#7 PMP - Project Cost Management

#7 Project Cost Management

Project Cost Management includes the process involved in planning, estimating, budgeting and controlling cost so that the project can be completed within the approved budget. Cost is resource sacrificed or something given up in exchange. Cost usually measured in monetary units, such as dollars.

Project Cost Processes

 The knowledge area of project Cost Management consists of the following processes

Process	Project Phase	Key Deliverables
Plan Cost Management	Planning	Cost Management Plan
Estimate Costs	Planning	Activity Cost Estimates, Basis of estimates
Determine Budget	Planning	Cost baseline
Control Costs	Monitoring and Controlling	Work performance measurements

Plan Cost Management

Plan Cost Management is the process that establishes the policies, procedures, and documentation for planning, managing, expending, and controlling project costs. The key benefit of this process is that it provides guidance and direction on how the project costs will be managed throughout the project. The inputs, tools and techniques, and outputs of this process are

Inputs	Tools & Techniques	Outputs
Project management plan	Expert judgment	Cost management plan
Project Charter	Analytical techniques
Enterprise environmental factors	Meetings
Organizational process assets

Analytical Techniques

Developing the cost management plan may involve choosing strategic options to fund the project such as: self-funding, funding with equity, or funding with debt.

Organizational policies and procedures may influence which financial techniques are employed in these decisions. Techniques may include (but are not limited to): payback period, return on investment, internal rate of return, discounted cash flow, and net present value.

Cost Management plan

The cost management plan can establish the following:

-          Unit of measure. Each unit used in measurements (such as staff hours, staff days, weeks for time measures; or meters, liters …) is defined for each of the resources.

-          Level of precision. The degree to which activity cost estimates will be rounded up or down.

-          Level of accuracy. The acceptable range (e.g., ±10%) used in determining realistic activity cost estimates is specified, and may include an amount for contingencies

-          Organizational procedures links. The work breakdown structure (WBS) provides the framework for cost management plan allowing the consistency with estimates, budgets, and control costs. The WBS component used for project cost accounting is called the control account. Each control account is assigned a unique code or account number(s) that links directly to performing organization's account system.

-          Control Threshold. Variance threshold for monitoring cost performance may typically expresses as percentage deviations from baseline plan.

-          Rules of performance measurement. Earned Value Management (EVM) rules of performance management are set. For example, the cost management plan may:

o   Define the points in the WBS at which measurement of control account may performed.

o   Establishing the earned value measurement techniques to be employed.

o   Specify tracking methodologies and the earned value management computation equations for calculating projected estimate at completion (EAC) forecast to provide a validity check on the bottom-up EAC.

-          Report formats. The formats and frequency for the various cost reports are defined.

-          Process descriptions. Descriptions of each of the other cost management processes are documented.

-          Additional details. Additional details about cost management activities include, but are not limited to:

o   Description of strategic funding choices.

o   Procedure to account for fluctuations in currency exchange rates.

o   Procedure for cost recording.

Estimate Costs Process

Estimate Costs is the process of developing an approximation of the monetary resources needed to complete project activities. The key benefit of this process is that it determines the amount of cost required to complete project work. The inputs, tools and techniques, and outputs of this process are.

Inputs	Tools & Techniques	Outputs
Cost management plan	Expert judgment	Activity cost estimates
Human resource management plan	Analogous estimating Parametric estimating Bottom-up estimating Three-point estimating	Basis of estimates
Scope baseline	Reserve analysis	Project documents updates
Project schedule	Cost of quality
Risk register	Project management software
Enterprise environmental factors	Vendor bid analysis
Organizational process assets	Group decision-making techniques

Cost estimates are a prediction that is based on the information known at a given point in time. Cost estimates include the identification and consideration of costing alternatives to initiate and complete the project. Cost tradeoffs and risks should be considered, such as make versus buy, buy versus lease, and the sharing of resources in order to achieve optimal costs for the project. The accuracy of a project estimate will increase as the project progresses through the project life cycle. For example, a project in the initiation phase may have a rough order of magnitude (ROM) estimate in the range of −25% to +75%. Later in the project, as more information is known, definitive estimates could narrow the range of accuracy to -5% to +10%.

Analogous Estimating

When estimating costs, this technique relies on the actual cost of previous, similar projects as the basis for estimating the cost of the current project. Analogous cost estimating is generally less costly and less time consuming than other techniques, but it is also generally less accurate. Analogous cost estimates can be applied to a total project or to segments of a project, in conjunction with other estimating methods. Analogous estimating is most reliable when the previous projects are similar in fact and not just in appearance, and the project team members preparing the estimates have the needed expertise.

Parametric Modeling

Parametric estimating uses a statistical relationship between relevant historical data and other variables (e.g., square footage in construction) to calculate a cost estimate for project work. This technique can produce higher levels of accuracy depending upon the sophistication and underlying data built into the model. Parametric cost estimates can be applied to a total project or to segments of a project, in conjunction with other estimating methods.

