1. Chapter 9 Contemporary Project Management Kloppenborg
Budgeting Projects
Chapter 9
Contemporary Project Management
Kloppenborg
© 2009 South-Western, a part of Cengage Learning

2. At the end of this chapter…
Describe how to perform cost planning for a project and give four reasons for its importance.
Compare and contrast methods of estimating cost and tell when each is appropriate.
Compare and contrast pairs of cost terms.
Describe several issues in cost estimating and how to deal with each.
Create a bottom-up budget for a project.

3. At the end of this chapter…
Assign costs per time period to determine commitments, invoiced amounts and cash flow.
Describe activity based costing and its role in project budgeting.
State several assumptions and constraints that apply when estimating for your example project.
Describe three causes of variation that impact project cost and how to deal with each.

4. Cost Planning Involves developing a cost management plan for a project
For small projects 
Ensure accurate cost estimates
Secure the funding
Develop cost reporting procedures
For large projects 
Develop and use accurate cash flow estimates
Cost management planning – “the document that sets out the format and establishes the activities and criteria for planning, structuring, and controlling the project costs.” PMBOK® Guide

5. Purposes of the Cost Management Plan
The plan shows how to develop and share relevant, accurate and timely information for decision making
The plan provides feedback linking the project to business objectives
The plan provides detail and summary information
The plan helps project stakeholders focus on schedule and performance as well as cost.

6. Cost Estimating
Cost estimating is linked to scope, schedule, and resource planning
Never lie to yourself
You must understand what the project costs really are
Never lie to anyone else
Avoid shading the truth to secure necessary funding
Cost estimating – “the process of developing an approximation of the cost of the resources needed to complete project activities.” PMBOK® Guide

7. Cost Estimating Types of costs Timing and accuracy of cost estimates
Methods used to estimate costs
Cost estimating issues

8. Types of Costs

9. Types of Costs – Fixed vs. Variable
Fixed costs remain the same regardless of volume of work
Variable costs vary directly with volume of use
Cost curve reflects as low a total cost as possible at the current project size
Fixed and variable costs involve consideration of the project scope

10. Project cost and volume curve

11. Types of Costs – Direct vs. indirect
Direct costs only occur because of the project
Direct labor
Other direct costs – material, travel, consultants, subcontracts, purchased parts, computer time
Indirect costs are costs necessary to keep the organization running that are not associated with one specific project
Salaries, buildings, utilities, insurance, clerical assistance
Costs are allocated across projects

12. Direct and Indirect Costs in a Work Package

13. Types of Costs – Recurring vs. Nonrecurring
Recurring costs repeat as the project work continues
Cost of writing cost; laying bricks
Occur during project evaluation
Nonrecurring costs happen only once during a project
Design development
Occur during project planning and closing

14. Types of Costs – Regular or Expedited
Regular costs occur when progress can be made by normal work hours and purchasing agreements (the preferred cost)
Expedited costs occur when the project must be conducted faster than normal
Overtime and extra charge apply

15. Types of Costs – Estimate vs. Contingency reserve
Project estimates to be aggressive – some estimates will run over and others cost less
Project managers frequently add a contingency to cover activities that run over aggressive estimates
Estimate – “a quantified assessment of the likely amount… It should always include an indication of accuracy.” PMBOK® Guide
Contingency reserve – “the amount of funds… needed above the estimate to reduce the risk of overruns of project objectives to a level acceptable to the organization.” PMBOK® Guide

16. Types of Costs – Accrual vs. Cash Accounting
Accrual – transactions are recorded in the time period the expense occurred
Cash – records transactions when money is spent
Cash accounting is more frequently used on projects

17. Accuracy and timing of cost estimates
When should cost estimates be developed?
How accurate do cost estimates need to be?
How will cost estimates be used?

