In addition to establishing a baseline schedule for a project, it is also necessary to develop a baseline budget. Estimates must be made of the costs for each specific activity. The project budget is determined by aggregating the estimated costs for all the activities. The budget must then be spread over the expected time span of the project to create a time-phased baseline budget that is used to analyze cost performance of the project. Once the project starts, it is important to monitor actual costs and earned value of the work performed. At regular intervals during the project, the following cost-related parameters should be monitored:
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Cumulative actual amount spent since the start of the project
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Cumulative earned value of the work performed since the start of the project
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Cumulative budgeted amount planned to be spent, based on the project schedule, from the start of the project.
Comparisons must be made among these three parameters to evaluate whether the project is being accomplished within budget and whether the earned value of the work performed is in line with the actual cost expended.
If at any time during the project it is determined that the project is overrunning the budget or the value of the work performed is not keeping up with the actual cost expended, corrective action must be taken immediately. Once project costs get out of control, it will be very difficult to complete the project within budget. As you will see in this chapter, the key to effective cost control is to analyze cost performance on a timely and regular basis. Early identification of cost variances allows corrective action to be taken before the situation gets worse. Based on the actual cost expended and the earned value of the work performed, you will learn how to regularly forecast whether the entire project will be completed within budget.
Based upon this chapter, you will become familiar with:
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Estimating the costs of activities
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Determining a time-phased baseline budget
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Determining the earned value of the work performed
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Analyzing cost performance
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Forecasting project cost at completion
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Controlling project costs
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Managing cash flow
After studying this chapter, the you should be able to:
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Estimate the cost of activities
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Aggregate the total budgeted cost
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Develop a time-phased baseline budget
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Describe how to accumulate actual costs
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Determine the earned value of work performed
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Calculate and analyze key project performance measures
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Discuss and apply approaches to control the project budget
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Explain the importance of managing cash flow
- Project Cost Management
- Real-World Project Management Examples
DoD is the source of project management techniques and is plagued by cost overruns. A project by the US Army was analyzed using earned value techniques. The assessment led to a reduction in the scope of the project to limit the losses and have a positive outcome for the funding spent.
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Department of Defense (DoD) projects have used project management techniques formally beginning in the 1950s within the U.S. Polaris missile development project. Critical paths were examined and managed.
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Although there are core practices to project management and earned value calculations, it seems that managing DoD projects requires additional factors to be considered, quite possibly because of the long time span from conception to production.
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Half of major defense programs are not meeting costs goals and 98 projects between 2008 and 2010 experienced a growth in budget by 9 percent.
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Most common reasons for failure to stay on time and within budget include budget pressure, schedule pressure, and changing user requirements.
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Examined hundreds of projects and developed a work flow process to help forecast the earned value and future costs of DoD projects more accurately
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To determine if the project should continue, the planned schedule and budget is compared to the actual performance and a number of ratios are calculated.
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Depending upon positive or negative magnitude of the ratios, a change in schedule or budget is implemented.
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Future Combat System was designed by the U.S. Army.
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The U.S. Army decided that the initial project for developing a Future Combat System for the entire army was not a feasible project.
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The initial project budget was $130 billion.
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After analysis that resulted in an estimate of $210 billion with only 86 percent of the performance delivered and a potential completion date of 2022.
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Earned value methods are a valuable asset in the tool set of a project manager. Using the cost estimates at completion in comparison to schedule, costs, and performance are good strategies to determine if a project should continue or be terminated. One of the most difficult decisions by a project manager is to terminate a project or limit its scope. The U.S. Army project managers made this difficult decision based on analysis of the costs, schedule, performance, and earned value.
Canada has aging power transmission lines that are inadequate to meet the needs of the country. New lines are needed. Two project teams from western Canada provide lessons learned to new project teams to help avoid cost and schedule overruns and the problems that plagued their power transmission line projects.
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Problems were identified by each of the western Canadian power transmission project teams.
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Topping both project teams’ lists of problems for their transmission line installation projects was high employee turnover, especially the turnover in the engineering and procurement aspects of the project.
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The continuing training of new personnel not only was a problem for engineering and procurement, a shortage of staff in general and changes in key project personnel and senior team members in the middle of the project caused milestones to not be met and increased project costs.
