more efficiently and effectively, leading to better outcomes.
