Chapter 9 Contemporary Project Management Kloppenborg Budgeting Projects Chapter 9 Contemporary Project Management Kloppenborg © 2009 South-Western, a part of Cengage Learning

At the end of this chapter… Describe how to perform cost planning for a project and give four reasons for its importance. Compare and contrast methods of estimating cost and tell when each is appropriate. Compare and contrast pairs of cost terms. Describe several issues in cost estimating and how to deal with each. Create a bottom-up budget for a project.

At the end of this chapter… Assign costs per time period to determine commitments, invoiced amounts and cash flow. Describe activity based costing and its role in project budgeting. State several assumptions and constraints that apply when estimating for your example project. Describe three causes of variation that impact project cost and how to deal with each.

Cost Planning Involves developing a cost management plan for a project For small projects  Ensure accurate cost estimates Secure the funding Develop cost reporting procedures For large projects  Develop and use accurate cash flow estimates Cost management planning – “the document that sets out the format and establishes the activities and criteria for planning, structuring, and controlling the project costs.” PMBOK® Guide

Purposes of the Cost Management Plan The plan shows how to develop and share relevant, accurate and timely information for decision making The plan provides feedback linking the project to business objectives The plan provides detail and summary information The plan helps project stakeholders focus on schedule and performance as well as cost.

Cost Estimating Cost estimating is linked to scope, schedule, and resource planning Never lie to yourself You must understand what the project costs really are Never lie to anyone else Avoid shading the truth to secure necessary funding Cost estimating – “the process of developing an approximation of the cost of the resources needed to complete project activities.” PMBOK® Guide

Cost Estimating Types of costs Timing and accuracy of cost estimates Methods used to estimate costs Cost estimating issues

Types of Costs

Types of Costs – Fixed vs. Variable Fixed costs remain the same regardless of volume of work Variable costs vary directly with volume of use Cost curve reflects as low a total cost as possible at the current project size Fixed and variable costs involve consideration of the project scope

Project cost and volume curve

Types of Costs – Direct vs. indirect Direct costs only occur because of the project Direct labor Other direct costs – material, travel, consultants, subcontracts, purchased parts, computer time Indirect costs are costs necessary to keep the organization running that are not associated with one specific project Salaries, buildings, utilities, insurance, clerical assistance Costs are allocated across projects

Direct and Indirect Costs in a Work Package

Types of Costs – Recurring vs. Nonrecurring Recurring costs repeat as the project work continues Cost of writing cost; laying bricks Occur during project evaluation Nonrecurring costs happen only once during a project Design development Occur during project planning and closing

Types of Costs – Regular or Expedited Regular costs occur when progress can be made by normal work hours and purchasing agreements (the preferred cost) Expedited costs occur when the project must be conducted faster than normal Overtime and extra charge apply

Types of Costs – Estimate vs. Contingency reserve Project estimates to be aggressive – some estimates will run over and others cost less Project managers frequently add a contingency to cover activities that run over aggressive estimates Estimate – “a quantified assessment of the likely amount… It should always include an indication of accuracy.” PMBOK® Guide Contingency reserve – “the amount of funds… needed above the estimate to reduce the risk of overruns of project objectives to a level acceptable to the organization.” PMBOK® Guide

Types of Costs – Accrual vs. Cash Accounting Accrual – transactions are recorded in the time period the expense occurred Cash – records transactions when money is spent Cash accounting is more frequently used on projects

Accuracy and timing of cost estimates When should cost estimates be developed? How accurate do cost estimates need to be? How will cost estimates be used?

Accuracy and timing of cost estimates Costs in Project Initiation Necessary for project charter approval Estimates are only approximate Costs in Project Planning Cost estimates are more precise Cost estimates should be documented The level of confidence in the cost estimate should be described

Project Cost Estimate Comparisons

Estimate Names Order of magnitude Budget Definitive Often used to seek initial charter approval Created when limited project detail is available Ball park, conceptual, initial, or level one estimates Budget Definitive Rolling wave planning allows for creating a definitive estimate for the first stage of planning and an order of magnitude estimate for the rest of the project

Methods of estimating costs As more details of a project are known, more detailed estimating methods may be used Analogous estimating Parametric estimating Bottom-up estimating

Methods of estimating costs

Analogous Estimating Consider a similar project as a cost estimating starting point Requires that the organization have experience performing similar projects and actual cost of similar projects Analogous estimating – “an estimating technique that uses the cost along with measures of scale such as size, weight or complexity from a previous project to estimate cost for a similar, future project.” PMBOK® Guide

Analogous Estimating Requires knowledge of how the proposed project differs from the previous project Estimator needs to have experience with methods to be used in the project

Parametric estimating Involves finding more information regarding the project Parametric estimating – “an estimating technique that uses a statistical relationship between historical data and other variables to calculate project costs.” PMBOK® Guide

Bottom-up estimating Most detailed – specifications need to be very clear Time consuming Most accurate form of estimating Ensure every item is included Bottom-up estimating – “a method of estimating project costs in which the work is decomposed into more detail. An estimate is prepared of what is required to meet the requirements of each of the lower, more detailed pieces of work, and these estimates are then aggregated into a total quantity for the project.” PMBOK® Guide

Cost Estimating Method Comparison

Issues in project cost estimating

Issues in project cost estimating – Supporting detail Includes describing the scope, method used to create the estimate, assumptions, constraints, and range of possible outcomes Version control is critical

Issues in project cost estimating – Use of assumptions and constraints People from different backgrounds may make different assumptions Untrue assumptions cause more work or other problems Assumptions related to direct labor costs Workers will be paid at the prevailing wage rate of $14 per hour, Workers are already familiar in general with the technology being used on the project, Workers will be paid for 40 hours per week whether there is always that much work for them or not, Overtime will never be authorized, and The project schedule can be delayed if the only alternative is to pay overtime.

