Project Cost Management
Successful projects accomplish the stated project goals, with minimal scope creep, and do so within the approved budget. By implementing project cost management into your project management processes, you can control the costs of your project while maintaining quality and meeting deadlines.
Table of Contents
- What is project cost management?
- Why is cost management important?
- The benefits of implementing project cost management.
- The challenges of project cost management.
- Project cost management tools.
- Frequently asked questions.
What is project cost management?
Cost management in project management involves the planning, estimating and overall control of budget. Cost management processes are in place to help project teams plan and control budgets during the project life cycle.
While cost management overall is a complicated process and a critical project management knowledge area, we can break it down into four processes:
1. Resource planning.
While resource management is in place to plan, allocate, and schedule the resources needed for each stage of a project, resource planning looks specifically at the costs associated with each of these resources.
Because of the complexity of this process, a work breakdown structure (WBS) can help to simplify and provide clarity.
Using your resource management software, identify what resources will be used to complete each item in the WBS, determine the associated costs, and perform a cost-benefit analysis.
2. Cost estimation.
Cost estimation is the process of approximating the costs associated with each of the resources required for all scheduled activities. It’s an important part of the cost management process.
Cost estimating forecasts the cost of completing a project within a defined scope. Given that scope tends to shift throughout the life of a project, cost estimation is not a one-time process.
Effective cost management requires project managers to keep abreast of budgetary changes during a project’s lifespan. These estimations sum up all the costs involved in successfully completing a project.
To get a good estimate at the costs, you can use one of the following techniques:
- Analogous estimating – Past projects should inform the cost estimate, here. Analogous estimations use previous, similar projects as a reference point for costing up the new one.
- Parametric modeling – Mathematical formulas, based on Regression Analysis or Learning Curve models, inform potential project cost estimations.
- Bottom-up estimating – Costs are based on known quantities, such as individual work or item cost and duration or time spent on individual tasks.
3. Cost budget.
Cost estimations lead directly into cost budgets. Here, you’ll work out the base costs and any additional requirements for the project.
A good project budget will help you make key decisions with respect to the project schedule and resource allocation constraints.
These budgets should account for everything from direct labor costs, to material costs, factory costs, equipment costs, administrative costs, and software costs.
To set the cost budget, consider the following techniques:
- Cost aggregation – This requires you to aggregate or combine costs from an activity level to a work package level. The final sum of the cost estimates is applied to the cost baseline.
- Reserve analysis – With this cost management method, you create a buffer or reserve to protect against cost overruns. The degree of protection should be equivalent to the risk foreseen in the project. The buffer is part of the project budget, but not included in the project baseline.
- Historical data – Under this technique, you use estimates from closed projects to determine the budget of the new project. This is very similar to analogous estimation.
- Funding limit reconciliation – Here, you adhere to the constraints of a funding limit. This is based on the limited amount of cash dedicated to your project. To avoid large variations in the expenditure of project funds, you may need to revise the project schedule or the use of project resources.
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4. Cost control.
Good project managers should have a constant eye on cost and potential scope creep. This includes being vigilant for times when costs vary from estimations. Cost control also involves informing the stakeholders of cost discrepancies that vary too much from the budgeted cost.
Controlling the budget means being aware of the:
- Original budget
- Approved costs
- Forecasted costs
- Actual costs
- Committed costs
Budget control involves being aware of and acting on changes and issues as and when they occur.
To effectively control project costs, consider these tools and techniques:
- Earned value management – This uses a set of formulas to help measure the progress of a project against the plan. It integrates schedule, scope and costs to measure project success against planned and actual values. Benefits include measuring cost alongside other factors.
- Forecasting – This uses a project’s current financial situation to project future costs. The forecast is based on budgeted cost, total estimated cost, cost commitments, cost to date, and any over or under budgeted costs. It can be useful as part of the controlling and monitoring phase.
- To-Complete Performance index (TCPI) – A cost management tool that represents the level of project performance needed for future work to meet the budget. Useful to make decisions about efficiency when a project is under way. A TCPI figure above 1.0 indicates your project is running above budget.
