Chapter 6: Project Cost Management

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Chapter 6Project Cost Management

• adopted from PMIs PMBOK 2000 and
• Textbook Information Technology Project
  Management
• (author Dr. Kathy Schwalbe)

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Contents

• Importance of Project Cost Management
• Problem cost overrun and cannot meet cost goals
• Costs are measured in monetary units
• Project Cost Management
• Resource planning, Cost estimating, Cost
  budgeting, Cost control
• Resource Planning consideration
• difficulty, uniqueness, track record, people,
  equipment and materials
• Types of cost estimate
• basic tools and techniques
• Earned value management is an important tool for
  cost control

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The Importance of Project Cost Management

• IT projects have a poor track record for meeting
  cost goals
• Average cost overrun from 1995 CHAOS study was
  189 of the original estimates improved to 45
  in the 2001 study
• In 1995, cancelled IT projects cost the U.S. over
  81 billion

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Typical allocation of cost
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What is Cost and Project Cost Management?

• Cost is a resource sacrificed or fore-gone to
  achieve a specific objective or something given
  up in exchange
• Costs are usually measured in monetary units like
  dollars
• This is the process group to ensure the project
  is completed within the approved budget.
• The major output is the cost management plan
• There are 4 processes in Project Cost Management

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Project Cost Management Processes

• Resource planning (planning phase)
• determining what resources and quantities of them
  should be used
• Cost estimating (planning phase)
• developing an estimate of the costs and resources
  needed to complete a project
• Cost budgeting (planning phase)
• allocating the overall cost estimate to
  individual work items to establish a baseline for
  measuring performance
• Cost control (control phase)
• controlling changes to the project budget

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Basic Principles of Cost Management

• Most CEOs and boards know a lot more about
  finance than IT, IT project managers must speak
  their language
• Profits are revenues minus expenses
• Life cycle costing is estimating the cost of a
  project over its entire life
• Cash flow analysis is determining the estimated
  annual costs and benefits for a project
• Benefits and costs can be tangible or intangible,
  direct or indirect
• Sunk cost should not be a criteria in project
  selection

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Cost of Software Defects
It is important to spend money up-front on IT
projects to avoid spending a lot more later.
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Resource Planning

• 8th of 21 planning phase process
• The nature of the project and the organization
  will affect resource planning
• Some questions to consider
• How difficult will it be to do specific tasks on
  the project?
• Is there anything unique in this projects scope
  statement that will affect resources?
• What is the organizations history in doing
  similar tasks?
• Does the organization have or can they acquire
  the people, equipment, and materials that are
  capable and available for performing the work?

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Inputs to Resource Planning

• WBS
• identifies the project elements that require
  resources.
• Historical information
• identifies required resourced used in similar
  work on previous project.
• Scope statement
• contains the project justification and the
  project objectives.
• Resource pool description
• identifies available project resources.
• Organizational policies
• may impact some of the project management
  decision. These are constraints, such as
  staffing, rentals, and purchasing supplies and
  equipment.
• Activities duration estimates
• the best estimates of the time that it will take
  to perform the work
• It is the output of Time Management Process
  Activity Duration Estimating.

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Tools techniques

• Expert judgment
• access the inputs to the process by
  subject-matter expect, group, or individual,
  including consultants, professional or technical
  associations, industrial advisory groups.
• Project management software
• help to organize resource pools, define resource
  availabilities and their rates, and define
  resource calendars.

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Outputs from Resource Planning

• Resources requirement
• describes the types (e.g. skills levels) and
  number of resources required by each element of
  the WBS.

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Cost Estimating

• 9th planning phase process
• collecting and predicting the costs over the life
  cycle of a project or phase of a project
• developing cost estimates for all the resources
  needed to complete project activities.
• An important output of project cost management is
  a cost estimate
• There are several types of cost estimates and
  tools and techniques to help create them
• It is also important to develop a cost management
  plan that describes how cost variances will be
  managed on the project

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Inputs to Cost Estimating (1)

• WBS
• Resource requirement
• Outputs from Resource Planning
• Resource rates unit rates for each resource
  that are used to calculate project costs.
• Activities duration estimates
• output of Time Management Process Activity
  Duration Estimating.
• Estimating publication
• provide commercial cost data.

