Chapter 4

Project Cost Management

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 Self check Exercise
1. Define project time management?
2. What are the main processes that are involved in project time
management ?
3. What is meant by slack (or float)?
4. What is the difference between crashing and fast tracking a
project‘s schedule?
5. What are the advantages project network diagrams?
6. How can parallel activities help shorten the project schedule?
are there any trade-offs?

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What is Cost and Project Cost Management?
 Cost is a resource sacrificed or foregone to achieve a
specific objective or something given up in exchange
 Costs are usually measured in monetary units like birr,
dollar, etc
 Project cost management includes the processes
required to ensure that the project is completed within
an approved budget
 Project managers must make sure their projects are well
defined, have accurate time and cost estimates and have a
realistic budget that they were involved in approving
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 The Importance of Project Cost Management

 Project cost can easily get out of control if no appropriate

project cost management is in place.
 The following are the benefits of project cost management:

 Accountability

 Decreased Expenses

 Enhanced Efficiency

 Stress Relief

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 Basic Principles of project Cost Management
 Most members of an executive board have a better understanding and
are more interested in financial terms than IT terms.
 In order to perform effective project cost management, there are a
few financial terms related to project cost management one needs to
understand.
 Profits are revenues minus expenses.

 Life cycle costing considers the total cost of ownership, or

development plus support costs, for a project.
 Cash flow analysis determines the estimated annual costs and benefits
for a project and the resulting annual cash flow.

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 Basic Principles of project Cost Management
 Tangible costs or benefits are those costs or benefits that an
organization can easily measure in dollars.
 Intangible costs or benefits are costs or benefits that are difficult to
measure in monetary terms.
 Direct costs are costs that can be directly related to producing the
products and services of the project.
 Indirect costs are costs that are not directly related to the products or
services of the project, but are indirectly related to performing the
project.
 Sunk cost is money that has been spent in the past; when deciding what
projects to invest in or continue, you should not include sunk costs.

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 Project Cost Management Processes
1. Resource planning: determining what resources and
quantities of them should be used
2. Cost estimating: developing an estimate of the costs and
resources needed to complete a project
3. Cost budgeting: allocating the overall cost estimate to
individual work items to establish a baseline for measuring
performance
4. Cost control: controlling changes to the project budget
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 1. Resource Planning
 The first step in project cost management is planning how the
costs will be managed throughout the life of the project
 The major inputs to resource planning include a project’s

work breakdown structure, scope statement, historical

information, resource information, and policies.

 The main output of the resource planning processing is a list

of resource requirements, including people, equipment, and

materials.
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 cont..
 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 project’s scope
statement that will affect resources?
 What is the organization’s history in doing similar tasks?
 Does the organization have or can it acquire the people,
equipment, and materials that are capable and available for
performing the work?

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 2.Cost Estimating
 Project managers must take cost estimates seriously if they

want to complete projects within budget constraints.

 Accurate cost estimating is very important as it provides the

basis for cost budgeting and cost control.

 It’s important to know the types of cost estimates, how to

prepare cost estimates, and typical problems associated with

IT cost estimates.

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 Cont..
 The main outputs of project cost management are a cost estimate,
supporting details and a cost management plan.

 The supporting details include the ground rules and assumptions

used in creating the cost estimate, a description of the project used as a

basis for the estimate, and details on the cost estimation tools and

techniques used to create the estimate.

 A cost management plan is a document that describes how the

organization will manage cost variances on the project.

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 Cont..

 A large percentage of total project costs are often labor costs,

so project managers must develop and track estimates for

labor.
 There are three types of cost estimates, namely,
 Rough order of magnitude (ROM) estimate,

 budgetary estimate, and

 definitive estimate.

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 Types of Cost Estimates
Type of Estimate When Done Why Done How Accurate
Rough Order of Very early in the Provides rough –25%, +75%
Magnitude (ROM) project life cycle, ballpark of cost for
often 3–5 years selection decisions
before project
completion
Budgetary Early, 1–2 years out Puts dollars in the –10%, +25%
budget plans
Definitive Later in the project, < Provides details for –5%, +10%
1 year out purchases, estimate
actual costs

• A ROM estimate that actually cost $100,000 would range between $75,000 to $175,000.
• A budgetary estimate that actually costs $100,000 would range between $90,000 to $125,000.
• A definitive estimate that actually costs $ 100,000 would rang between $95,000 to $110,000.

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 Cost Estimation Tools and Techniques
 basic tools and techniques for cost estimates:
 Analogous or top-down: use the actual cost of a previous, similar
project as the basis for the new estimate
 Bottom-up: estimate individual work items and sum them to get a
total estimate
 Parametric: use project characteristics in a mathematical model to
estimate costs
 Computerized tools: Tools, such as spreadsheets and
project management software, that can make working with
different cost estimates and cost estimation tools easier.
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 Typical Problems with Cost Estimates
 Estimates are done too quickly. Developing an estimate for a large
software project is a complex task requiring a significant amount
of effort.
 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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 3. Cost Budgeting
 Cost budget involves allocating the project cost estimate

to individual work items and providing a cost baseline

 The WBS is a required input for the cost budgeting

process because it defines the work items.