Bottom-up Estimation.

Bottom-up estimating is a method of estimating a component of work. The cost of individual work packages or activities is estimated to the greatest level of specified detail. The detailed cost is then summarized or “rolled up” to higher levels for subsequent reporting and tracking purposes. The cost and accuracy of bottom-up cost estimating are typically influenced by the size and complexity of the individual activity or work package.

Reserve Analysis

Cost estimates may include contingency reserves (sometimes called contingency allowances) to account for cost uncertainty. Contingency reserves are the budget within the cost baseline that is allocated for identified risks, which are accepted and for which contingent or mitigating responses are developed. Contingency reserves are often viewed as the part of the budget intended to address the “known-unknowns” that can affect a project. For example, rework for some project deliverables could be anticipated, while the amount of this rework is unknown. The contingency reserve may be a percentage of the estimated cost, a fixed number, or may be developed by using quantitative analysis methods.

Estimates may also be produced for the amount of management reserve to be funded for the project. Management reserves are an amount of the project budget withheld for management control purposes and are reserved for unforeseen work that is within scope of the project. Management reserves are intended to address the “unknown unknowns” that can affect a project. The management reserve is not included in the cost baseline but is part of the overall project budget and funding requirements.

Determine Budget Process

Determine Budget is the process of aggregating the estimated costs of individual activities or work packages to establish an authorized cost baseline. The key benefit of this process is that it determines the cost baseline against which project performance can be monitored and controlled. The inputs, tools and techniques, and outputs of this process are

Inputs	Tools & Techniques	Outputs
Cost management plan	Cost aggregation	Cost baseline
Activity cost estimates	Reserve analysis	Project funding requirements
Basis of estimates	Expert judgment	Project documents updates
Scope baseline	Historical relationships
Project schedule	Funding limit reconciliation
Resource calendar
Risk register
Agreements
Organizational process assets

Cost Baseline

The cost baseline is the approved version of the time-phased project budget, excluding any management reserves, which can only be changed through formal change control procedures and is used as a basis for comparison to actual results. It is developed as a summation of the approved budgets for the different schedule activities.

Control Cost Process

Control Costs is the process of monitoring the status of the project to update the project costs and managing changes to the cost baseline. The key benefit of this process is that it provides the means to recognize variance from the plan in order to take corrective action and minimize risk. The inputs, tools and techniques, and outputs of this process are

Inputs	Tools & Techniques	Outputs
Project management plan	Earned value management	Work performance information
Project funding requirements	Forecasting	Cost forecast
Work performance data	T-complete performance index (TPCI)	Change requests
Organizational process assets	Performance reviews	Organizational process assets updates
	Reserve analysis	Project management plan updates
	Project management software	Project documents updates

Project cost control includes:

-          Influencing the factors that create changes to the authorized cost baseline;

-          Ensuring that all change requests are acted on in a timely manner;

-          Managing the actual changes when and as they occur;

-          Ensuring that cost expenditures do not exceed the authorized funding by period, by WBS component, by activity, and in total for the project;

-          Monitoring cost performance to isolate and understand variances from the approved cost baseline;

-          Monitoring work performance against funds expended;

-          Preventing unapproved changes from being included in the reported cost or resource usage;

-          Informing appropriate stakeholders of all approved changes and associated cost; and

-          Bringing expected cost overruns within acceptable limits.

Earned Value Management (EVM)

Earned value management (EVM) is a methodology that combines scope, schedule, and resource measurements to assess project performance and progress. It is a commonly used method of performance measurement for projects. It integrates the scope baseline with the cost baseline, along with the schedule baseline, to form the performance baseline, which helps the project management team assess and measure project performance and progress.

EVM develops and monitors three key dimensions for each work package and control account:

-          Planned value. Planned value (PV) is the authorized budget assigned to scheduled work. It is the authorized budget planned for the work to be accomplished for an activity or work breakdown structure component, not including management reserve. The total of the PV is sometimes referred to as the performance measurement baseline (PMB). The total planned value for the project is also known as budget at completion (BAC).

-          Earned value. Earned value (EV) is a measure of work performed expressed in terms of the budget authorized for that work. It is the budget associated with the authorized work that has been completed. The EV being measured needs to be related to the PMB, and the EV measured cannot be greater than the authorized PV budget for a component. The EV is often used to calculate the percent complete of a project. Progress measurement criteria should be established for each WBS component to measure work in progress. Project managers monitor EV, both incrementally to determine current status and cumulatively to determine the long-term performance trends.

-          Actual cost. Actual cost (AC) is the realized cost incurred for the work performed on an activity during a specific time period.

