Project Cost Management

ITEC 459
Project Management
Project Cost Management

Learning Outcomes
Illustrate cost estimation of an IT project.
3.1 Explain the importance of estimating the cost of an IT
project.
3.2 Discuss different tools and techniques used for cost
estimation and problems that can arise with improper
estimation.
3.3 Discuss Earned Value Management and use it as a tool to
estimate cost.

Graduate Outcomes
 Critical and Creative Thinking
Cognitive Level: Knowledge

Lesson Objectives
 Understand Project Cost
 Apply Cost Management Planning
Processes
 Perform EVM calculations

Cost
Management
involves new
processes that
will be covered
in this lesson

Cost
 You get what you pay for!
 IT projects have a poor track record
for meeting budget goals
 Where does Budget overrun come from?
– Based on unclear project requirements
– PM’s do not have good financial estimate skills

Project Cost
 Cost is a resource sacrificed to achieve a
specific objective
 Costs are usually measured in monetary
units like dollars
 Project cost management includes the
processes required to ensure that the
project is completed within an approved
budget

Project Cost Management Processes
 Estimating costs: developing an
approximation or estimate of the
costs of the resources needed to
complete a project
 Determining the budget: allocating
the overall cost estimate to individual
work items to establish a baseline for
measuring performance
 Controlling costs: controlling
changes to the project budget

Project Cost Management
Summary

Basic Principles of Cost
Management
 Profits are revenues minus
expenditures
 Profit margin is the ratio of revenues
to profits
 Life cycle costing considers the total
cost of ownership, or development plus
support costs, for a project
 Cash flow analysis determines the
estimated annual costs and benefits for
a project and the resulting annual cash
flow

Cost of Downtime for IT
Applications

Basic Principles of Cost Management
 Tangible costs or benefits are those costs or
benefits that an organization can easily measure in
dollars
 Intangible costs or benefits are costs or benefits
that are difficult to measure in monetary terms
 Direct costs are costs that can be directly related to
producing the products and services of the project
 Indirect costs are costs that are not directly related
to the products or services of the project, but are
indirectly related to performing the project
 Sunk cost is money that has been spent in the past;
when deciding what projects to invest in or continue,
you should not include sunk costs

Basic Principles of Cost Management
 Learning curve theory states that when many items
are produced repetitively, the unit cost of those items
decreases in a regular pattern as more units are
produced
 Reserves are dollars included in a cost estimate to
mitigate cost risk by allowing for future situations that
are difficult to predict
– Contingency reserves allow for future situations that
may be partially planned for (sometimes called known
unknowns) and are included in the project cost
baseline
– Management reserves allow for future situations that
are unpredictable (sometimes called unknown
unknowns)

Resource Planning
 Determine what physical resources
(people, equipment, materials) and how
much of them (units)
 This can help you estimate costs

Quick Note
Using MS Project you can define all project resources
MS PROJECT 2007

1. Estimating Cost
 Cost estimating is the process of calculating the costs
of the identified resources needed to complete the
project work
 The person doing the estimating must consider the
possible fluctuations, conditions, and other causes of
variances that could affect the total cost of the
estimate
 Project teams normally prepare cost estimates at
various stages of a project, and these estimates
should be fine-tuned as time progresses
 It is also important to provide supporting details for
the estimates, including ground rules and
assumptions

Cost Management Plan
 A cost management plan is a
document that describes how the
organization will manage cost
variances on the project
 A large percentage of total project
costs are often labor costs, so
project managers must develop and
track estimates for labor

Cost Estimating Techniques
 Analogous estimates, also called top-down estimates
– use the actual cost of a previous, similar project as the basis for
estimating the cost of the current project
– This technique requires a good deal of expert judgment and is
generally less costly than others are, but it can also be less
accurate
 Example:
– An IT project to develop a certain application required
500 development hours. The total cost was $50,000
– A similar IT project is expected to be completed in 300
hours. What would be the cost?

 Bottom-up estimates
– involve estimating individual activities and
summing them to get a project total
– This approach can increase the accuracy of
the cost estimate, but it can also be time
intensive and, therefore, expensive to develop

 Parametric modeling
– uses project characteristics (parameters) in a
mathematical model to estimate project costs
– For example, in software development, the
software code could be estimated by $50 per
line depending on the type of software
– In other words, price per unit
It is good practice to use more than
one technique for creating a cost
estimate

Problems with IT Cost Estimates
 Estimates are done too quickly
 Lack of estimating experience
 Human beings are biased toward
underestimation
 Management desires accuracy

2. Determining the Budget
 Cost Budgeting is the process of assigning cost to
individual work item, based on the project’s WBS
 The difference between cost estimates and cost
budgeting is that cost estimates show costs by
category, whereas a cost budget shows costs
across time
 Inputs to project cost budgeting are the cost
estimates, the WBS and the project schedule