 Important goal is to produce a cost baseline:

 A time-phased budget that project managers use to

measure and monitor cost performance.

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 4. Cost Control
 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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 Earned Value Management (EVM)

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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.
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 Earned Value Management

 Earned Value Analysis is an industry standard way to:

• measure a project’s progress,
• forecast its completion date and final cost, and
• provide schedule and budget variances along the way.
 By integrating three measurements, it provides consistent,
numerical indicators with which you can evaluate and
compare projects.

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 EVM enables

1. Knowing where you are on schedule?

2. Knowing where you are on budget?

3. Knowing where you are on work

accomplished?

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 Earned Value Management Terms

 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
 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 Management Terms
 Cost variance (CV): is the earned value minus the actual cost
 –ve, means preforming the work cost more than planned
 +ve, means performing the work cost less than planned
 Schedule variance (SV): is the earned value minus the planned
value
 -ve, means it took longer time than planned to perform the work
 +ve, means the work took less than the planned
 Cost performance index (CPI): is the ratio of earned value to
actual cost. It used to estimate the projected cost of completing
the project
 CPI = 1, means planned and actual cost are equal
 CPI<1, means project is over budget
23  CPI>1, means the project is under budget
 Earned Value Management Terms
 Schedule performance index (SPI): is the ratio of
earned value to planned value
 SPI=1, means the project is on schedule
 SPI <1, means the project is behind the schedule
 SPI >1, means the project is ahead of schedule
 Estimate at completion (EAC): is an estimated cost
of completing a project based on Performance date
EAC=BAC/CPI , where BAC is budget at completion

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 Earned Value Formulas
TERM FORMULA

Earned Value EV = BAC  Percent Completed

Cost Variance CV = EV – AC

Schedule Variance SV = EV – PV

Cost Performance Index CPI = EV/AC

Schedule Performance Index SPI = EV/PV

Estimate at completion EAC = BAC/CPI

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 EVM Numbers

 Negative numbers for cost and schedule variance indicate problems in

those areas.
 The project is costing more than planned or taking longer than planned

 Zero variance shows that the project is running according to the plan

 CPI and SPI > 1.0, indicate exceptional performance

 CPI and SPI < 1.0, indicate poor performance

 If CPI or SPI = 1, it shows that the project is performing according to

its plan
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 Example
 Suppose you have a software project which is planned to be
completed in 9 months with a budget of Birr 900,000. After
a month,10% of the project is completed at a total expense
of Birr 100,000, but the planned completion was 15%.
 Given:
 Budget At Complete (BAC) = Birr 900,000
 AC = Birr 100,000

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 Compute
a) PV
b) EV
c) CV - interpretation
d) SV - interpretation
e) CPI - interpretation
f) SPI - interpretation
g) Forecast -Budget at complete
h) Forecast - Time at complete
i) Overall project’s traffic light status
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 …solution

a) Planned Value = Planned Completion (%) * BAC

= 15% * Birr 900,000
= Birr 135,000
b) Earned Value = Percent Completed (%) * BAC
= 10% * Birr 900,000
= Birr 90,000
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 …continued
 CV = EV – AC The project is
costing more
= 90,000 – 100,000 than planned
because CV is
= -10,000 less than zero.

 SV = EV – PV
= 90,000 – 135,000
The project is
= - 45,000 taking longer
than planned
because SV is
less than zero.

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 …continued
 CPI= EV / AC
= 90,000 / 100,000
= 0.90 It shows Poor
Performance
 SPI= EV/PV because CPI
and SPI are
= 90,000 / 135,000 less than one.

= 0.67

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 Forecasting Cost
 If the project continues at the current
performance, what is the true cost of the project?
 Estimate at Complete
= Budget at Complete (BAC) / CPI
= Birr 900,000 / 0.90 = Birr 1,000,000
 At the end of the project, the total project cost
will be Birr 1,000,000

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 Forecasting Time
 If the project continues at the current
performance, what is the true time of the
project?
 Estimate at Complete
= Original Time Estimate / SPI
= 9 months / 0.67 = 13.43 months
 The project will be completed by the end of
13.34 months.

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 Establish Ranges to Guide Traffic Light
Status

 Traffic light status is useful in conveying overall project’s

status with one color
 Establish objective SPI and CPI ranges to determine the true
project color.
 Average of CPI & SPI i.e. (CPI+SPI)/2

Green [1.0 - 0.95] Good

Warning
Yellow [0.94 - 0.85]
Bad
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Red [0.84 - 0]
  Therefore, for the above example, overall

project’s traffic light status is

= (CPI+SPI)/2
= (0.90+0.67)/2
= 0.78 Bad

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