Premium Resources

Cost Management Overview

The concept of Earned value is one of the most critical topics of this chapter. For earned value, the PMP exam can have from 10-15 questions. More than half of the questions on Earned value require you to perform calculations. In this chapter, we will have in-depth understanding of this concept so that the exam becomes easy for you.

Time Management and Cost Management are strongly connected. Many of the topics covered in Cost Management are covered in Time Management as well. In Time Management, we studied the creation of work packages. These work packages were further bifurcated as activities. In multiple projects, cost estimates are created basis these activities. However, in large projects, cost estimates are created at control account level. This level will be equal to a work package level or higher than that.

Cost Management Plan

Though the Cost Management Plan is a required part of Project Management Plan, unlike time and scope management, it is not listed as a part of formally defined cost management process. The Develop Project management Plan in Integration Management involves creation of the cost management plan. Cost and Budget, these two words are used interchangeably in the exam. It is important to note that the step of creating the cost management plan exists irrespective of where it is created.

Cost Management Plan focuses on:

  • Planning cost for the project

  • Managing project to the cost

  • Control cost

  • Manage cost variances

Cost management plan forms a part of project management plan. Like other project management plans even cost management plans requires proactive thinking. Some important steps involved in cost management plan are:

  • The way in which the cost estimates should be stated

  • Cost estimates accuracy levels

  • Instructions for identifying, tracking and reporting cost performance

  • Reporting formats

  • Bifurcation and definitions of direct and indirect costs

  • Maximum cap for cost expenditure

  • Change control procedures required for cost changes

Maximum cap for cost expenditure allows project manager and members to allow variation for the cost. As the cost increases beyond the ceiling provided, actions should be taken to control it. These ceiling numbers (maximum cap) are proactively thought through by the project manager in the cost management planning stage.

Life Cycle Costing

Life cycle costing is taking into consideration of the whole life of the product, and not just the cost of the project. For example, a product costs $50,000 which has a very low maintenance cost ($5000) over its life period. An alternate product is available for $38,000 however, has higher maintenance cost amounting to $50,000 over the products life. As a project manager, would you prefer reducing the cost of the project by saving $12,000 (by buying the alternate product)? remember, this increases the maintenance cost for the company by $45,000. Or would you take into consideration the entire life cycle costing of the product and forgo $12,000 for a future saving of $45,000 for the company? You will be going with option 1 considering the Life Cycle costing of the product i.e. though it costs more initially, the maintenance costs is much lesser.

Value Analysis

Value analysis focuses on decreasing cost of the project without any degradation in scope and performance levels. A systematic identification of various functions, assignment of values to those functions and identifications of less costly resources and activities to be performed maintaining the performance levels is done in value analysis. Value Analysis concurs with value engineering.

Cost Risk

Any risk related to cost such as procurement risk, cost management risk is termed as cost risk. This risk is not just covered in risk management and requires to be covered in all phases of the project. The costs required to complete the project involve:

  • Quality efforts

  • Risk efforts

  • Project management activities

  • Resources

  • Direct and Indirect costs

  • Overhead costs

Types Of Cost

There are two types of cost:

Variable cost: As understood by the name, these costs vary with the amount of work being done. For example, the cost of raw material, labor wages, etc.

Fixed cost: These are non-variable costs. These costs are fixed and includes set up cost, working capital, lease (rent), etc.

A cost can be direct or indirect cost:

Direct Costs: The costs that can be directly attributed to the work done in the project is considered as Direct Costs. Examples: travel and entertainment expenses, stationary cost, labor salaries, etc.

Indirect Costs: The overhead items or costs incurred that cannot be apportioned to a specific project or activity and can be used for multiple projects are termed as Indirect costs.

Inputs To Estimating Costs

Following are the inputs that help in estimating costs better and quicker:

Scope Baseline: Scope baseline includes the project scope statement, WBS and WBS dictionary. It helps in allowing the project manager to know what is in-scope and what is out-of-scope.

Project Schedule: A schedule is required before a budget is created. The project schedule contains the list of activities, the allocated resources and the time when work will occur. Cost expenditure can be controlled if the project team is aware of the timing on when to buy the product. The other way that it can be controlled is when project expenditures are made in a time-phased manner. Thus, a schedule can affect cost. Likewise, cost can also affect the schedule. If an activity is to be executed on a project when the cost of purchasing the raw material is very high, the activity may need to be preponed or postponed for the reasons to accommodate the surge in price.

Human Resource Plan: The system to reward project members, rates of labor required and the number of resources (individuals) required for the project and their cost is arrived at by the human resource plan. This plan enables the project manager to keep the resources motivated to work achieving savings and still ensuring the cost of the project is controlled.

Risk Register: Risk is an effective contributor to reduce time and money associated with the project. Cost is required to the work required to manage and control risks. These costs can also lead to more risks such as cost risks. Thus, risk is both an input and output of Estimate Cost process.

Historical Records and Lessons Learned: Historical records from past projects are extremely helpful to make the cost calculations and the estimates easier. The templates provided by these records help in executing these efforts faster and quicker.

Enterprise Environmental Factors: Estimation of costs is done by the conditions prevailing in the market and the costs required for commercials. Products are procured from several vendors. It is also advisable for the project manager to review these sources and understand the effort of estimation.

Project Management Costs: Project management efforts also require costs. The expense of the project manager, status reports, change analysis, execution, etc are included in these costs.

How Is Estimating Done?

Costs can be estimated using the methods that we have already learned in the Time Management i.e. One-point estimating, analogous estimating, parametric estimating, and three-point (PERT) estimating. Another method of estimation that we will now study is bottom-up estimating technique.

Bottom-Up Estimating

A project is finely distributed in the form of activities and work packages. The technique of bottom-up estimating involves estimation of costs involved at activity or work package, rolling it up into control units and then finally to the overall project estimate. This is another reason why a WBS should be well created by the project team.

Related Topics