Chapter 7:

Project Cost Management

& Software Effort
Estimation

PMP 1
Learning Objectives
Understand the importance of project cost management.
Explain basic project cost management principles, concepts, and terms.
Describe the process of planning cost management.
Discuss different types of cost estimates and methods for preparing them.
Understand the processes of determining a budget and preparing a cost estimate for an
information technology (IT) project.
Understand the benefits of earned value management and project portfolio management to
assist in cost control.
Describe how project management software can assist in project cost management.

PMP 2
Part 1: Project Cost
Management

PMP 3
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 dollars.
Project cost management includes the processes required to ensure that the project is
completed within an approved budget.

PMP 4
Project Cost Management Processes
1. Planning cost management :determining the policies, procedures, and documentation that
will be used for planning, executing, and controlling project cost.
2. Estimating costs: developing an approximation or estimate of the costs of the resources
needed to complete a project.
3. Determining the budget: allocating the overall cost estimate to individual work items to
establish a baseline for measuring performance.
4. Controlling costs: controlling changes to the project budget.

PMP 5
Figure 7-1. Project Cost Management
Summary

PMP 6
Basic Principles of Cost Management
Most members of an executive board better understand and are more interested in financial
terms than IT terms , so IT project managers must speak their language.
◦ Profits are revenues minus expenditures.
◦ Profit margin is the ratio of revenues to profits.
◦ 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.

PMP 7
Types of Costs and Benefits
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.

PMP 8
More Basic Principles of Cost
Management
Learning curve theory states that when many items are produced repetitively, the unit cost of
those items decreases in a regular pattern as more units are produced.

Reserves are dollars included in a cost estimate to mitigate cost risk by allowing for future
situations that are difficult to predict.
◦ Contingency reserves allow for future situations that may be partially planned for (sometimes called
known unknowns) and are included in the project cost baseline.
◦ Management reserves allow for future situations that are unpredictable (sometimes called unknown
unknowns.

PMP 9
1. Planning Cost Management
The project team uses expert judgment, analytical techniques, and meetings to develop the cost
management plan.
A cost management plan includes:
◦ Level of accuracy and units of measure
◦ Organizational procedure links
◦ Control thresholds
◦ Rules of performance measurement
◦ Reporting formats
◦ Process descriptions

PMP 10
2. Estimating Costs
Project managers must take cost estimates seriously if they want to complete projects within
budget constraints.
It’s important to know the types of cost estimates, how to prepare cost estimates, and typical
problems associated with IT cost estimates.
Estimates are usually done at various stages of a project and should become more accurate as
time progresses.
A large percentage of total project costs are often labor costs.

PMP 11
Table 7-2. Types of Cost Estimates

PMP 12
What’s a ROM Estimate?

A ROM estimate is generally completed in one of the first phases of a project. In general, when a
company or business wants a ROM cost completed, they are looking for a ballpark number
instead of an exact figure.
The variation between estimated and actual costs with a ROM estimate can easily be plus or
minus fifty percent. Anyone preparing a ROM estimate should be sure to indicate that the
accuracy of the estimate can vary greatly, especially if it is in the early stages of a project

PMP 13
How Do I Prepare A ROM Estimate?

Although there is more accepted variation with a ROM estimate, it is still vital that a project
management professional complete the work to make the estimate as accurate as possible.
There are limits to what is acceptable in regard to the price variation.
Often, projects are completed over a period of several years. It can difficult to forecast and plot
the cost of raw materials or labor over a multi-year time frame. However, there are known
inputs that the project manager is sure to get correct. As a general rule, the longer the time
horizon for the project, the more the possible variation in the final price.
For example, if someone estimated the construction of a new house to be $200,000 and the
final cost was $1,000,000, the level of variation would not be acceptable. When preparing cost
estimates using this method, the most important aspect is to get the known factors right

PMP 14
Tools for ROM Estimates

There are several handy tools on the market to help project managers provide likely ROM
estimates. SEER is an interoperable suite of products that can help project managers with many
steps along the way, including software solutions that help with both ROM and Definitive
Estimates.
There are also ROM templates like this one from Doctonic that will help map out all variables to
take into account.

PMP 15
What is a Definitive Estimate?

A definitive estimate is very different from a ROM estimate. First, the accepted level of variation
between projected cost and final cost is usually -10% to +10%. A company or client that
requests a definitive estimate usually has much less room for error than one that will accept
ROM pricing.
Anyone that has worked in the field of project management long enough knows how difficult
preparing a definitive estimate can be on a long or complex project. This means that the person
preparing the cost estimates for a project using a definitive estimate must perform a
considerable amount of research in order to get the variation this low.
A definitive estimate may also turn out to be incorrect, since it is likely based on quite a few
assumptions, including factors beyond anyone’s control. Estimates changing is an accepted fact
of life, and the only way to counter uncertainty in estimates is to update them regularly—the
more uncertainty, the more frequently they need to be revisited. This is the only way to mitigate
the risks. The PMBOK terms this “rolling wave planning.”

PMP 16
How Do I Prepare A Definitive
Estimate?

