Best Practices for Project Cost Management

The ability to manage projects within their given constraints is one of the keys to managing and delivering successful projects.

Every project that is initiated has certain constraints that govern the project and its management. These constraints include the triple constraints of project scope, schedule, and cost. Other constraints include the project resources and quality.

Project cost is one of the most important constraints of a project, and it is essential that the project is managed and executed according to the allocated budget in order not to have a project that can no longer go on due to lack of finance.

This post provides insight into the importance of project cost management, project cost management processes, and some project cost management best practices for

What is Project Cost Management?

Project cost management is a combination of processes and activities that are designed to plan, estimate, and monitor and control the project’s budget with the primary aim of ensuring the project is completed within the allocated budget.

Money is very important as practically everyone knows, and so no client or organization wants to incur expenses on a project beyond what is allocated for it.

Managing the project costs is a fundamental responsibility of a project manager. This is no easy task as according to this PMI Global Project Management Survey, the average percentage of projects completed within budget is 57.5%.

Obviously, a lot of projects are exceeding their budgets and it is essential to realize that cost overruns impact other project constraints such as the schedule, scope, quality, and the organization’s margins.

The cost management of a project starts even before the project initiation and continues throughout the project life cycle to project closing.

Understanding how to properly manage the project costs by utilizing the project cost management processes is essential to successfully manage the project and achieving the expected project goals and objectives.

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Why is Project Cost Management Important?

When it comes to money, practically everybody knows its importance. Money is one resource that is very important when working on projects and it has to be managed as best as possible.

The budget of a project is a key constraint, and it determines a lot of critical decisions in the project. It will determine the resources to be used on the project, and also impacts the project scope, schedule, and quality.

The goal of project cost management is to ensure a feasible budget is estimated for the project, and this budget is adhered to throughout the project life cycle to its completion.

A feasible project budget helps to set a baseline for the project costs. This baseline is to help to keep the project on track and avoid spending over the budget.

Delivering a project within the stipulated budget is one of the key project success criteria. Without proper project cost management, the project is set out to fail from the beginning as it will inevitably lead to cost overruns and losses.

Project Cost Management Processes

As a project manager, there are 4 processes that will help you to manage project costs effectively.

1. Plan Cost Management

This process helps in identifying and documenting how to plan, estimate, budget, manage, monitor, and control project costs including the costs of resources.

This plan is a detailed guide and road map on how to create feasible estimates for the project costs, develop a cost baseline, manage the project according to this cost baseline, monitor the project costs for variances, and control it.

While the project charter developed during the project initiation has a high-level cost constraint, as a project manager you need to check how feasible this initial constraint is from proper project costs estimation and budget.

Plan Cost Management Process Inputs

The inputs to this process include:

• Project Charter.
• Project Schedule Management Plan.
• Project Risk Management Plan.

Plan Cost Management Process Tools and Techniques

The tools and techniques required for this process include:

• Expert Judgement.
• Data Analysis.
• Meetings.

Plan Cost Management Output

The key output of this process is the project cost management plan or project budget plan. This plan should be created and documented by the project manager and approved by the project sponsor and other relevant stakeholders.

Also, it should include the following:

• The format of the estimates to be used (currency).
• The level of accuracy to be used for the estimates.
• The approved estimating technique to be used.
• The acceptable threshold variances.
• Guidance to indicate if indirect costs will be added to the project budget.
• The reporting format to be used.
• The cost change control procedure.
• The roles and responsibilities for various cost activities.
• Guidelines for dealing with fluctuations in costs of resources and exchange rates.
• The methods for documenting costs.
• Information on control accounts and other ways to monitor project spending.
• Guidance on the establishment of a cost baseline.

2. Estimate Project Costs

This process involves coming up with cost estimates for all the project tasks and activities, and the resources required to complete them.

It is essential to know what costs should be estimated, and the cost of all efforts required to complete the project.

This includes project costs such as labor, equipment, and training.

Other costs to be considered include the following:

• The costs of quality efforts.
• The costs of risk efforts.
• The costs of the project manager’s time and skill.
• The costs of project management activities.
• Expenses for office spaces used directly for the project.
• Overhead costs such as management salaries, and general office expenses.

For projects that involve procurement, the buyer estimates the profit that is being paid to the seller. While the seller estimates the profit as part of the cost of providing the product or service.

