Cost Management

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Location:  PMKI > PMBoK Knowledge Areas > Cost Management. 
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This subject covers the processes involved in planning, estimating, budgeting, financing, funding, managing and controlling costs so the project can be completed within the approved budget. Earned Value Management is a key technique.

Topics included in Cost Management:

- Cost management overview
- Estimating costs
- Determining the budget and price
- Earned Value basics
- Controlling costs
- Useful External Web-links & Resources.

Other related sections of the PMKI:

- Earned Value and Earned Schedule
- Resource management
- Project Controls


Cost management overview

Cost ManagementProject cost management in both the PMP and CAPM exam has two distinct aspects, both of which are important but both of which have a very different focus:
 

Cost Management

Cost management is the process of planning and controlling the budget of a project. It includes activities such as cost planning, estimating, budgeting, financing, funding, managing payments, and controlling costs so that the project can be completed within the approved budget. It covers the full life cycle of a project from the initial planning to completion, and supports the organization’s accounting function. Key aspects include:

  • Estimating the cost of performing the project work based on the resources planned to be used
  • Allocating the estimated to cost to various ‘cost centers’ or account codes
  • Determining the time based cash-flow (budget)
  • Ensuring invoices and payments are authorized correctly
  • Monitoring actual expenditure against the budget
  • Taking action to control the expenditure, and
  • Reporting on the cost performance of the project, including cash-flow forecasts and the expected profit/loss.

Cost ManagementCost management is a proactive function that considers the optimization of the costs associated with acquiring and deploying / using the resources needed to accomplish the project scope of work and the effect of project decisions on these costs. It also looks at balancing project cost decisions against the long term costs associated with owning and operating the product to achieve the best cost balance. This ability to positively influence cost is greatest early in the project and diminishes over time, therefore achieving the optimum outcome requires a proactive approach during the early planning phases.

The money spent by the project is owned by the client or the performing organization; more than in other disciplines this means the project has to communicate regularly with the relevant stakeholders and be aware different stakeholders have different views of when money is spent and what constitutes project vs organizational costs. Most of this interaction is accomplished through a combination of structured reporting and dealing with inputs to the organization’s financial management systems.

As with time management, there is no point in producing detailed estimates of work that is not fully defined. In most projects a process needs to be agreed to determine a high level budget for the overall work and then add detail as better information becomes available.
 

Earned Value Management

Using project cost information as a project management control process that extends beyond simple cost control - see below.


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Estimating costs

Cost Uncertainty

There is no such thing as a 100% accurate estimate. What is important is understanding the degree of error likely in any estimate. The primary driver of uncertainty is the degree of technical uncertainty in the project, what we don't know about the how the work will be accomplished and how long the work will actually take to do. There are also inherent errors in the cost estimating process, including variability in the price paid for goods and services in the future and the estimating process itself. PMI expects every estimate to be accompanied by a range indicator of some form - see our Risk Management page for more.

A good estimate balances and optimizes the overall cost, for example, additional time and money spent on refining a design should produce savings during production.

WP: Cost Estimating. Guidelines for creating a good estimate at the right level of detail.

EstimatingPMI's Practice Standard for Project Estimating is available free of charge to PMI members, see: https://www.pmi.org/pmbok-guide-standards/framework
 
 
 

Prs: Estimating Fallacies - excessive detail does not help. Detailed is not synonymous with accurate! Excessive detail can reduce accuracy and devalue an estimate.

WP: The innate effect of Bias. Discusses the important effect of cognitive biases on the way estimates are developed.

One solution to group effects on estimating is Planning poker, also called Scrum poker, is a consensus-based, gamified technique for estimating, mostly used to estimate effort or relative size of development goals in software development. In planning poker, members of the group make estimates by playing numbered cards face-down to the table, instead of speaking them aloud. The cards are revealed, and the estimates are then discussed. By hiding the figures in this way, the group can avoid the cognitive bias of anchoring, where the first number spoken aloud sets a precedent for subsequent estimates.
 

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Determining the budget and price

Cost estimating is not ‘pricing’. Cost estimating is the calculation of the expected cost of the project based on the unit cost rate of all of the inputs (resources) used. It is an approximation of the actual cost. Pricing (ie, deciding on a tender price, or a quotation, or a market price) uses the cost estimate as one input (of many) to the overall business process of deciding the ‘best’ price to charge. Other factors include a return on capital invested, a premium for managing risks, the desired profit, and an assessment of any competing prices/bids.