Variance from the approved baseline will also be monitored:

-          Schedule variance (SV) is a measure of schedule performance expressed as the difference between the earned value and the planned value. It is the amount by which the project is ahead or behind the planned delivery date, at a given point in time. The EVM schedule variance will ultimately equal zero when the project is completed because all of the planned values will have been earned.

Equation: SV = EV – PV

-          Cost variance (CV) is the amount of budget deficit or surplus at a given point in time, expressed as the difference between earned value and the actual cost. The CV is particularly critical because it indicates the relationship of physical performance to the costs spent. Negative CV is often difficult for the project to recover.

Equation: CV= EV − AC

-          The schedule performance index (SPI) is a measure of schedule efficiency expressed as the ratio of earned value to planned value. It measures how efficiently the project team is using its time. It is sometimes used in conjunction with the cost performance index (CPI) to forecast the final project completion estimates. An SPI value less than 1.0 indicates less work was completed than was planned. An SPI greater than 1.0 indicates that more work was completed than was planned.

Equation: SPI = EV/PV

-          The cost performance index (CPI) is a measure of the cost efficiency of budgeted resources, expressed as a ratio of earned value to actual cost. It is considered the most critical EVM metric and measures the cost efficiency for the work completed. A CPI value of less than 1.0 indicates a cost overrun for work completed. A CPI value greater than 1.0 indicates a cost underrun of performance to date.

Equation: CPI = EV/AC

Forecasting

As the project progresses, the project team may develop a forecast for estimate at completion (EAC) that may differ from the budget at completion (BAC) based on the project performance. Forecasting the EAC involves making projections of conditions and events in the project's future based on current performance information and other knowledge available at the time of the forecast.

EACs are typically based on actual costs incurred for work completed, plus an estimate to complete ETC the remaining work. It is incumbent on the project team to predict what it may encounter to perform the ETC, based on its experience to date. The EVM method works well in conjunction with manual forecast of required EAC cost. The most common EAC forecasting approach is a manual, bottom-up summation by the project manager and project team.

The project manager's bottom-up EAC method builds upon the actual costs and experience incurred for the work completed, and requires a new estimate to complete the remaining project work.
EAC = AC + Bottom-up ETC

Methods to Calculate EAC

The project manager's manual EAC is quick compared with a range of calculated EACs representing various risk scenarios. When calculating EAC values, the cumulative CPI and SPI values are typically used. While EVM data quickly provide many statistics EACs, only three of the more common methods are described as follow:

-          EAC forecast for ETC work performed at the budgeted rate. This EAC method accepts the actual project performance to data (whether favorable or unfavorable) as represented by the actual costs and predicts that all future ETC work will be accomplished at budgeted rate. When actual performance is unfavorable, the assumption that future performance will improve should be accepted only when supported by project risk analysis.

Equation: EAC = AC + (BAC - EV)

-          EAC forecast for ETC work performed at the present CPI. This method assumes what the project performance has experienced to data can be expected to continue in the future. The ETC work is assumed to be performed at the same time cumulative cost performance index (CPI) as that incurred by the project to date.

Equation: EAC = BAC/CPI

-          EAC forecast for ETC work considering both SPI and CPI factors. In this forecast, the ETC work will be performed at an efficiency rate that considers both cost and schedule performance indices. This method is most useful when the project schedule is a factor impacting the ETC effort. Variations of this method weight the CPI and SPI at different values (e.g. 80/20, 50/50, or some other ratio) according to the project manager's judgment.

Equation: EAC = AC + ((BAC-EV) / (CPI * SPI))

Each of these approaches is applicable for any given project and will provide the project management team with an early warning signal if the EAC forecast are not within acceptable tolerances.

To Complete Performance Index (TCPI)

The to-complete performance index (TCPI) is a measure of the cost performance that is required to be achieved with the remaining resources in order to meet a specified management goal, expressed as the ratio of the cost to finish the outstanding work to the remaining budget. TCPI is the calculated cost performance index that is achieved on the remaining work to meet a specified management goal, such as the BAC or the EAC. If it becomes obvious that the BAC is no longer viable, the project manager should consider the forecasted EAC. Once approved, the EAC may replace the BAC in the TCPI calculation. The equation for the TCPI based on the BAC: (BAC – EV) / (BAC – AC).

If the cumulative CPI falls below the baseline plan, all future work of the project will need to immediately be performed in the range of the TCPI (BAC) to stay within the authorized BAC. Whether this level of performance is achievable is judgment call based on number of considerations including risk, schedule, and technical performance. This level of performance is displayed as the TCPI (EAC) line.