Estimate Project Costs Inputs

The following are useful inputs in estimating project costs.

• Project cost management plan.
• Project quality management plan.
• Project scope baseline.
• The lessons learned register.
• Project risk register.
• Project schedule.
• Project resource requirements.
• Enterprise environment factors (EEFs). These include marketplace conditions, inflation, exchange rates, etc.
• Organizational process assets (OPAs).
• Project management costs.

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Estimate Project Costs Tools and Techniques

This process uses the following techniques to get realistic and useful estimates for the project costs.

Data Analysis

The estimating activity duration uses 2 forms of data analysis. These are alternatives and reserve analysis.

Alternative analysis is a technique that is used when the activity estimates are not acceptable within the project constraints.

Options thus have to be considered, and the impact of each of the options on the project is weighed in order to pick the best alternative.

Reserve analysis helps identify more risks. Risk management reduces uncertainty in time and cost estimates.

As a project manager, it is your responsibility to create reserves to accommodate risks that remain after risk management processes are complete.

When it comes to project reserves, there are contingency and management reserves. Contingency reserves are kept for risks that have been identified. Management reserves are allocated for covering risks that are unforeseen.

Project Management Information System (PMIS)

The Project Management Information System (PMIS) consists of tools used for the documentation, storage, and retrieval of information on the project.

It includes estimating spreadsheets and software.

Cost of Quality

This is the cost of the work added to the project to accommodate quality efforts.

Estimate Ranges

Cost estimation is an iterative process and it is expected that the estimates become more accurate as the project goes on.

These estimates should be made in ranges that narrow as the project progresses. There are different ranges that are used for different scenarios. These include:

Rough Order of Magnitude (ROM) estimates. This is usually done during the project initiation phase and is in the range of -25 to 25%.

Budget estimates. This is usually done during the project planning phase and is in the range of -10 to 25%.

Definitive estimates. This is a more refined project cost estimation and is in the range of -5 to 10%.

Decision Making

When creating estimates for project costs, decisions inevitably have to be made as there are various techniques that can be used for estimating.

To make these decisions, there are also different ways to go about it. Voting is a common method used for making decisions about activity estimates or the amount of reserves needed.

For projects using the plan-driven or traditional project management methodology, voting may result in decisions based on unanimity, plurality, or majority.

For change-driven or agile project management methodology, a method called fist to five is often used.

This technique is used for rapid feedback on decisions where for each option, the stakeholders show their level of agreement by showing a number of fingers ranging from 5 to show total support to 0 which denotes vehement opposition.

Estimating

Estimation of project costs is done with one or more of the following techniques:

1. One-Point Estimating

This technique involves submitting one estimate for each project activity. This estimate is gotten through expert judgment, guessing, or the history of other similar projects.

This technique is fast but not that accurate.

2. Parametric Estimating

This is a form of one-point estimating that creates estimates by using mathematical formulas gotten from historical data or other sources.

The estimates can be created by using regression analysis (scatter diagram), learning curve (improved efficiency), and heuristics (generally accepted rule).

3. Analogous Estimating (Top-Down Estimating)

Analogous estimating is a form of the one-point estimation technique that uses historical information. The level of accuracy depends on how closely the current project or activity matches the historical data to be used.

4. 3-Point Estimating

This estimation technique gives 3 estimates for each project activity. An optimistic, pessimistic, and most realistic estimate. From these 3 estimates, the project costs estimates are derived.

The triangular distribution is given by the formula (P + M + O)/3.

The beta distribution is given by the formula (P + 4M + O)/3.

5. Bottom-Up Estimating

This involves creating estimates from a detailed analysis of the project and deliverables. It is more costly and time-consuming than the top-down (analogous) estimation technique.

This technique requires an accurate Work Breakdown Structure (WBS) in order to properly harness the benefits of this technique.

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Estimate Project Costs Outputs

The outputs from this process include:

• Activity estimates.
• Project cost reserves.
• Updates to the project documents including the lessons learned register, risk register, assumption log, and activity attributes.
• Basis of estimates. This details how the estimates were derived, including the assumptions, constraints, risks that were taken into consideration, and the confidence level of the estimates.

3. Determine Project Budget

This process entails the summation of all the project costs, and the result is the project budget.