Issues in project cost estimating – Use of assumptions and constraints Constraints often dictate methods available for performing the work Examples of constraints: Only in-house workers will be used, No extra space will be provided, No extra budget will be allowed, and The current version of the XYZ software will be incorporated into the design.

Issues in project cost estimating The range of possible outcomes should always be stated with any project cost estimate There are many causes of variation in project costs Statisticians classify variation as coming from either normal or special causes

Normal and Special Cause Variation

Variation Occurs in all work processes Normal variation comes from small causes inherent in a work process Special cause variation is the result of something out of the ordinary

Securing services and supplies from vendors Use vendor bid analysis to determine whether the price is reasonable For competing buds, assume the lowest responsible offer is fair Prices may be determined in the market place Examine business papers and web sites Develop a “should cost estimate” Try to determine vendor effort expended and add a fair profit margin to arrive at a price

Value engineering A powerful method of double checking all of the chosen methods for accomplishing work and the features of the project deliverable A separate stage may be incorporated late in the project planning to ensure time is spent on value engineering Value engineering – “a creative approach used to optimize project costs, save time, increase profits, improve quality, expand market share, solve problems, and/or use resources more effectively.” PMBOK® Guide

Issues in project cost estimating – what type of accounting system is used Functional based accounting systems used historically Overhead (indirect) costs were assigned to a cost pool allocated to direct costs based on volume Contemporary approach Indirect costs form a larger percentage of total costs Allocation of indirect costs is more carefully considered

Activity based costing Indirect costs are allocated to fixed costs based on drivers Cost drivers Number of units produced Number of batches run Number of product variations Amount of facility utilized More involved methods for allocating indirect costs yields more accurate cost information

Life cycle costing Includes the total costs of creating and using the project during its useful life Consider disposition costs of the product after its useful life is complete

Time value of money Discounting the value of future revenue and cost streams will enable better project decisions Discount future dollars by the appropriate factor The finance department may provide the appropriate rate The rate depends on the underlying inflation rate plus the cost of capital

Cost Budgeting Aggregating costs Analyzing reserve needs Determining cash flow Cost budgeting – “the process of aggregating the estimated costs of individual activities or work packages to establish a cost baseline.” PMBOK® Guide

Aggregating Costs Direct and indirect costs add up to the cost baseline The cost baseline is an integral part of the project management plan The cost baseline can only be changed through a formal change management process Cost baseline – “the approved time-phased budget against which project execution is compared and deviations are measured for management control.” PMBOK® Guide

Aggregation of Project Budget

Analyzing Reserve Needs

Analyzing Reserve Needs Known knowns are discovered during planning and can be estimated directly Known unknowns are events discovered during risk identification that may or may not occur Unknown unknowns (unk unks) are totally unexpected occurrences that cause an increase in cost and/or schedule The money used to cover unk unks is called management reserve

Analyzing Reserve Needs The amount placed into contingency reserve is calculated during risk analysis The amount placed into management reserve is determined by how much uncertainty management feels exists in the project The cost baseline, contingency reserve, and management reserve are used to determine if sufficient funds are available

Determining cash flow Expenses are applied to individual activities in the schedule to see when case is needed Cash may be supplied through organization budgets on a periodic basis The cumulative amount of cash coming in to the project must meet or exceed demands for cash payouts

Project Cumulative Cash and Revenue

Establishing Cost Control Approved project budget serves as a baseline for project control Milestones are used as a typical measuring point Identified in the milestone schedule in the project charter Identified in constructing the project schedule Use cash flow projections to determine how much funding is expected to reach each milestone Create enough milestones to keep track of progress without creating an administrative burden

Using MS Project for Project Budgets MS Project supports bottom up and summary level cost modeling Bottom up cost modeling is based on the cost of each resource assignment Summary level cost modeling consists of a summary level estimate for all effort represented by that level

Develop Bottom-up Project Budget Assignment cost Activity cost Project total cost Various Perspectives

Assignment Cost Required data Assignment work hours Resource Standard Rate Resource Overtime Rate Assignment Cost = total number of assignment hours times the standard rate

Assign Cost Rates Source: Microsoft product screen shot reprinted with permission from Microsoft Corporation.

Activity Cost The sum of all assignment Costs values plus any activity Fixed Cost Start at the Gantt view, right-click and select split, select task usage view from the View menu

Task Usage View with Resource Work Form Source: Microsoft product screen shot reprinted with permission from Microsoft Corporation.

Various Perspectives Cost data may be viewed from a resource perspective using the Resource Usage view Assignment costs are summarized at the resource level The “unassigned” set represents activities with no assigned resources. Resources with no show/hide control have no assignments

Resource Usage View Source: Microsoft product screen shot reprinted with permission from Microsoft Corporation.

Develop Summary Project Budget Add a dummy activity under each phase summary not yet planned in detail Estimate the phase duration and the phase cost Put the duration estimate in the dummy activity’s duration field Put the cost estimate in the dummy activity’s Cost field Remove each dummy activity when detail is added

Dummy Activity for Late Phase Source: Microsoft product screen shot reprinted with permission from Microsoft Corporation.

Summary The cost management plan lays out how you plan to structure and control project costs Cost estimating can be challenging because some activities may have a great deal of variation. Many methods are available to assist in cost estimating.

Summary Cost budgeting includes aggregating individual costs, analyzing needs for cost reserves where uncertainty exits, and determining cash inflow and outflow. Establishing cost controls includes establishing cost reporting systems. MS Project can assist in developing either bottom-up project budgets or summary project budgets.