18. Accuracy and timing of cost estimates
Costs in Project Initiation
Necessary for project charter approval
Estimates are only approximate
Costs in Project Planning
Cost estimates are more precise
Cost estimates should be documented
The level of confidence in the cost estimate should be described

19. Project Cost Estimate Comparisons

20. Estimate Names Order of magnitude Budget Definitive
Often used to seek initial charter approval
Created when limited project detail is available
Ball park, conceptual, initial, or level one estimates
Budget
Definitive
Rolling wave planning allows for creating a definitive estimate for the first stage of planning and an order of magnitude estimate for the rest of the project

21. Methods of estimating costs
As more details of a project are known, more detailed estimating methods may be used
Analogous estimating
Parametric estimating
Bottom-up estimating

22. Methods of estimating costs

23. Analogous Estimating
Consider a similar project as a cost estimating starting point
Requires that the organization have experience performing similar projects and actual cost of similar projects
Analogous estimating – “an estimating technique that uses the cost along with measures of scale such as size, weight or complexity from a previous project to estimate cost for a similar, future project.” PMBOK® Guide

24. Analogous Estimating
Requires knowledge of how the proposed project differs from the previous project
Estimator needs to have experience with methods to be used in the project

25. Parametric estimating
Involves finding more information regarding the project
Parametric estimating – “an estimating technique that uses a statistical relationship between historical data and other variables to calculate project costs.” PMBOK® Guide

26. Bottom-up estimating
Most detailed – specifications need to be very clear
Time consuming
Most accurate form of estimating
Ensure every item is included
Bottom-up estimating – “a method of estimating project costs in which the work is decomposed into more detail. An estimate is prepared of what is required to meet the requirements of each of the lower, more detailed pieces of work, and these estimates are then aggregated into a total quantity for the project.” PMBOK® Guide

27. Cost Estimating Method Comparison

28. Issues in project cost estimating

29. Issues in project cost estimating – Supporting detail
Includes describing the scope, method used to create the estimate, assumptions, constraints, and range of possible outcomes
Version control is critical

30. Issues in project cost estimating – Use of assumptions and constraints
People from different backgrounds may make different assumptions
Untrue assumptions cause more work or other problems
Assumptions related to direct labor costs
Workers will be paid at the prevailing wage rate of $14 per hour,
Workers are already familiar in general with the technology being used on the project,
Workers will be paid for 40 hours per week whether there is always that much work for them or not,
Overtime will never be authorized, and
The project schedule can be delayed if the only alternative is to pay overtime.

31. Issues in project cost estimating – Use of assumptions and constraints
Constraints often dictate methods available for performing the work
Examples of constraints:
Only in-house workers will be used,
No extra space will be provided,
No extra budget will be allowed, and
The current version of the XYZ software will be incorporated into the design.

32. Issues in project cost estimating
The range of possible outcomes should always be stated with any project cost estimate
There are many causes of variation in project costs
Statisticians classify variation as coming from either normal or special causes

33. Normal and Special Cause Variation

34. Variation Occurs in all work processes
Normal variation comes from small causes inherent in a work process
Special cause variation is the result of something out of the ordinary

35. Securing services and supplies from vendors
Use vendor bid analysis to determine whether the price is reasonable
For competing buds, assume the lowest responsible offer is fair
Prices may be determined in the market place
Examine business papers and web sites
Develop a “should cost estimate”
Try to determine vendor effort expended and add a fair profit margin to arrive at a price

36. Value engineering
A powerful method of double checking all of the chosen methods for accomplishing work and the features of the project deliverable
A separate stage may be incorporated late in the project planning to ensure time is spent on value engineering
Value engineering – “a creative approach used to optimize project costs, save time, increase profits, improve quality, expand market share, solve problems, and/or use resources more effectively.” PMBOK® Guide

37. Issues in project cost estimating – what type of accounting system is used
Functional based accounting systems used historically
Overhead (indirect) costs were assigned to a cost pool allocated to direct costs based on volume
Contemporary approach
Indirect costs form a larger percentage of total costs
Allocation of indirect costs is more carefully considered

38. Activity based costing
Indirect costs are allocated to fixed costs based on drivers
Cost drivers
Number of units produced
Number of batches run
Number of product variations
Amount of facility utilized
More involved methods for allocating indirect costs yields more accurate cost information

39. Life cycle costing
Includes the total costs of creating and using the project during its useful life
Consider disposition costs of the product after its useful life is complete