The portion you have control over as a project manager is the project cost baseline.

It is necessary to review the business case and the benefits measurement plan as these express the reason why the project is being done in the first place and could include financial benefits of the project such as return on investment (ROI).

Determine Project Budget Process Inputs

The following are inputs used to create the project budget.

• Project cost management plan.
• Project scope baseline.
• Project cost estimates.
• Basis of estimates.
• Purchasing agreements.
• Project schedule.
• Organizational process assets (OPAs) and enterprise environment factors (EEFs).
• Project risk register.
• Lessons learned register.
• Project resource requirements.
• Business case.
• Benefits management plan.

Determine Project Budget Process Tools and Techniques

The tools and techniques used for determining the project budget include:

• Expert judgment.
• Data analysis (reserve analysis).
• Historical information reviews.
• Funding limit reconciliation.
• Cost aggregation. The costs to be aggregated include the project activity estimates, work package estimates, control account estimates, contingency reserves, project cost baseline, and management reserves.

Determine Project Budget Process Outputs

The outputs from the process of determining the project budget include:

• Project cost baseline. This baseline determines when cash will be needed, and its ties to the different phases, milestones, and capital expenses.
• Project funding requirements. This is mapped to the project schedule.
• Updates to project cost estimates, project risk register, and the project schedule.

4. Control Project Costs

The project cost management plan details how to measure performance, frequency of reports, and cost change procedures.

The control project costs process infers following the project cost management plan, measuring the performance, and managing changes.

The process requires analyzing the work performance data, comparing it with the cost baseline, influencing factors that lead to changes, and recommending corrective actions for variances above the threshold.

Control Project Costs Inputs

The inputs to this process include the following:

• Project cost management plan.
• Project cost baseline.
• Performance management baseline.
• Lessons learned.
• Project funding requirements.
• Work performance data.

Control Project Costs Tools and Techniques

• Project Management Information System (PMIS).
• Expert judgment.
• Data analysis (earned value analysis, reserve analysis, trend analysis, variance analysis, and to-complete performance index. Earned value analysis is used to measure the project performance against the performance measurement baseline. This helps to forecast future performance.

Control Project Costs Outputs

The outputs from the control project costs process include:

• Work performance information.
• Project costs forecast.
• Updates the project cost management plan, cost baseline, performance measurement baseline, lessons learned, risk register, cost estimates, and the assumption log.

Types of Project Costs

There are different categories of costs that are associated with managing projects. These are:

1. Fixed Costs

These are costs that stay fixed and do not change throughout the life cycle as the production level changes. These include the cost of setup, rent, and other related costs.

2. Variable Costs

Variable costs are costs that change with the level of production of the project. These include the cost of supplies, wages, cost of materials, fuel, etc.

3. Direct Costs

These are costs that are directly attributable to the work on the project. Examples of direct costs include expenses for reward and recognition of project team members, team travel expenses, etc.

4. Indirect Costs

Indirect costs are overhead costs incurred for the benefit of several or all projects. Examples of indirect costs include taxes, fringe benefits, the salary of a project manager working across several projects, etc.

5. Sunk Costs

Sunk costs are project costs that were incurred but did not contribute to the project’s objectives. Consider sunk costs to be spilled milk. If they cannot be recovered, they must be treated as if they are irrelevant.

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Key Project Cost Metrics

To properly manage requires measurement. There are key project cost metrics that are used to measure the project performance relating to the project costs and budget.

1. Earned Value Management

This consists of formulas used to measure the cost and value of the work performed and represents the project’s progress.

It shows whether the project is progressing in tandem with the budget, and forecasts the project performance.

Earned value EV = % of work completed x Budget at completion (BAC)

2. Cost Variance

The cost variance is the difference between the earned value and the actual cost of the project.

Cost variance = Earned value (EV) – Actual cost (AC)

3. Cost Performance Index (CPI)

The cost performance index measures the cost and financial effectiveness of a project by calculating the amount of work done for every unit of cost spent.

CPI = Earned value (EV) / Actual cost (AC)

4. To-Complete Performance Index (TCPI)

The to-complete performance index (TCPI) measures the likelihood of the project meeting the budget at completion (BAC) and the estimate at completion (EAC).

