Chapter 9 Cost Planning and Performance 1 1 1 1 1 1 1 1 1

Learning Objectives Items to consider when estimating cost Preparing a baseline budget Cumulating actual costs Determining the earned value of work performed Analyzing cost performance Forecasting project cost at completion Controlling project costs Managing cash flow 2 2 2 2 2 2 2 2 2 2 2 2

Real World Example Vignette: Feds Miscalculate Costs Department of Defense (DOD) knew that data used to calculate costs of closing Fort Monmouth were incorrect and would lead to underestimating the project’s cost by hundreds of millions of dollars. Officials had written a memo warning DOD about the inaccurate data. The Base Realignment and Closure (BRAC) commission voted in August 2005 to close the fort and move it to Aberdeen Proving Ground for a cost of about $780 million. The correct estimate to close the fort could be closer to $1.5 billion. Two years later, the DOD was forced to admit the miscalculation when its Fiscal Year 2008 budget estimated the total cost at about $1.5 billion. A Gannett New Jersey review revealed that a warning about the incorrect information that was sent to the DOD on July 8, 2005 by Fort Monmouth officials. 3 3 3 3 3 3 3 3 3 3 3 3

Real World Example Vignette: A $4 million Landscape Project Total cost of fixing the massive landslide problem next to Rancho Santa Fe Road in Carlsbad, California had risen from $1 million to almost $4 million. City officials remained optimistic. Initially the project was estimated to cost less than $1 million. Once work had begun the city realized they underestimated the scope and complexity. They believe they finalized their projects after adding in another $1.95 million bringing the new total to almost $3.9 million. Meanwhile across town, another project has been started on another landslide site, the Marbella landslide. After extended legal battles, the Homeowners Association decided that they would work with the city to revise their landslide agreement. City officials are hoping they won’t face the same kind of project cost overruns that happened on the Agua Dulce landslide! 4

Project Cost Estimates Cost planning starts with the proposal. The cost section may include: Labor Materials Subcontractors and consultants (if used) Equipment and facilities rental Travel Contingencies 5

Project Budgeting: Two Steps First, the project cost estimate is allocated to the various work packages in the project work breakdown structure. Second, the budget for each work package is distributed over the duration of the work package. 6 5 5 4 5 4 5 4 4 4

Allocating the Total Budgeted Cost Allocating total project costs for the various elements to the appropriate work packages will establish a total budgeted cost (TBC) for each work package. There are two approaches to establishing the TBC for each work package: top-down and bottom-up. When all budgets are summed, they cannot exceed the TBC. 7 7 7 5 7 5 6 5 5 5

Developing the Cumulative Budgeted Cost The second step is to distribute each TBC over the duration of its work package. A cost is determined for each period. The cumulative budgeted cost (CBC) is the amount that was budgeted to accomplish the work that was scheduled to be performed up to that point in time. One uses the CBC as the standard against which actual cost is compared. 8 8 8 6 8 6 7 6 6 6

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Determining Actual Cost Track actual cost by establishing a system to collect data on funds actually expended. Periodically assign a portion of the total committed cost to actual cost. Funds may be committed but not yet paid Total actual and committed cost by work package for comparison to the CBC. Cumulative actual cost (CAC) should be calculated. 11 10 10 7 10 7 8 7 7 7

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Determining the Value of Work Performed Earned value is the value of the work actually performed. Determine earned value by collecting data on the percent complete for each work package. Convert this percentage to a dollar amount by multiplying the TBC of the work package by the percent complete. 14 11 11 8 11 8 9 8 8 8

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Cost Performance Analysis Four Measures TBC (total budgeted cost) CBC (cumulative budgeted cost) CAC (cumulative actual cost) CEV (cumulative earned value) 17 14 14 9 14 9 10 9 9 9

Cost Performance Index (CPI) A measure of the cost efficiency with which the project is being performed. CPI = Cumulative Earned Val ------------------------------- Cumulative Actual Cost 18 16 16 10 16 10 11 10 10 10

Cost Variance (CV) The difference between the cumulative earned value of the work performed and the cumulative actual cost. Cost variance = Cum earned value – Cum actual cost 19 17 17 11 17 11 12 11 11 11

Cost Forecasting: Three Methods Three methods for determining forecasted cost at completion (FCAC): FCAC = TBC / CPI Project continues at same rate of efficiency FCAC = CAC + (TBC - CEV) Remaining work performed at CPI = 1 FCAC = CAC + Re-estimate of remaining work New forecast for remaining work 20 18 18 12 18 12 13 12 12 12

Cost Control The key is to analyze cost performance on a regular and timely basis. Identify cost variances and inefficiencies early. 21 19 19 13 19 13 14 13 13 13

Cost Control (Cont.) Involves the following: Analyzing cost performance to determine which work packages may require corrective action. Deciding what corrective action should be taken Revising the project plan. When evaluating work packages that have a negative cost variance, focus should be on taking corrective actions to reduce the costs of: Activities that will be performed in the near term. Activities that have a large cost estimate. 22

Ways to Reduce Costs of Activities Substitute less expensive materials. Assign a person with greater expertise to perform or help with the activity. Reduce the scope or requirements. Increase productivity through improved methods or technology. 23 20 20 14 20 14 16 14 14 14

Managing Cash Flow Make sure that sufficient payments are received from the customer in time for you to cover the costs of performing the project. The key to managing cash flow is to ensure that cash comes in faster than it goes out. 24 21 21 15 21 15 17 15 15 15

Project Management Software All costs associated resources can be stored. The software calculates the budget for each work package and for the entire project. The software allows the user to define different rate structures for each resource and when charges for those resources will be accrued. Cost tables and graphs are available to help analyze cost performance. 25 22 22 16 22 16 18 16 16 16