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Inputs to Cost Estimating (2)

• Historical information
• the cost of many categories of resources is
  available from the following sources a) project
  file b) commercial cost-estimating databases c)
  project team knowledge.
• Chart of accounts (COA)
• describes the coding structure or the budget
  categories that the performing organization uses
  to report financial information in its general
  ledger.
• Risk
• to show the importance of considering the impacts
  of both opportunities and threats for costs
  estimates for each activity

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Tools techniques

• Analogous estimating
• known as top-down
• A form of expert judgment because it uses actual
  costs from previous, similar projects to estimate
  current costs
• Although it is less costly than other estimates,
  it is the least accurate
• It is frequently used to estimate total project
  costs when a limited amount of detailed
  information is available.
• Parametric modeling
• uses project characteristics as the parameters is
  a mathematical model to predict project costs
• Models may be simple or complex (e.g. simulations
  using statistics or function point analysis to
  estimate software development durations)
• The costs and accuracy of parameters model vary.

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Tools techniques (2)

• Bottom up estimating
• estimating the cost of individual activities or
  work packages and then adding the individual
  estimates to arrive at a project total
• Defining smaller activities or work packages
  increases both the cost and accuracy of the
  estimate.
• Computerized tools
• Project management software, spreadsheets,
  simulation tools, and statistical packages can
  help estimate costs.
• Other cost estimating methods
• includes vendor bid analyses.

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Types of Cost Estimates
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Outputs from Cost Estimating

• Cost estimates
• Quantitative assessments of the likely costs of
  the resources required to complete project
  activities. Cost estimates types include
• preliminary estimate
• budget estimate
• analogy estimates
• definitive and control estimates
• Supporting details
• include description of the scope of work
  estimated, reference to WBS, the basis of the
  estimate, assumptions, and the range of possible
  results.
• Cost management plan
• describe how cost variances will be managed. It
  is part of the project plan.

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Constructive Cost Model (COCOMO)

• Prof Barry Boehm helped develop the COCOMO models
  for estimating software development costs
• a famous parametric model for software
  development industry
• Parameters include source lines of code or
  function points (these two are common parameters
  to measure the complexity of a program)
• COCOMO II is a computerized model available on
  the web
• Boehm suggest that only parametric models do not
  suffer from the limits of human decision-making

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Typical Problems with IT Cost Estimates

• Developing an estimate for a large software
  project is a complex task requiring a significant
  amount of effort.
• Remember that estimates are done at various
  stages of the project
• Many people doing estimates have little
  experience doing them.
• Try to provide training and mentoring
• People have a bias toward underestimation
• Review estimates and ask important questions to
  make sure estimates are not biased
• Management wants a number for a bid, not a real
  estimate.
• Project managers must negotiate with project
  sponsors to create realistic cost estimates

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Cost Budgeting

• 10th of 21 planning process
• It is the process of allocating cost estimates to
  individual work activates
• Cost budget involves allocating the project cost
  estimate to individual work items and providing a
  cost baseline
• For example, in the Business Systems Replacement
  project, there was a total purchased costs
  estimate for FY97 of 600,000 and another 1.2
  million for Information Services and Technology
• The project budget is the planned cost of each
  activity at the lowest level, which is then
  rolled into a project total.

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Inputs to Cost Budgeting

• Cost estimates
• output from cost estimates process
• WBS
• output from scope definition process
• Project schedule
• includes planned start and expected finish dates
  for the activities or work packages in order to
  allocate costs.
• Risk management plan
• A part of the project plan that contains
  procedures to manage risk throughout the project.

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Outputs from Cost Budgeting

• Cost baseline
• A time-phased budget that will be used to measure
  and monitor cost performance on the project
• It is developed by summing estimated costs by
  period and is usually displayed in the form of an
  S-curve
• Larger projects may have multiple cost baselines
  to measure different aspects of cost performance.