40. Time value of money
Discounting the value of future revenue and cost streams will enable better project decisions
Discount future dollars by the appropriate factor
The finance department may provide the appropriate rate
The rate depends on the underlying inflation rate plus the cost of capital

41. Cost Budgeting Aggregating costs Analyzing reserve needs
Determining cash flow
Cost budgeting – “the process of aggregating the estimated costs of individual activities or work packages to establish a cost baseline.” PMBOK® Guide

42. Aggregating Costs
Direct and indirect costs add up to the cost baseline
The cost baseline is an integral part of the project management plan
The cost baseline can only be changed through a formal change management process
Cost baseline – “the approved time-phased budget against which project execution is compared and deviations are measured for management control.” PMBOK® Guide

43. Aggregation of Project Budget

44. Analyzing Reserve Needs

45. Analyzing Reserve Needs
Known knowns are discovered during planning and can be estimated directly
Known unknowns are events discovered during risk identification that may or may not occur
Unknown unknowns (unk unks) are totally unexpected occurrences that cause an increase in cost and/or schedule
The money used to cover unk unks is called management reserve

46. Analyzing Reserve Needs
The amount placed into contingency reserve is calculated during risk analysis
The amount placed into management reserve is determined by how much uncertainty management feels exists in the project
The cost baseline, contingency reserve, and management reserve are used to determine if sufficient funds are available

47. Determining cash flow
Expenses are applied to individual activities in the schedule to see when case is needed
Cash may be supplied through organization budgets on a periodic basis
The cumulative amount of cash coming in to the project must meet or exceed demands for cash payouts

48. Project Cumulative Cash and Revenue

49. Establishing Cost Control
Approved project budget serves as a baseline for project control
Milestones are used as a typical measuring point
Identified in the milestone schedule in the project charter
Identified in constructing the project schedule
Use cash flow projections to determine how much funding is expected to reach each milestone
Create enough milestones to keep track of progress without creating an administrative burden

50. Using MS Project for Project Budgets
MS Project supports bottom up and summary level cost modeling
Bottom up cost modeling is based on the cost of each resource assignment
Summary level cost modeling consists of a summary level estimate for all effort represented by that level

51. Develop Bottom-up Project Budget
Assignment cost
Activity cost
Project total cost
Various Perspectives

52. Assignment Cost Required data
Assignment work hours
Resource Standard Rate
Resource Overtime Rate
Assignment Cost = total number of assignment hours times the standard rate

53. Assign Cost Rates
Source: Microsoft product screen shot reprinted with permission from Microsoft Corporation.

54. Activity Cost
The sum of all assignment Costs values plus any activity Fixed Cost
Start at the Gantt view, right-click and select split, select task usage view from the View menu

55. Task Usage View with Resource Work Form
Source: Microsoft product screen shot reprinted with permission from Microsoft Corporation.

56. Various Perspectives
Cost data may be viewed from a resource perspective using the Resource Usage view
Assignment costs are summarized at the resource level
The “unassigned” set represents activities with no assigned resources.
Resources with no show/hide control have no assignments

57. Resource Usage View
Source: Microsoft product screen shot reprinted with permission from Microsoft Corporation.

58. Develop Summary Project Budget
Add a dummy activity under each phase summary not yet planned in detail
Estimate the phase duration and the phase cost
Put the duration estimate in the dummy activity’s duration field
Put the cost estimate in the dummy activity’s Cost field
Remove each dummy activity when detail is added

59. Dummy Activity for Late Phase
Source: Microsoft product screen shot reprinted with permission from Microsoft Corporation.

60. Summary
The cost management plan lays out how you plan to structure and control project costs
Cost estimating can be challenging because some activities may have a great deal of variation.
Many methods are available to assist in cost estimating.

61. Summary
Cost budgeting includes aggregating individual costs, analyzing needs for cost reserves where uncertainty exits, and determining cash inflow and outflow.
Establishing cost controls includes establishing cost reporting systems.
MS Project can assist in developing either bottom-up project budgets or summary project budgets.