The equation for the TCPI based on EAC: (BAC-EV) / (EAC-AC)

Performance Reviews

Performance reviews compare cost performance over time, schedule activities or work packages overrunning and underrunning the budget, and estimated funds needed to complete work in progress. If EVM is being used, the following information is determined:

-          Variance analysis. Variance analysis, as used in EVM, is the explanation (cause, impact, and corrective actions) for cost (CV = EV – AC), schedule (SV = EV – PV), and variance at completion (VAC = BAC – EAC) variances. Cost and schedule variances are the most frequently analyzed measurements. For projects not using earned value management.

-          Trend analysis examines project performance over time to determine if performance is improving or deteriorating. Graphical analysis techniques are valuable for understanding performance to date and for comparison to future performance goals in the form of BAC versus EAC and completion dates.

-          Earned value performance compares the performance measurement baseline to actual schedule and cost performance. If EVM is not being used, then the analysis of the cost baseline against actual costs for the work performed is used for cost performance comparisons.

Earned Value Calculations Summary Table

Earned Value Analysis
Abbreviation	Name	Lexicon Definition	How Used	Equation	Interpretation of Result
PV	Planned Value	The authorized budget assigned to scheduled work.	The value of the work planned to be completed to a point in time, usually the data date, or project completion
EV	Earned Value	The measure of work performed expressed in terms of the budget authorized for that work.	The planned value of all the work completed (earned) to a point in time, usually the data date, without reference to actual costs.	EV = sum of the planned value of completed work
AC	Actual Cost	The realized cost incurred for the work performed on an activity during a specific time period.	The actual cost of all the work completed to a point in time, usually the data date.
BAC	Budget at Completion	The sum of all budgets established for the work to be performed.	The value of total planned work, the project cost baseline.
CV	Cost Variance	The amount of budget deficit or surplus at a given point in time, expressed as the difference between the earned value and the actual cost.	The difference between the values of work completed to a point in time, usually the data date, and the actual costs to the same point in time.	CV = EV – AC	Positive = Under planned cost Neutral = On planned cost Negative = Over planned cost
SV	Schedule Variance	The amount by which the project is ahead or behind the planned delivery date, at a given point in time, expressed as the difference between the earned value and the planned value	The difference between the work completed to a point in time, usually the data date, and the work planned to be completed to the same point in time.	SV = EV – PV	Positive = Ahead of Schedule Neutral = On schedule Negative = Behind Schedule
VAC	Variance at Completion	A projection of the amount of budget deficit or surplus, expressed as the difference between the budget at completion and the estimate at completion.	The estimated difference in cost at the completion of the project.	VAC = BAC – EAC	Positive = Under planned cost Neutral = On planned cost Negative = Over planned cost
CPI	Cost Performance Index	A measure of the cost efficiency of budgeted resources expressed as the ratio of earned value to actual cost.	A CPI of 1.0 means the project is exactly on budget that the work actually done so far is exactly the same as the cost so far. Other values show the percentage of how much costs are over or under the budgeted amount for work accomplished.	CPI = EV/AC	Greater than 1.0 = Under planned cost Exactly 1.0 = On planned cost Less than 1.0 = Over planned cost
SPI	Schedule Performance Index	A measure of schedule efficiency expressed as the ratio of earned value to planned value.	An SPI of 1.0 means that the project is exactly on schedule, that the work actually done so far is exactly the same as the work planned to be done so far. Other values show the percentage of how much costs are over or under the budgeted amount for work planned.	SPI = EV/PV	Greater than 1.0 = Ahead of schedule Exactly 1.0 = On schedule Less than 1.0 = Behind schedule
EAC	Estimate At Completion	The expected total cost of completing all work expressed as the sum of the actual cost to date and the estimate to complete.	If the CPI is expected to be the same for the remainder of the project, EAC can be calculated using: If future work will be accomplished at the planned rate, use: If the initial plan is no longer valid, use: If both the CPI and SPI influence the remaining work, use:	EAC = BAC/CPI   EAC = AC + BAC – EV EAC = AC + Bottom-up ETC EAC = AC + [(BAC – EV)/ (CPI x SPI)]
ETC	Estimate to Complete	The expected cost to finish all the remaining project work.	Assuming work is proceeding on plan, the cost of completing the remaining authorized work can be calculated using: Reestimate the remaining work from the bottom up.	ETC = EAC – AC ETC = Reestimate
TCPI	To Complete Performance Index	A measure of the cost performance that must be achieved with the remaining resources in order to meet a specified management goal, expressed as the ratio of the cost to finish the outstanding work to the budget available.	The efficiency that must be maintained in order to complete on plan. The efficiency that must be maintained in order to complete the current EAC.	TCPI = (BAC – EV)/(BAC – AC) TCPI = (BAC – EV)/(EAC – AC)	Greater than 1.0 = Harder to complete Exactly 1.0 = Same to complete Less than 1.0 = Easier to complete Greater than 1.0 = Harder to complete Exactly 1.0 = Same to complete Less than 1.0 = Easier to complete