What is Cost Management in Project Management?
Cost management is the process of managing project costs through the process of planning, estimating, and controlling a project’s budget. While project cost management begins before a project starts, it continues on throughout the entire project lifecycle to completion. Upon completion, the data provides a view of the project’s planned predicted costs versus its actual costs; which can be used for benchmarking future projects and portfolios.
Project cost control is a critical part of project management and project controls, as major construction projects are, on average, delivered one year behind schedule and 30% over-budget (McKinsey & Company).
Project Cost Management Processes
Effective cost management throughout a project significantly helps project organizations and enterprises avoid cost overruns. According to PMBoK, the project cost management processes for making this happen include:
- Forming a plan cost management / resource planning
- Estimating project costs
- Determining the project budget
- Controlling project costs
The first three processes of project cost management occur prior to the project during planning, while the last process occurs throughout the project’s execution.
1. Plan Cost Management / Project Resource Planning
During the creation of a cost management plan (a key component of the overall project management plan), descriptions of how project costs will be planned, structured, and controlled are defined. Resource planning involves utilizing a work breakdown structure (WBS), a hierarchical breakdown of all of a project’s deliverables and the work required to complete them. The WBS is used to calculate the full cost of resources needed to complete a project successfully.
2. Estimating Project Costs
Cost estimation is an important process in project cost management in which costs associated with all required resources needed to complete the project are quantified.
In some projects, estimates are built item by item as part of the Work Breakdown Structure (WBS) to provide a bottom-up, total cost of the project. Sometimes, an item estimate is provided based on industry heuristics that provide costs based on square footage, feet of pipe, miles of road and number of work months compiled from similar projects.
A project estimate may also include costs for contingency for future situations that are partially predictable or quantifiable (“known-unknowns”) and risks that are impossible to predict (“unknown-unknowns”). Once approved, the estimate becomes the budget for the project.
Integration with Cost Management Systems
Our integration system, PRISM Integrator, is able to integrate the synchronization of a project’s cost control elements from the ARES PRISM cost management system and the work breakdown structure within the scheduling system to various other systems. PRISM Integrator is also able to bring in project estimating data via PRISM Estimating. This allows the business to use standardized (synchronized) code throughout the business. Hence, supporting further services or business processes to be initiated from the standardization of a control account structure. Business processes such as change management and risk management can also be integrated. This allows the change and risk data to be raised in a contract management system and the impact measured through the cost control system. Now the organization has a single view of cost, change, risk and schedule throughout the program.
3. Determining Project Budget
Creating a project budget involves calculating individual project task budgets into an overall budget for the entire project. A project budget is used to determine project funding needs, and they include contingency reserves allocated to manage unexpected project costs.
For medium to large projects, it often involves establishing a time-phased budget.
Time-Phased Budget Method
A time-phased budget is a budget that is not only defined in terms of magnitude, but also indicates the planned expenditure of that budget over time. The Time-Phased Budget method begins with an estimate and a schedule, but instead of incorporating one within the other, it uses “control accounts” to link them together. A “control account” or “cost account” is a management control point where earned value measurement takes place. It is the place where scope, schedule, and budget are integrated at the organizational level responsible for the day-to-day management of a segment of a project. Cost management applications use a control account as the centralized record that, at times, represents multiple activities and multiple estimate line items.
Cost-Loaded Schedule Method
An alternative method is creating a cost-loaded schedule. This method often involves the simultaneous development of a project estimate using various estimating tools, and a project schedule using the Critical Path Methodology. This is typically done using Primavera P6, Microsoft Project or even MS Excel. When the activities have been sequenced and spread across the duration of the project, and the resources with their estimated costs have been included, the result is a Cost-Loaded Schedule. The time-phased budget method is usually preferable to the cost-loaded schedule method.
4. Controlling Project Costs
Project cost control is imperative to successful project management and delivery. How enterprises and organizations accurately predict and report on the success of their projects and still have time to actually manage them is a challenge all projects face. The answer is applying earned value management (EVM).
A starting point for EVM is creating a Performance Measurement Baseline to plan, track, and report project progress against. Project management is the art of planning, tracking, coordinating, aligning, communicating, and, of course, reporting progress on a project. It is the project manager’s responsibility to ensure a successful project, in its various forms and inform everyone when obstacles threaten the success of the project.
Successful Project Cost Management
When predicting the likelihood of a project’s success, there are many different questions that can be asked:
- Will the project be completed on-time?
- Will the project be delivered within budget?
- Will the project quality meet or exceed standards and expectations?
- Does the project meet all the requirements and scope?
Performance Measurement Baseline
Performance Measurement Baseline (PMB) is part of the ANSI Standard for Earned Value Management Systems (ANSI EIA 748-A). The two most widely used methods to fulfill the ANSI requirement: Cost-loading a schedule and using a control account time-phased budget, both of which are discussed above.
Project Costs: Budget, Scope & Time
To facilitate managing and reporting on the project, the project manager needs to combine budget, scope and time in a way that allows a comparison of the actual progress against the plan and provides an accurate forecast of the future but is not burdensome to create or maintain.
For each task within a project, the project manager will gather the:
- Planned value: The value of the work that is planned to be completed.
- Earned value: The actual value of all the work completed.
- Actual cost: The actual cost of all the work completed.
With planned value, earned value, and actual costs, we can calculate additional project values that indicate the project’s current status and performance– from either a budget perspective (CV and CPI), or from a schedule perspective (e.g., Schedule Variance (SV) and Schedule Performance Index (SPI)).
Four additional values can then be calculated to determine the project’s current status through to the end of the project (e.g., Estimate to Complete (ETC), Estimate at Completion (EAC), Variance at Completion (VAC), and To-Complete Performance Index (TCPI).
The Importance of Project Cost Management
It’s important to measure and control project costs, report them to stakeholders throughout the project lifecycle, and use them for benchmarking progress during the project and forecasting for future projects.
Key Cost Management Metrics:
- Earned Value
- Project Cost Performance
- Cost Performance Index (CPI)
Earned value tracks the cost and value of the work performed, and represents the progress of the project. Earned value management determines if the project is falling behind schedule or over budget. By measuring the historical performance of the project, EVM forecasts the probability of successful delivery.
Project Cost Performance Report
A project’s cost performance can be assessed by measuring how the actual expenditures compare with the planned expenditures per the project budget. It often serves as the basis for preventive or corrective actions to avoid cost overruns. Project controls software like ARES PRISM offers a project cost performance report out-of-the-box and meets federal government reporting requirements.
Cost Performance Index (CPI)
The Cost Performance Index measures a project’s financial effectiveness and efficiency, and represents the amount of completed work for every unit of cost spent. A CPI of 1 means that the project is performing on budget. A CPI of less than 1 means that the project is over budget.