Quick Note
COST BUDGETING AND COST ESTIMATES MAY GO
HAND-IN-HAND, BUT ESTIMATING SHOULD
BE COMPLETED BEFORE A BUDGET IS ASSIGNED

Cost Baseline
 Cost Baseline is time-phased budget
that the PM uses to measure and
monitor the cost performance
 A project’s cost baseline shows what is
expected to be spent on the project
 The purpose of a cost baseline is to
measure performance, and a baseline
will predict the expenses over the life of
the project

Cost Baseline
 Budget At Completion (BAC)

3. Controlling the Cost
 Includes monitoring cost
performance, ensuring that
appropriate changes are
included in a revised cost
baseline and Informing
project stakeholders of
authorized changes to the
project that will affect costs
 Cost control is concerned
with understanding why the
cost variances, both good
and bad, have occurred

Cost Control Tools
 Tools include:
– Performance Management Reports
– Earned Value Management (EVM)
 EVM
– Earned Value Management (EVM) is the
process of measuring performance of
project work against a plan to identify
variances

EVM
 EVM is a project performance measurement
technique that integrates scope, time, and
cost data
 Given a baseline (original plan plus
approved changes), you can determine how
well the project is meeting its goals
 You must enter actual information
periodically to use EVM
 More and more organizations around the
world are using EVM to help control project
costs

EVM Values
 Planned Value (PV)
– The work scheduled and the authorized budget to
accomplish that work
– Also known as Budget Cost of Work Schedule (BCWS)
 Earned Value (EV)
– The physical work completed to date and the authorized
budget for that work
– Also known as Budgeted Cost of Work Performed
(BCWP)
 Actual Cost (AC)
– The actual amount of monies the project has required to
date
– Also known as Actual Cost of Work Performed (ACWP)

Rate of Performance (RP)
 Rate of performance (RP) is the
ratio of actual work completed to the
percentage of work planned to have
been completed at any given time
during the life of the project or
activity

Quick Example
A PROJECT HAS A BUDGET OF
$100,000 AND 12 MONTHS TO
COMPLETE

EVM Example: PV
 What's the PV in month 6?
– 6 months means 50% (6/12)
PV = 50% X $100,000 = $50,000
BAC = $100,000
Month = 6 (50%)
50% of the project
What’s the PV here?
PV = $50,000

EVM Example: EV
 If to date we finished 25% of the
work, what’s the EV?
EV = 25% X $100,000 = $25,000
BAC = $100,000
Month = 6
(50%)
What’s the EV here?
EV = $25,000
25%
completed
to date

EVM Example: AC
 But what if we actually spent so far
$35,000?
AC = $35,000
BAC = $100,000
Month = 6
(50%)
We actually spent $35,000
Even though the EV is $25,000
25%
completed
to date

Quick Question
Do you see a problem because AC > EV?
What does that tell you?
COST VARIANCE = EV – AC = -$10,000

CPI
 Cost Performance Index
– A value that demonstrates how the
project costs are performing
– CPI is a value that reveals how much
money the project is losing (or making)
CPI = EV / AC

CPI Example
 BAC =$100,000
 We completed 30%
EV = 30% x 100,000 = $30,000
 Actual Costs were
AC = $32,000
 CPI = EV/AC
CPI= 30,000/32,000 = 0.94
 If CPI = 0.94
– This means that for every $1we spent, we’ve
done only $0.94 worth of work (6 cents are
wasted)

Quick Note
CPI SHOULD BE VERY CLOSE TO 1
IF CPI < 1  POOR PERFORMANCE
IF CPI > 1  NOT NECESSARILY GOOD PERFORMANCE
(MAYBE OUR ESTIMATES WERE INFLATED)

EAC
 Estimate At Completion
– An estimate of what the total cost of the
project will be
– Before the project begins, the project
manager completes an estimate for the
project deliverables based on the WBS
– Different ways to calculate
EAC= BAC / CPI

EVM Example
Given
data
CV = EV – AC = 5000 -15000 = -10000
SV = EV – PV = 5000 – 10000 = -5000
CPI = EV/AC = 5000/15000 = 33%
SPI = EV /PV = 5000/10000 = 50%

CPI and Cumulative CPI
 Consider a company that took
earned value measurements at
monthly intervals for the past 3
months as summarized in the table
below:
EV AC
Month 1 $22,000 $13,700
Month 2 $151,000 $137,900
Month 3 $107,000 $98,400

Review
 Mark one value in each column that
shows the most desirable value.
SPI CPI Payback
Period
ROI
1 .5 16 mos. 9%
0 1 2 yrs. 12%
0.8 1.2 16 wks. -2%
1.2 1.15 25 mos. 3%

Review
 Project X was projected to take 4
months and cost $70,000 per month.
At the end of month one, the project
was 20% complete, and had spend
$89,000. At the end of month two, it
was 40% complete and had spent
$151,000. What is the cumulative
CPI for project at the end of month
two.

Project Cost Management

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