- Variance analysis – A technique that involves analyzing the differences between the budget and final cost projections.
- Performance reviews – These are used to check the health of a project. A performance review includes an analysis of project costs, schedule, scope, quality and team morale. This may help to gain a broader view — for instance, if you suspect an unprofitable project will cause talent drain in the long term.
By learning how to estimate expenses, determine budgets, and control costs, you can be a better project manager and leader. Effective cost management will help you get projects done on time and under budget, the golden ticket for any successful project manager.
Why is cost management important?
In project management, the cost management process is an important tool to keep profits healthy, reducing the risk your project could become unviable. When you define what healthy finances look like, it’s easy to make decisions in real time when work is underway.
- Does an aspect of the work need scaling back?
- Do you need to cut investment in a low-priority area?
The earlier these questions are answered, the more opportunity there is for a project manager to recalibrate and preserve return on investment (ROI).
The importance of cost management comes into play from the very beginning of the project lifecycle, however. This is because costs and budgets affect key project decisions — from the people you hire to the materials you use.
When a project doesn’t stay within budget, it can remain incomplete, harming a project manager’s reputation. In a worst-case scenario, mismanaged costs can make an organization unviable.
Great project cost management lets you generate data to share with stakeholders. When you view this using intuitive software, it’s easy to lift insights for future project plans.
The benefits of implementing project cost management.
The project cost management process empowers you to plan a project well, make informed decisions once activities are underway, and measure success.
Keep track of multiple types of project cost, including:
- Direct costs – These include money earmarked for software fees and other mission-critical overheads.
- Indirect costs – In business, indirect costs are a fact of life. Each individual project contributes to your organization’s electricity bill, for instance.
- Fixed costs – One-off fees may be considered fixed, since they aren’t linked to time management.
- Variable costs – This type of cost rises if a project is extended or delayed. Staffing costs are a common example.
- Sunk costs – These are purchases that have already been made, effectively the cost is deemed to be sunk.
Understanding each can help you to differentiate and find ways to make savings.
The challenges of project cost management.
When elements of your project plan change, the corresponding cost figures will alter too. Losing grip of your project’s scope is a fast way to also lose track of costs, putting your entire project at risk.
Accurate cost management also requires schedule and cost integration. Communication can be key for this. Ask your finance analysts to provide direction to managers responsible for aspects of project delivery, and for teams to report back on issues in turn. If tasks are stretching beyond timelines in the original plan, this should be reflected in a project manager’s calculations right away.
Finally, when reporting is slow or inaccurate, it makes the above aims harder to achieve. Check figures for accuracy regularly to avoid surprises.
Project cost management tools.
A work management software like Adobe Workfront provides a centralized location for all project data and information, helping you to stay aware of variances in the budget, make approvals, track comments, and see all-important project data.
Frequently asked questions.
How do you manage project costs?
To manage project costs effectively, bring together all elements of a strong project cost management plan. This involves resource planning, cost estimation, cost budgeting and cost control.
Managing project costs requires strategic thinking and careful processes at every stage. Though it’s important to budget well, losing track of time or resources can also increase costs.
What are the three main methods of cost estimating?
The three main methods of estimating cost are the:
- Expert judgement – The quickest and involves asking expert people or groups to provide insight. They may use data on past projects also.
- Parametric estimating – Uses statistical information about the relationship between variables and may use an algorithm to map past project data onto current plans.
- Analogous estimating – something of a half-way house between the above two methods. Uses values such as scope, duration and project-specific measures from past activities. The actual costs in previous projects help to shape estimates.
How are project costs aggregated?
Project costs are aggregated – combined and calculated – by adding the baseline cost estimates for each element of a project and its subtasks. With the sum of the lowest estimates for each part, a project manager can get a sense of the minimum costs to plan for.
Cost aggregation also allows you to see scheduled spending for each subtask and time period. It also helps to calculate the cost-performance baseline, helping project managers keep track of cash flow throughout the project life cycle.