Advanced Project Management Project Cost Management Ghazala Amin

2 Project Cost Management Reference study materials – A guide to the Project Management Body of Knowledge (PMBOK Guide), Chapter 7 – Study notes – Dr. Kerzner’s book, Chapters 14 and 15 – Quantitative Methods for PM, Pages

Project Parameters: Cost All projects necessarily incur a cost because they consume resources. There can be a multitude of cost items which are incurred on projects, some of which are regular, others periodic, and others non- recurring (i.e. which are incurred usually once in the course of the project life-cycle) in nature. Estimating the cost of a complex project with a high degree of accuracy can be quite difficult in its early stages due to a paucity of information. Project Management offers several methods for estimating a project‘s cost. However, cost over-runs are common on projects and are considered a manifestation of project failure.

 Land acquisition  Establishment of project and furnishing site office  Recruitment, selection and training of key project staff  Procurement of hardware, software and other technical equipment for project  Consultancy  Special project audit  Licenses and permits from officials concerned  Salaries of project staff  Rent for project facilities  Operating expenses (incl. utilities)  Travelling and meetings  Project inputs and raw material being supplied on regular basis  General administrative and miscellaneous Project Parameters: Cost (Examples of Non-Recurring & Regularly Recurring Costs) Usually Non-RecurringUsually Regularly Recurring

Project Parameters: Cost (Important Topics in Project Cost Management)  Categorization of Project Cost Items  Top-Down Project Cost Estimation Methods  Bottom-Up Project Cost Estimation Methods  Deterministic / Probabilistic Project Cost Forecasting  Project Cost Baseline  Synchronization of payments due with release of funds  Earned Value Method

PMBOK Area: Cost Management Project Cost Management includes the processes which are required to plan, manage and control costs so that the project can be completed within the budget allocated for it. Processes covered under project Cost Management are cost estimating, cost budgeting, and cost control.

7 Project Cost Management Includes processes required to ensure that the project is completed within the approved budget Project Life-Cycle Costing, includes costs for: – R&D – Production – Construction – Operation and maintenance – Product retirement and phase-out

8 Cost Management Processes Cost Management processes (per PMBOK); – Estimate Costs – Determine Budget – Control Costs Process GroupsInitiationPlanningExecutionControlClosing Knowledge Areas Cost Managem entEstimate CostsControl Costs Determine Budget

9 Estimate Costs Involves developing an approximation (estimate) of the costs of the resources needed to complete project activities

10 Estimate Costs Analogous estimating – Also called Top-down and Budget estimating – Uses actual cost of a previous, similar project Parametric modeling – Uses project characteristics (parameters) in a mathematical model to predict project costs – Also called Rough Order of magnitude – It is scalable Bottom-up estimating – Estimating the cost of individual work items – Summarizing or rolling-up the individual estimates to get a project total – Also known as Definitive estimating

11 Estimate Costs Estimating ranges – Rough Order of Magnitude: +75%, -25% – Intermediate Budget:+25%, -10% – Definitive:+10%, -5%

12 The Rules of Estimating Use the approach most appropriate for the project. Communicate the level of accuracy required to the estimating team. Involve the project team in the estimating process Base estimates on history Use available standards Do not make estimates to fit desired cost or delivery date Validate estimates with the team Do not pad estimates Recognize that estimating takes time. DOCUMENT YOUR ESTIMATING ASSUMPTIONS

13 Determine Budget Involves allocating the overall cost estimates to individual work items in order to establish a cost baseline for measuring project performance

14 Present Value A dollar today is worth more than a dollar from a year from now The reason is the time value of money Mathematically: PV = FV/(1+r) where, PV = Present Value FV = Future Value r = Rate of Return n = Number of years n

15 Net Present Value It is a sophisticated capital budgeting technique that equates the discounted cash flow against the initial investment Mathematically NPV =  [FV /(1+r) ] - II where, NPV = Net Present Value FV = Future Value r = Rate of Return t = Time Period n = Number of Years II = Initial Investment t t t=1 n

16 Internal Rate of Return »It is discount rate where the present value of the cash inflows exactly equals to the initial investment »Mathematically  [FV /(1+IRR) ] - II = 0 where, NPV = Net Present Value FV = Future Value IRR = Internal Rate of Return t = Time Period n = Number of Years II = Initial Investment t t t=1 n

17 Control Costs Concerned with – (a) influencing the factors which create changes to the cost baseline to ensure that changes are beneficial and agreed upon, – (b) determining that the cost baseline has changed and – (c) managing the actual changes when and as they occur

18 Earned Value Analysis - Definitions Budgeted Cost of Work Scheduled (BCWS) – Planned Value – The budgeted amount of cost for work scheduled to be accomplished in a given time period Actual Cost of Work Performed (ACWP) – Actual Cost – The amount reported as actually expended in completing the work accomplished within a given time period Budgeted Cost of Work Performed (BCWP) – Earned Value – The budgeted amount of cost for completed work within a given time period.

19 Cost and Schedule Variances Cost variance – CV = BCWP – ACWP or – CV = EV – Actual Cost – Negative variance indicates a cost overrun situation Schedule variance – SV = BCWP – BCWS or – SV = EV – Planned Value – Negative variance indicates a behind schedule situation

20 Variance Percents Cost Variance Percent (CVP) = CV/BCWP Schedule Variance Percent (SVP) = SV/BCWS

21 Performance Index (PI) Cost Performance Index (CPI) = EV/Actual Cost (BCWP/ACWP) Schedule Performance Index (SPI) = EV/Planned Value (BCWP/BCWS) PI = 1.0 (Perfect performance) PI > 1.0 (Exceptional performance) PI < 1.0 (Poor performance)

22 Estimate at Complete - Definitions Budget at Completion (BAC) – The planned cost for the entire project Estimate at Completion – The current estimated cost for the entire project based on current performance EAC = AC + ETC EAC = BAC – EV EAC = AC + BAC - EV EAC = BAC/CPI

23 Estimate at Complete - Definitions Estimate to Complete (ETC) – The planned cost to complete the project from a given point on ETC = EAC - ACWP