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The budgets for each project were subjected to inaccurate estimates of the work to be done by the project team and subcontractors submitted bids for work with inflated bid prices.
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Heavily imposed restrictions by the industry on the project team related to permits, licenses, landowners, and the environment were beyond the control of the project team yet delayed project progress as hearings had to be held and approvals obtained before work could be completed
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The teams offered solutions to future project teams.
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The top rated solution suggested future teams acquire a clear understanding of the scope of work and the client’s requirements and suggested they include sufficient time to spend with the subcontractors to clarify the scope of work and requirements necessary to complete all the work needed for the subtasks.
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This increased planning and clarification translates into spending more time creating realistic schedule and cost estimates based upon sound conceptual design with visits to the project sites and upon budget development by lead engineers, project managers, and key project personnel
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The project teams recommended that future project teams should be established that completed a specific project task before they were assigned to another task
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Using lessons learned from your prior projects will help you accurately estimate costs, budget, and schedules.
- Estimate Activity Costs
The total project cost is often estimated during the initiating phase of the project or when the project charter or a proposal is prepared
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The estimated cost for each specific activity can include the following elements:
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Labor -- estimated costs for the various types or classifications of people who are expected to work on the project, based on the estimated work time (not necessarily the same as the activity’s estimated duration) and the dollar labor rate for each person or classification
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Materials -- the estimated costs of materials that the project team or contractor needs to purchase for the project
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Equipment -- equipment that must be purchased as part of the project
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Facilities -- special facilities or additional space for the project team, for security, or for storing materials, or to build, assemble, and test the project end item (deliverable)
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Subcontractors and consultants -- outsourced when project teams or contractors do not have the expertise or resources to do certain project tasks
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Travel -- travel (other than local travel) required during the project
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Reserve -- also referred to as contingency, to cover unexpected situations that may come up during the project, such as items that may have been overlooked when the initial project scope was defined, activities that may have to be redone because they may not work the first time (redesigns), or a high-probability or high-impact risk that may occur
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Figure 7.1 depicts the estimated costs for each activity in the consumer market study project.
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It is good practice to have the person who will be responsible for the costs associated with the work make the cost estimates.
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Historical data can be used as on the current project.
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Cost estimates should be reasonable and realistic.
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At the beginning of the project, it may not be possible to accurately estimate the costs for all activities. This is especially true for longer-term projects. It may be easier to estimate the costs for near-term activities, but as the project progresses, the project team can progressively elaborate the estimated costs as more information is known or becomes clear to allow for more accurate estimated costs.
- Determine Project Budget
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The project budgeting process has two steps.
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First, the project cost estimate is allocated to the various work packages in the project work breakdown structure.
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Second, the budget for each work package is distributed over the duration of the work package.
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Allocating total project costs for the various elements to the appropriate work packages will establish a total budgeted cost (TBC) for each work package.
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There are two approaches to establishing the TBC for each work package: top-down and bottom-up.
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Often, the sum of the initial estimated costs is greater than the amount of funds budgeted by the sponsor. Several iterations may need to be made to reduce the costs.
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Figure 7.2 illustrates the allocation for a $600,000 project. The costs are assigned to each work package. -
When the budgets for all the work packages are summed, they cannot exceed the total project budgeted cost. -
Figure 7.3 and Figure 7.4 depict the network diagram and the work breakdown structure with costs assigned. This example is used throughout the remainder of this chapter.
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Once a total budgeted cost has been established for each work package, the second step in the project budgeting process is to distribute each TBC over the duration of its work package.
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A cost is determined for each period, based on when the activities that make up the work package are scheduled to be performed to create the time-phased budget.
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The cumulative budgeted cost (CBC) is the amount budgeted to accomplish the work scheduled to be performed up to that point in time. -
Figure 7.5 depicts the budgeted cost by period for the packaging machine project.
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Figure 7.6 depicts the cumulative budgeted cost curve for the packaging machine project. The points on the graph correspond to the cumulative total in Figure 7.5. -
The CBC for the entire project or each work package provides a baseline against which actual cost and work performance can be compared at any time during the project.
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The cumulative budget is the standard against which actual cost is compared.
- Determine Actual Cost
- Once the project starts, it’s necessary to keep track of actual cost and committed cost so they can be compared to the CBC.
