A note on Project Cost Management

Organizations aim for their projects to be successful and to meet client expectations as well as their
internal objectives. But what is the reality on the ground? As per PMI study, 14% of the surveyed IT
projects were deemed as failures. Only 57% of the projects finished within their initial budgets, with
the others exceeding the target they had set for themselves.

This is certainly not good news for enterprises as cost overruns not only impact their margins, but
also hinder the ability to execute future projects and keep client relationship and business growth.
Understanding what project cost management is and how to be effective at it can be beneficial for
organizations to stay on course.

In this article, we look at what project cost management is, its benefits and the steps involved in its
implementation.

What is Project Cost Management?

Project cost management is the process of estimating, budgeting, and controlling costs throughout
the project life cycle, with the objective of keeping expenditures within the approved budget.

For a project to be called successful, it’s necessary that

 it delivers on the requirements and scope

 its execution quality is of a high standard
 it’s completed within schedule and
 it’s completed within budget.

Hence, project cost management is one of the key pillars of project management and is relevant
regardless of the domain, be it manufacturing, retail, technology, construction and so on. It helps to
create a financial baseline against which project managers can benchmark the status of their project
costs and realign the direction if needed.

Importance

The importance of cost management is easy to understand with a simple, real-life example. If you
decide to build a house, the first thing to do is set the budget. When you have a sense of how much
to spend on the project, the next step is to divide the high-level budget into expenses for sub-tasks
and smaller line items.

The budget will determine critical decision points such as: which designer to hire—a high-end one
who will construct and deliver the project end-to-end, or someone who can help with a few
elements and be able to work for a smaller budget? How many stories should the house have? What
quality of materials should be used?

Without a predefined budget, not only is it difficult to answer these questions, but it becomes
impossible to assess whether you are progressing in the right direction once the project is underway.
In large organizations, the scale of this problem is further magnified due to concurrent running of
multiple projects, change in initial assumptions and the addition of unexpected costs. That’s where
cost management can help.

By implementing efficient cost management practices, project managers can:

  Set clear expectations with stakeholders
 Control scope creep due to transparencies established with the customer
 Track progress and respond with corrective action at a quick pace
 Maintain expected margin, increase ROI, and avoid losing money on the project
 Generate data to benchmark for future projects and track long-term cost trends

The Four Steps in Project Cost Management

While cost management is viewed as a continuous process, it helps to split the function into four
steps: resource planning, estimation, budgeting, and control. They are mostly sequential, but it’s
possible that some resource changes happen midway through the project, forcing the budgets to be
adjusted. Or, the variances observed during the control process can call for estimate revisions.

1. Project Resource Planning

Resource planning is the process of identifying the resources required to execute a project and take
it to completion. Examples of resources are people (such as employees and contractors) and
equipment (such as infrastructure, large construction vehicles and other specialized equipment in
limited supply). Resource planning is done at the beginning of a project before any actual work
begins.

To get started, project managers first need to have the work-breakdown structure (WBS) ready.
They need to look at each subtask in the WBS and ask how many people, with what kind of skills are
needed to finish this task, and what sort of equipment or material is required to finish this task?

By adopting this task-level approach, it becomes possible for project managers to come up with an
accurate and complete inventory of all resources, which is then fed as an input into the next step of
estimating costs.

A few tips to consider during the process:

 Consider historical data—past schedules and effort—before determining sub-tasks and the
corresponding resources.
 Take feedback from SMEs and team members—a collaborative approach works well
especially in projects that do not have past data to use.
 Assess the impact of time on resource requirements. For instance, a resource may be
available only after a few months, dragging the project’s schedule. This could have an impact
on cost estimation.
 Although this step happens at the planning stage, project managers need to account for
ground realities. For example, you may identify the need for a resource with certain
expertise, but if such a resource is not available within the organization, you must consider
hiring a contractor or training your team to get them up to speed. All these real variables
impact cost management.

2. Cost Estimation

Cost estimation is the process of quantifying the costs associated with all the resources required to
execute the project. To perform cost calculations, we need the following information:

 Resource requirements (output from the previous step)

  Price of each resource (e.g., staffing cost per hour, vendor hiring costs, server procurement
costs, material rates per unit, etc.)
 Duration that each resource is required
 List of assumptions
 Potential risks
 Past project costs and industry benchmarks if any
 Insight into the company’s financial health and reporting structures

Estimation is arguably the most difficult of the steps involved in cost management as accuracy is the
key here. Also, project managers must consider factors such as fixed and variable costs, overheads,
inflation and the time value of money.

The greater the deviation between estimation and actual costs, the less likely it is for a project to
succeed. However, there are many estimation models to choose from. Analogous estimation is a
good choice if you have plenty of historical cost data from similar projects. Some organizations
prefer mathematical approaches such as parametric modelling or program evaluation and review
technique (PERT).