The method of preparing a definitive estimate must be more detailed than a ROM estimate. In
addition, there must be more solid data when preparing a definitive estimate. A company or
business cannot expect an accurate definitive estimate to be prepared if the proper data points
are not provided. In general, there are contract documents and a scope of work that is provided
in order to back up the estimate claims. A definitive estimate should be prepared from fully
designed plans with different scenarios that can be projected out.
Any direct costs associated with the project, such as building materials and labor for a home,
should be itemized. A contingency should also be incorporated into a definitive estimate which
can cover a project manager in the event that the market conditions change. To use the home
building example, if the price of bricks suddenly goes up by fifty percent it would not be
reasonable that the estimated cost of bricks in the home will be the same as the final cost. To
help reduce the impact of this situation, indirect costs should also be budgeted into a project.

PMP 17
Tools for Definitive Estimates

Many companies offer templates and calculators to assist with definitive estimates. Smartsheet
offers a template in additional to a helpful guide on project cost estimation.
As a general rule, it is important to understand that an estimate is only as good as the inputs
that are put in. Any wild variations in market costs or deviations from the plan can and will result
in estimates being less accurate.

PMP 18
How Do I Calculate Variation for These Estimates?

As a project manager, it is important to be able to accurately account for variation. If the

estimated cost of a project is $200,000 and the actual cost of the project ends up being
$250,000, the dollar variation is $50,000. However, what really matters is the percent variation.
In this case, we would take the difference of $50,000 and divide that by the estimated cost of
the project at $200,000. In this simple example, the cost variation would be 25%. This would be
acceptable for a ROM estimate—but not for a definitive estimate.
As a general rule, it is important to understand that an estimate is only as good as the inputs
that are put in. Any wild variations in market costs or deviations from the plan can and will result
in estimates being less accurate.
Any definitive estimate should have a scope of work and an itemized list of costs that went into
the project. Unlike an ROM estimate, a business is not going to tolerate or accept large
variations from the estimated and final costs. Finally, as a project manager it is important to lay
out the expectations on the accuracy of the different estimation methods. A business should
understand that an ROM estimate is not going to be nearly as accurate as a definitive one.

PMP 19
Cost Estimation Tools and Techniques
Basic tools and techniques for cost estimates:
◦ Analogous or top-down estimates: use the actual cost of a previous, similar project as the basis for
estimating the cost of the current project.
◦ Bottom-up estimates: involve estimating individual work items or activities and summing them to get a
project total.
◦ Parametric modeling uses project characteristics (parameters) in a mathematical model to estimate
project costs.

PMP 20
Typical Problems with IT Cost Estimates
•Estimates are done too quickly
•People lack estimating experience
•Human beings are unfair toward underestimation
•Management desires accuracy

PMP 21
Sample Cost Estimate
Before creating an estimate, know what it will be used for, gather as much information as
possible, and clarify the ground rules and assumptions for the estimate.
If possible, estimate costs by major WBS categories.
Create a cost model to make it easy to make changes to and document the estimate.

PMP 22
Figure 7-2. Sample Project Cost Estimate

PMP 23
3. Determining the Budget
Cost budgeting involves allocating the project cost estimate to individual work items over time.
The WBS is a required input to the cost budgeting process since 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 .

PMP 24
Figure 7-4. Sample Project Cost Baseline

PMP 25
4. Controlling Costs
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

Many organizations around the globe have problems with cost control.

PMP 26
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.
More and more organizations around the world are using EVM to help control project costs.

PMP 27
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 an
estimate of the value of the physical work actually completed.
EV is based on the original planned costs for the project or activity and the rate at which the
team is completing work on the project or activity to date.

PMP 28
Rate of Performance
Rate of performance (RP) is the ratio of actual work completed to the percentage of work
planned to have been completed at any given time during the life of the project or activity.
For example, suppose the server installation was halfway completed by the end of week 1. The
rate of performance would be 50% because by the end of week 1, the planned schedule reflects
that the task should be 100 percent complete and only 50 percent of that work has been
completed.

PMP 29
Table 7-5. Earned Value Formulas

PMP 30
Rules of Thumb for Earned Value
Numbers
Negative numbers for cost and schedule variance indicate problems in those areas.
CPI and SPI less than 100% indicate problems.
Problems mean the project is costing more than planned (over budget) or taking longer than
planned (behind schedule).
The CPI can be used to calculate the estimate at completion (EAC)—an estimate of what it will
cost to complete the project based on performance to date. The budget at completion (BAC) is
the original total budget for the project.

PMP 31
Figure 7-5. Earned Value Chart for
Project after Five Months

PMP 32
Table 7-4. Earned Value Calculations for
One Activity After Week One

PMP 33
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, especially enterprise PM
software.
Portfolio management software can help reduce costs.