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Cost Control

• 5th of 8 controlling phase process
• Project cost control include
• 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
• During this process, project manager try to
  determine what facts impact, cost, how these
  factors can be influenced, whether these changes
  are beneficial to the project or product.
• Earned value management (EVM) is an important
  tool for cost control

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Inputs to Cost Control

• Cost baseline
• includes a time-phased budget used to measure and
  monitor cost performance on the project
• The cost baseline is usually shown as
  cost-by-period and can be charted in the form of
  an S-curve.
• Performance reports
• provide information on cost performance, such as
  which budgets have been met and which have not.
• Change requests
• take many forms oral or written, direct or
  indirect, external or internally initiated, and
  legally mandated or optional.
• Cost management plan
• describes managing cost variances

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Tools techniques

• Cost change control system
• defines the procedures by which the cost baseline
  may be changed
• It includes the paperwork, tracking systems, and
  approval levels necessary for authorizing
  changes.
• Performance measurement techniques
• help to assess the magnitude or any variation
  that do occur.
• Earned value analysis is especially useful for
  cost control
• Earned value management (EVM) is the tools
  commonly used to determine variance causes and
  deciding if the variance requires corrective
  action.
• Additional planning
• prospective changes may require new or revised
  cost estimates or analysis of alternative
  approaches.
• Other general computerized tools
• project management software or spreadsheets that
  track planned versus actual costs or that
  forecast the effects of cost changes.

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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.
• The following shows a sample form for collecting
  information

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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 the
  percentage of work actually completed multiplied
  by the planned value

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Earned Value Calculations for One Activity After
Week One
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Earned Value Formulas
To estimate what it will cost to complete a
project or how long it will take based on
performance to date, divide the budgeted cost or
time by the appropriate index.
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Rules of Thumb for EVA Numbers

• Negative numbers for cost variance (CV) and
  schedule variance (SV) indicate problems in those
  areas.
• The project is costing more than planned
• The project is taking longer than planned
• CPI and SPI less than 100 indicate problems
• The of the project is over budget in cost
• The of the project is behind schedule in time

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Earned Value Calculations for a One-Year Project
After Five Months
Excel file
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Earned Value Chart for Project After Five Months
Excel file
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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

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Outputs from Cost Control

• Revised cost estimates
• update of the project cost estimates.
• Budget updates
• changes to an approval cost baseline. The numbers
  are generally revised only in response to scope
  changes.
• Cost variance may be so severe that re-baselining
  is needed in order to provide a realistic measure
  of performance.
• Corrective action
• anything done to bring expected future project
  performance into line with the project plan.

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Outputs from Cost Control (2)

• Estimate at completion (EAC)
• A forecast of total project costs based on
  project performance. The most common variations
  are
• actual cost to date plus the remaining project
  budget modified by a performance factor
• actual costs to date plus a new estimate for all
  remaining works
• actual cost to date plus the remaining budget.
• Project closeout
• processes and procedures for closing or canceling
  the project.
• Lessons learned
• document the causes of variances, reasons behind
  the corrective action chosen, and other lessons
  learned.

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Summary

• Importance of Project Cost Management
• Problem cost overrun and cannot meet cost goals
• Costs are measured in monetary units
• Project Cost Management
• Resource planning determining what resources and
  quantities of them should be used
• Cost estimating developing an estimate of the
  costs and resources needed to complete a project
• Cost budgeting allocating the overall cost
  estimate to individual work items to establish a
  baseline for measuring performance
• Cost control controlling changes to the project
  budget
• Resource Planning consideration
• difficulty, uniqueness, track record, people,
  equipment and materials

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Summary (2)

• Types of cost estimate
• ROM, Budgetary and definitive
• Basic tools and techniques in cost estimation
• top-down, bottom-up, parametric Cocomo
• Cost budget involves allocating the project cost
  estimate to individual work items and providing a
  cost baseline
• 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
• Earned value management is an important tool for
  cost control

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Quiz
2. What would a single payment of 35,000 two
years from now be worth today with a 10 interest
rate? a. 42,350 b. 28,926 c. 31,818 d.
26,296 answer B

• 1.The future value of 2000 invested for 2 years
  at 8.5 will be?
• a. 2,710
• b. 2,355
• c. 2,555
• d. 7,772
• answer B

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Short Questions

• Negative numbers for cost variance (CV) mean
  _______
• Negative number for schedule variance (SV) mean
  ________________
• Which problem can be detected if CPI is less than
  100 ? _________________________________
• Which problem can be detected if SPI is less than
  100 ? ________________________________
• ans The project is costing more than planned
• The project is taking longer than planned
• The of the project is over budget in cost
• The of the project is behind schedule in time