Then there is the choice between employing a top-down versus bottom-up approach. Top-down
typically works when past costing data are available. In this, project managers usually have
experience executing similar projects and can therefore take a good call. Bottom-up works for
projects in which organizations do not have a lot of experience with, and, therefore, it makes sense
to calculate a cost estimate at a task-level and then roll it up to the top.

Cost Estimation as a Decision Enabler

It’s useful to remember that cost estimation is done at the planning stage and, therefore, everything
is not yet set in stone. In many cases, project teams come up with multiple solutions for a project,
and cost estimation helps them decide which way to go. There are many costing methodologies,
such as activity-based costing, job costing, and lifecycle costing that help perform this comparative
analysis.

Lifecycle costing, for instance, considers the complete end-to-end lifecycle of a project. In IT
projects, for example, maintenance costs are often ignored, but lifecycle costing looks long-term and
accounts for resource usage until the end of the cycle. Similarly, in manufacturing projects, the goal
is to minimize future service costs and replacement charges.

Sometimes the estimation process also allows teams to evaluate and reduce costs. Value
engineering, for example, helps to gain the optimal value from a project while bringing costs down.

3. Cost Budgeting

Cost budgeting can be viewed as part of estimation or as its own separate process. Budgeting is the
process of allocating costs to a certain chunk of the project, such as individual tasks or modules, for a
specific time. Budgets include contingency reserves allocated to manage unexpected costs.

For example, let’s say the total costs estimated for a project that runs over three years is $2 million.
However, since the budget allocation is a function of time, the project manager decides to consider
just the first two quarters for now. They identify the work items to be completed and allocate a
budget of, say, $35,000 for this time, and these work items. The project manager uses the WBS and
some of the estimation methods discussed in the previous section to arrive at this number.
Budgeting creates a cost baseline against which we can continue to measure and evaluate the
project cost performance. If not for the budget, the total estimated cost would remain an abstract
figure, and it would be difficult to measure midway. Evaluation of project performance gives an
opportunity to assess how much budget needs to be released for future phases of the project.

Another reason to firm up budgets is that organizations often rely on expected future cash flows for
their funding. During the initial phases, the project manager has a limited financial pool and has to
set targets accordingly. It’s like building the foundation and one floor of the house in the initial few
months and later completing the rest of the project, as you save more.

4. Cost Control

Cost control is the process of measuring cost variances from the baseline and taking appropriate
action, such as increasing the budget allocated or reducing the scope of work, to correct that gap.
Cost control is a continuous process done throughout the project lifecycle. The emphasis here is as
much on timely and clear reporting as measuring.

Along with the cost baseline, the cost management plan is an essential input for cost control. This
plan contains details such as how project performance will be measured, what is the threshold for
deviations, what actions will be done if the threshold is breached, and the list of people and roles
who have the executive authority to make decisions.

Earned value management (EVM) is one of the most popular approaches to measuring cost
performance. Let’s take an example.

At the end of a week, you measure the progress of task X and find that it’s 25% complete. Now, how
do you assess if you are on track to meet the task budget?

First, a project manager calculates the planned value for this task (at the planning stage). Let’s say,
Task X has a budget of $4000 and is expected to be 50% complete by the week.

Planned value (PV) of task X by the week = $4000 * .5 = $2000

Earned value (EV) of task X by the week = $4000 * .25 = $1000

Now, you also determine the actual cost (AC) of the work, which involves other variables such as
equipment and material costs (say, $800).

Schedule variance = EV – PV = $1000 – $2000 = -$1000.

Cost variance = EV – AC = $1000 – $800 = $200.

The negative schedule variance indicates that the task is falling behind, but the positive cost variance
indicates that it’s under budget.

While dealing with hundreds of tasks in huge projects, cost control can provide the level of
transparency that decision makers require to respond quickly to the situation.
Project Cost Software

Cost management, like other aspects of project management, gets complex with many variables in
play. The process itself is elaborate, needing attention to detail along with a rigorous approach. The
use of project management software can simplify this process considerably and offer following
advantages.

 Automation of cumbersome quantitative analysis during estimation and measurement helps

avoid manual errors
 Integration of data across planning, estimation, budgeting, and control enables continuous
monitoring and quick, proactive responses, rather than one-off interventions
 Decision-making is made easier as cost software helps evaluate alternate solutions using
scenario forecasting and what-if analysis
 Clear and easy reporting in the form of dashboards and other rich UIs
 The complexity of multicurrency management in projects across different geographical
locations is simplified with project cost software
 Many project cost solutions allow third-party integrations, so data can be pooled and
analysed
 Benchmarking and standardization are possible with the availability of performance data
across multiple projects