PMP 34
Part 2: Software Effort
Estimation

PMP 35
Software Metrics
It refers to a broad range of quantitative measurements for computer software
that enable to:
◦ improve the software process continuously
◦ assist in quality control and productivity
◦ assess the quality of technical products
◦ assist in tactical decision-making

PMP 36
Motivation for Software Metrics
•Estimate the cost & schedule of future projects
•Evaluate the productivity impacts of new tools and techniques
•Establish productivity trends over time
•Improve software quality
•Forecast future staffing needs
•Anticipate and reduce future maintenance needs

PMP 37
Project Management Estimation
Estimation Methods:
1. Estimation by analogy: Software is built similar to one built before using experience from
previous occasions.
2. Estimation by work breakdown: Work is broken down into smaller chunks that can be
estimated by analogy.
3. Function Point analysis (FPA)
4. COCOMO

PMP 38
Metrics of Project Management
•Budget
•Schedule/Resource Management
•Risk Management
•Project goals met or exceeded
•Customer satisfaction

PMP 39
Metrics of the Software Product
•Focus on Deliverable Quality
•Analysis Products
•Design Product Complexity – algorithmic, architectural, data flow
•Code Products
•Effort

PMP 40
Source Lines of Code (SLOC)
Measures the number of physical lines of active code
In general the higher the SLOC in a module the less understandable and maintainable the
module is.
◦ the SLOC values for various operating systems in Microsoft's Windows NT product line are as follows

https://en.wikipedia.org/wiki/Source_lines_of_code#Example

PMP 41
Function Point Analysis (FPA)
FPA is a technique for estimating the size and complexity of a software project, and hence for providing a
measure of how much effort will be required to develop the software.
How to calculate FP?
Calculate function points (FP) as:
𝐹𝑃 = 𝑤1 × 𝐹1 + 𝑤2 × 𝐹2+………+𝑤n × 𝐹n

Where:
𝐹n is the count of every element functionality.
𝑤𝑢 and 𝑤c are adjustment factors (weights) which depend on complexity of the application. The actual
weights are usually somewhere in the range
4 to 10 for 𝒘n

PMP 42
FPA - Size Estimation
5 elements determine the ultimate complexity of an application. Take the weighted sum of these
counts to get the number of function points ( FP ) in a system.

Characteristic Weight
Number of Inputs 4
Number of Outputs 5
Number of Inquiries 4
Number of Files 10
Number of Interfaces 7

PMP 43
FPA- Size Estimation
Once the number of function points ( FP ) is calculated ( from requirements ), other data is used
to estimate module / system SIZE. For various languages, data was obtained on how many lines
of code are usually needed to implement one function point.
◦ Convert FP into LOC for the particular language being used.
◦ Table 3 shows one such mapping, based on the industry experience.
◦ Convert LOC into effort using e.g. COCOMO (see next)

PMP 44
FPA Example
Suppose the requirements for the University Registrar system project has been carefully
analyzed and the following estimates have been obtained. There is a need for 10 inputs, 11
outputs, 8 inquiries, 22 files, and 5 external interfaces.
◦ What is the approximate number of LOC for the following languages?
◦ “C” programming language
◦ “Java” Programming language

Solution
◦ 10*4+11*5+8*4+22*10+5*7=417 FP
◦ For Java: 60*417=25020 LOC
◦ For C: 148*417= 61716 LOC

PMP 45
COCOMO
The COnstructive COst Model (COCOMO) (developed by Barry Boehm) is used to find effort in terms of
size and in terms of project duration. This is done converting from code size (in KLOCs) to effort in
person-months and to optimal project duration in months.
Basic COCOMO: take the form
Effort: E = a∙(KLOC)b measured in person-months
Development Time: D = c∙Ed measured in months
Count of people required: P = E/D
Where:
◦ a is the nominal productivity, in person month, to produce 1000 lines of code (1 KLOC)
◦ b determines the degree of diseconomy of scale (if >1) OR economy of scale (if < 1).
◦ c is the basic duration, in months, per person-month
◦ d gives a measure of non-linearity, (d < 1) .

PMP 46
Basic COCOMO
These parameters a, b, c , and d are determined based on the class of software project.
Basic COCOMO, recognizes three classes of software project:
◦ Organic: relatively small, simple projects;
◦ Semi-detached: intermediate projects in terms of size and complexity;
◦ Embedded: complex software projects, such as a flight-control system.

PMP 47
Example
Perform a FPA and apply the basic COCOMO model to obtain the effort and the duration to develop a software
system for an online library: 5 inputs, 13 interfaces, and 9 files. Java language is used
◦ Step 1: estimate the size
◦ Step 2: apply basic COCOMO

With the aid of parameters

Effort is:
E = a∙(KLOC)b
E = 2.4 X (12.1)1.05 = 9.6 person-month

Duration is:
D = c∙Ed
D = 2.5 X (9.6)0.38 = 5.9 months

FP= 5 * 4+ 13*7+9*10= 201

Size= 201*60 = 12060 LOC= 12.1 KLOC (approximately )

PMP 48
Chapter Summary
Project cost management is a traditionally weak area of IT projects, and project managers must
work to improve their ability to deliver projects within approved budgets
Main processes include
◦ Plan cost management
◦ Estimate costs
◦ Determine the budget
◦ Control costs
Software Effort Estimation

PMP 49