TCPI = Budget at completion (BAC) – Earned value (EV) / Budget at completion (BAC) – Actual cost (AC)

Project Cost Management Best Practices

By now you should have a clearer idea of the importance of managing project costs and the fact that it is a core responsibility of a project manager.

To be able to do this, these are 5 project cost management best practices.

1. Create Clear Controls for Project Costs

When you are managing projects, especially large ones, the expenses seem to just keep coming every minute. Some of these expenses are unplanned.

If there are no strong procedures laid out from the planning stage, it is easy for a lot to slip through the cracks and gradually lead to cost overruns.

Every expense should be planned for even the ones that are unforeseen. It is important to plan how to control these costs, and who will oversee, sign off, and document every expense.

2. Track the Project Scope Religiously

A change in any of the project constraints has an impact on the rest constraints.

For projects especially with an agile project methodology, new requirements can be added to the scope at any time. Also, change and scope creep can occur. These imply additional effort and costs.

Tracking the scope regularly will help keep abreast of any change that may impact the project costs.

3. Continuously Revise the Project Budget

Project cost management starts even before the beginning of the project, and project costs and the budget will be updated throughout the project.

Project costs at the beginning of the project are still estimates, and therefore the budget which is an aggregation of these costs is also an estimate.

It is essential to revise the budget continuously as the project goes on for higher accuracy and better cost management.

4. Track Project Cost Metrics Regularly

The best way to manage your project costs is by constantly measuring them.

With the key project cost metrics such as earned value, and cost performance index, the financial progress of the project is visible and enables you properly control the costs according to the project’s budget.

5. Integrate With other Project Management Processes

The project costs are deeply interwoven with other project constraints such as the project scope, schedule, resources, and risks.

It is therefore important to integrate these processes together since the project budget is heavily dependent on these constraints.

Attempting to manage the project costs in isolation from these other processes is a sure recipe for disaster.

Who Is Responsible for Project Cost Management?

When it comes to project cost management, the project manager is responsible for this process.

As a project manager, you have to create a realistic project budget by analyzing the work required to complete the project, estimating the costs, and calculating the budget for the project while balancing the estimation and the project constraints.

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Benefits of Project Cost Management

Management of your project costs efficiently has lots of benefits which are all key to the overall success of the project. These include:

1. Improved Productivity

When project costs are properly tracked and managed, it enables money allocated for the project to be spent on the most important aspects of the project.

2. Reduced Project Risks

Having a project that goes over the allocated budget is a great risk that can jeopardize the success of the project and your reputation as a project manager.

With proper project cost management, there is a reduced risk of cost overruns and a project that is over budget.

3. Increased Customer Satisfaction

When you deliver a project successfully that meets the expectations of the customers or stakeholders and is within the budget, that is the peak of customer satisfaction.

The dream of a customer is getting a project of high quality at the cost which was budgeted for it., and project cost management is the key to this.

4. Helps in Planning Future Projects

Aside from the project deliverables, one key output from projects is the lessons learned and historical data.

When you properly manage the project costs, you develop a road map for managing the same for future projects that are similar in nature.

Challenges of Project Cost Management

Management of anything is no walk in the park, and it is not different when it comes to managing project costs. There are various challenges that will come up, and you need to know them in order to overcome them.

1. Inaccurate Data for Estimation

Getting accurate data to use for estimating the costs of project activities is one obstacle to effective project cost management.

This is especially challenging when the project is a novel one for the organization or you as a project manager. Getting expert judgment can help in facing this challenge,

2. Rapid Project Changes

For a project that has lots of changes to its requirements and scope, managing the project costs can be very challenging.

If these changes are not properly tracked with a subsequent revision of the project budget, then the project is on the road to financial failure.

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3. Poor Communication

Communication is the bedrock of project management, and it is estimated that as a project manager you spend up to 80% of your time on communication.

While project communication may sound or seem simple, it actually is not especially when dealing with mega projects with stakeholders scattered around different zones of the world.

Poor communication is one key challenge when managing project costs especially when there are changes to the project and not every one is updated on this.

Conclusion

In conclusion, while there are challenges that make managing project costs difficult, to have a smooth and successful project, you simply have to surmount them as a project manager considering their benefits and importance.

Using the project cost management best practices gives you a boost in handling the management of project costs and successfully delivering projects within the stipulated budget.

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