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To keep track of actual cost on a project, it’s necessary to set up a system to collect, on a regular and timely basis, data on funds actually expended.
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Large projects will have charge codes for the work package numbers to determine how the actual costs compare to the planned costs.
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In many projects, large dollar amounts are expended for materials or services (subcontractors, consultants) that are used over a period of time longer than one cost reporting period.
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These committed costs need to be treated in a special way so the system periodically assigns a portion of their total cost to actual cost.
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Committed costs are also known as commitments or encumbered costs.
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Costs are committed when an item is ordered, even though actual payment may take place at some later time.
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As data are collected on actual cost, including portions of any committed cost, they need to be totaled by work package so they can be compared to the cumulative budgeted cost.
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Cumulative actual cost (CAC) should be calculated. -
Figure 7.7 indicates that at the end of week 8, $68,000 has actually been expended on this project, although only $64,000 was budgeted as shown in Figure 7.5. -
With the CAC values, it’s possible to draw a cumulative actual cost curve as shown in Figure 7.8.
- Determine Value of Work Performed
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Consider a project for painting ten similar rooms over ten days (one room per day) for a total budgeted cost of $2,000. The budget is $200 per room.
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At of the end of day 5, you determine that $1,000 has actually been spent, but what if only three rooms have been painted?
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Earned value, the value of the work actually performed, is a key parameter that must be determined throughout the project.
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Determining the earned value includes collecting data on the percent complete for each work package, and then converting this percentage to a dollar amount by multiplying the TBC of the work package by the percent complete.
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In many cases, the estimate is subjective.
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It’s important that the person estimating the percent complete not only assess how much work has been performed but also consider what work remains to be done.
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For example, in the project to paint ten rooms for $2,000, if three rooms have been completed, it’s safe to say that 30 percent of the work has been performed.
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The earned value is- 0.30 x $2,000 = $600
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Figure 7.9 depicts the cumulative percent complete by period for the packaging machine project. -
Figure 7.10 depicts the cumulative earned value by period for the packaging machine project. -
Figure 7.11 illustrates the CBC, CAC, and CEV for the entire project.
- Analyze Cost Performance
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The following four cost-related measures are used to analyze project cost performance:
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TBC (total budgeted cost)
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CBC (cumulative budgeted cost)
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CAC (cumulative actual cost)
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CEV (cumulative earned value)
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Plot CBC, CAC, and CEV curves on the same graph to reveal any trends toward improving or deteriorating cost performance.
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In the packaging machine project we see that:
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$64,000 was budgeted through the end of week 8.
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$68,000 was actually expended by the end of week 8. -
$54,000 was the earned value of work actually performed by the end of week 8.
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Figure 7.12 depicts the packaging machine project status as of week 8.
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The cost performance index (CPI) is a measure of the cost efficiency with which the project is being performed. The formula for determining the CPI is
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Cost performance index = Cumulative earned value/Cumulative actual cost
- CPI = CEV/CAC
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In the packaging machine project, the CPI as of week 8 is given by
- CPI = $54,000/$68,000 = 0.79
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This ratio indicates that for every $1.00 actually expended, only $0.79 of earned value was received.
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When the CPI goes below 1.0 or gradually gets smaller, corrective action should be taken.
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Another indicator of cost performance is cost variance (CV), which is the difference between the cumulative earned value of the work performed and the cumulative actual cost.
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Cost variance = Cumulative earned value – Cumulative actual cost
- CV = CEV – CAC
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In the packaging machine project, the cost variance as of week 8 is given by
- CV = $54,000 – $68,000 = –$14,000
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This calculation indicates that the value of the work performed through week 8 is $14,000 less than the amount actually expended.
- Estimate Cost at Completion
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Based on analysis of actual cost, it’s possible to forecast what the total costs will be at the completion of the project or work package.
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There are three different methods for determining the forecasted cost at completion (FCAC).
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The first method assumes the remaining work will be done at the same rate of efficiency as the work performed so far.
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Forecasted cost at completion = Total budgeted cost/Cost performance index
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For the packaging machine project, the forecasted cost at completion is given by:
FCAC = $100,000/0.79 = $126,582
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A second method for determining the forecasted cost at completion assumes that, regardless of the efficiency rate the project or work package has experienced in the past, the remaining work will be done according to budget.