The cost estimate together with a project schedule forms the input for cost budgeting. The budget gives an overview of the periodic and total costs of the project. The cost estimate defines the cost of each work package or activity, whereas the budget allocates the costs over the time period when the cost will be incurred. A cost baseline is an approved time-phased budget that is used as a starting point to measure actual performance progress. The budget for the project is based on the estimate (including contingencies for known risks), distributed over the life of the project.

The cost baseline is the approved version of the time-phased budget, it becomes a component of the project management plan, and provides the basis to measure, monitor and control project expenditure.

Blg: The reference case for management reserves. Reference case forecasting is one way to remove the effect of optimism bias and other systemic errors in estimating the value of a project.

WP: Depreciation. Depreciation is a way of spreading the cost of an item over its useful life, this paper looks at what a PMP candidate needs to know.

WP: The Point of Total Assumption. The PTA is the point above which the seller effectively bears all the costs of a cost overrun on a fixed price ‘incentive fee’ (FPIF or FPI) contract.


Financial Ratios are used to assess the viability of a business some of the key assessments are:

  • The Quick Ratio measures liquidity (availability of cash) a ratio of 1:1 is acceptable.
    Quick Ratio = (Cash + Government Securities + Receivables) / Total Current Liabilities
  • The Current Ratio measures financial strength a ratio of 2:1 is acceptable.
    Current Ratio = Total Current Assets / Total Current Liabilities
  • Working Capital measures cash flow. a positive value is acceptable.
    Working Capital = Total Current Assets - Total Current Liabilities

     

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Earned Value Management (EVM)

EVM uses the information derived from the cost management function to aid in the overall control of the project (ie, using money as a performance metric).

EVM involves:

  • Determining the planned value of work to be performed in each time period
  • Measuring the actual value of work performed in each time period
  • Measuring the actual costs of performing the work accomplished
  • Using established formulae to understand the current performance and the projected outcomes for the project.

Cost Management

This page is for the PMP exam – see PMKI Section 3.8 for more detailed information on Earned Value Management and Earned Schedule.

Art: Earned Value - An Introduction to Earned Value Performance Management . This paper provides an overview of the workings of 'Earned Value Management' and how it assists in the effective management of projects.

WP: Earned Value Formulae. A summary of the basic values and formulae used in Earned Value calculations.

WP: Understanding the use of TCPI in EVM. The TCPI is the only EV metric that can provide a consistent measure of the likelihood of achieving a target total cost.

EVM StandardPMI's Practice Standard for Earned Value Management is available free of charge to PMI members, see: https://www.pmi.org/pmbok-guide-standards/framework 
- Australian sales only from our web shop

 


 

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Controlling costs

Cost Control is concerned with measuring variances from the cost baseline and taking effective corrective action to minimize cost overruns EVM is one way to achieve this. In every project, procedures are needed to monitor expenditures and performance against the budget, and the actual progress of a project. This includes:

  • Determining the current status of the project from a cost perspective
  • Understanding what has caused the status and searching out the causes of positive and negative variances (particularly if there are negative trends)
  • Influencing the factors that cause change to enhance positive influences and reduce negative influences
  • Determining the extent of change and acting to bring expected cost overruns within acceptable limits
  • Managing changes when they do occur and informing appropriate stakeholders of approved changes
  • Preventing unapproved changes
  • Ensuring that potential overruns do not exceed potential funding
  • Recording all changes against the cost baseline and managing their consequences
  • Forecasting the expected final total costs of the project on a regular basis.

Tight cost control gives a company considerable influence over its cash flows and reported profits.

Art: Stop Throwing Money Away! The effect of sunk costs and emotions on the decision to kill a project.

  

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Useful External Web-links & Resources

PMI EVMPMI's Practice Standard for Earned Value Management
- Australian sales only from our web-shop.

 

 

GAO Cost GuideDownload the U.S. Government Accountability Office (GAO) Cost Estimating and Assessment Guide


 

Compass International, Inc. commercial/industrial construction cost estimating data: https://compassinternational.net/

Training

Communication TrainingEarned Value Management for Business. This workshop is designed to provide students with an understanding of the power of using Earned Value as a practical control and monitoring technique to deliver added value and insight from their overall project control process (view course details).

Earned Value Management Mentored Email™ Course. This self-paced distance learning course is designed to provide you with an understanding of the power of using Earned Value as a practical control and monitoring technique to deliver added value and insight from their overall project control process  (view course details).

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Self-paced PMI-SP Training

Communication management template


Self-paced EVM Training

Stakeholder management tools


Self-paced PMI-SP Training

Risk management template


Self-paced PMI-SP Training

Stakeholder management tools