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Forecasted cost at completion = Cumulative actual cost + (Total budgeted cost – Cumulative earned value)
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For the packaging machine project, the forecasted cost at completion is given by:
FCAC = $68,000 + ($100,000 – $54,000)
= $68,000 + $46,000
= $114,000
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A third method for determining the forecasted cost at completion is to re-estimate the costs for all the remaining work to be performed and add this re-estimate to the cumulative actual cost.
- FCAC = CAC + Re-estimate of remaining work to be performed
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Another measure is the to-complete performance index (TCPI)
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TCPI = (TBC – CEV)/(TBC – CAC)
TCPI = ($100,000 − $54,000)/($100,000 − $68,000)
= $46,000/$32,000
= 1.44
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- Control Costs
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The key to effective cost control is to analyze cost performance on a regular and timely basis.
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It’s crucial that cost variances and inefficiencies be identified early so that corrective action can be taken before the situation gets worse.
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Cost control includes the following:
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Analyzing cost performance to determine which work packages may require corrective action.
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Deciding what specific corrective action should be taken.
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Revising the project plan—including time and cost estimates—to incorporate the planned corrective action.
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When evaluating work packages that have a negative cost variance, focus on taking corrective actions to reduce the costs of two types of activities:
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Activities that will be performed in the near term. If you put off corrective actions until some point in the distant future, the negative cost variance may deteriorate.
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Activities that have a large cost estimate. Taking corrective measures that reduce the cost of a $20,000 activity by 10 percent will have a larger impact than totally eliminating a $300 activity.
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There are various ways to reduce the costs of activities.
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Substitute less expensive materials.
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Assign a person with greater expertise or more experience to perform or help with the activity.
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Reduce the scope or requirements.
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Increase productivity through improved methods or technology.
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In many cases, there will be a tradeoff—reducing cost variances will require a reduction in project scope or a delay in the project schedule.
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The key to effective cost control is aggressively addressing negative cost variances and cost inefficiencies as soon as they are identified.
- Manage Cash Flow
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It is important to manage the cash flow on a project.
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Managing cash flow means making sure sufficient payments are received from the customer in time so that you have enough money to cover the costs of performing the project.
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The key to managing cash flow is to ensure that cash comes in faster than it goes out.
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The contractor might try to negotiate payment terms that require the customer to do one or more of the following:
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Provide a down payment at the start of the project.
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Make equal monthly payments based on the expected duration of the project.
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Provide frequent payments, such as weekly or monthly payments rather than quarterly payments.
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The worst scenario from the contractor’s point of view is to have the customer make only one payment at the end of the project.
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The contractor can control its outflow of cash by delaying payment until it is due.
- Cost Estimating for Information Systems Development
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Chapter 4 defined the information system (IS) as a computer-based system that accepts data as input, processes the data, and produces information required by users.
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Chapter 5 revealed that scheduling is often done in a haphazard manner, resulting in a large number of IS projects not finishing on time.
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Chapter 6 reinforced the resource requirements planning necessary for people, hardware, software, data, and network resources.
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This chapter addresses cost estimating in an IS project. Accurately estimating costs and including a reserve are essential in creating a realistic budget to complete the work without cost overruns. Having a good plan and schedule helps to develop cost estimates and a baseline budget.
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Common errors in estimating costs include:
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Underestimating the work time necessary to complete an activity.
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Requiring rework to meet the user requirements.
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Underestimating growth in the project scope.
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Not anticipating new hardware purchases.
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Correcting flaws in excess of the reserve plan.
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Changing the design strategy.
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Increasing resources to fast-track phases of the SDLC.
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Recall from Chapters 4, 5, and 6 that Beth Smith was assigned to be the project manager by the IS Department of ABC Office Designs.
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Chapter 5 described how Beth had scheduled the ES, EF, LS, and LF times for the activities necessary to complete the Web-based reporting system development project for ABC Office Designs.
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Chapter 6 described how Beth and the project team planned the resources for the 60-day schedule they have to complete the project. Management approved a budget of $125,000 to complete the project and train the sales staff.
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After confirming with the primary responsible resources that the tasks could be completed with the estimated level of effort on each task,
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Beth worked with the human resources team to use the hourly wage for each of the employees to determine the labor costs for each of the Web-based Reporting System project activities.
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Beth and the project team estimated the costs associated with traveling to complete the interviews with users ($3,000), the price of the packaged software ($500), and the costs of the training materials ($1,300).
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The budgeted costs of the work to complete the project were near the $125,000 limit without training the sales staff.
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Figure 7.13 depicts the estimated activity costs for the Web-Based Reporting Development project with a 5% reserve for cost overruns, fast-tracking of the project, or increased costs of materials or travel for the interviews.
- Project Management Information Systems
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All costs associated with each resource in a project can be stored, and the software will calculate the budget for each work package and for the entire project.
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Project management software usually allows the user to define different rate structures for each resource and when charges for those resources will actually be accrued.
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Cost tables and graphs are often available to help analyze cost performance.
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See Appendix A in the textbook for a thorough discussion of Project Management Software.
- Critical Success Factors
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Estimated activity costs must be based on the estimated activity resources.
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The person who will be responsible for performing the activity should estimate the costs for that activity. This generates commitment from the person.
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Cost estimates should be reasonable and realistic.
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Once the project starts, it is important to monitor actual costs and work performance to ensure that everything is within budget.
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A system should be established to collect, on a regular and timely basis, data on costs actually expended and committed, and the earned value (percent complete) of the work performed, so they can be compared to the cumulative budgeted cost (CBC).
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If at any time during the project it is determined that the project is overrunning the budget, or the value of the work performed is not keeping up with the actual amount of costs expended, corrective action must be taken immediately.
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It is important to use the time-phased cumulative budgeted cost (CBC), rather than the total budgeted cost (TBC), as the baseline against which cumulative actual cost (CAC) is compared. It would be misleading to compare the actual costs expended to the total budgeted cost, because cost performance will always look good as long as actual costs are below the TBC.
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To permit a realistic comparison of cumulative actual cost to cumulative budgeted cost, assign portions of the committed costs to actual costs while the associated work is in progress.
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The earned value of the work actually performed is a key parameter that must be determined and reported throughout the project.
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For each reporting period, the percent complete data should be obtained from the person responsible for the work. It is important that the person make an honest assessment of the work performed relative to the entire work scope.
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One way to prevent inflated percent complete estimates is to keep the work packages or activities small in terms of scope and duration. The person estimating the percent complete should assess not only how much work has been performed but also what work remains to be done.
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The key to effective cost control is to analyze cost performance on a timely and regular basis. Early identification of cost variances (CV) allows corrective actions to be taken immediately, before the situation gets worse.
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For analyzing cost performance, all the data collected should be as current as possible and be based on the same reporting period.
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Trends in the cost performance index (CPI) should be monitored carefully. If the CPI goes below 1.0 or gradually decreases, corrective action should be taken.
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As part of the regular cost performance analysis, the estimated or forecasted cost at completion (FCAC) should be calculated.
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The key to effective cost control is to aggressively address work packages or activities with negative cost variances and cost inefficiencies as soon as they are identified. A concentrated effort must be applied to these areas. The amount of negative cost variance should determine the priority for applying these concentrated efforts.
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When attempting to reduce negative cost variances, focus on activities that will be performed in the near term and on activities that have large estimated costs.
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Addressing cost problems early will minimize the negative impact on scope and schedule. Once costs get out of control, getting back within budget becomes more difficult and is likely to require reducing the project scope or quality or extending the project schedule.
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The key to managing cash flow is to ensure that cash comes in faster than it goes out.
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It is desirable to receive payments from the customer (cash inflow) as early as possible, and to delay making payments to suppliers or subcontractors (cash outflow) as long as possible.
- Summary
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The total project cost is often estimated during the initiating phase of the project when the project charter or a proposal is prepared, but detailed plans are not usually prepared at that time.
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The project budgeting process has two steps: the budget for each work package is determined, and the budget for each work package is then distributed over the expected time.
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Aggregating the estimated costs of the specific activities for the appropriate work packages in the work breakdown structure will establish a total budgeted cost (TBC).
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The cumulative budgeted cost (CBC) is the time-phased baseline budget that will be used to analyze the cost performance of the project.
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At any time during the project, it is possible to forecast what the total costs will be at the completion of the project or work package based on analysis of actual cost expended and the earned value of work performed.
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The key to effective cost control is to analyze cost performance on a regular and timely basis.
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It is important to manage the cash flow on a project.