1. Chapter 6 Project Cost Management

2. 2 Learning Objectives Explain basic project cost management principles, concepts, and terms. Discuss different types of cost estimates and methods for preparing them.

3. 3 Learning Objectives Understand the processes involved in cost budgeting and preparing a cost estimate and budget. Understand the benefits of earned value management and project portfolio management to assist in cost control. Describe how project management software can assist in project cost management.

4. 4 What is Cost and Project Cost Management? Cost is a resource sacrificed or foregone to achieve a specific objective, or something given up in exchange. Costs are usually measured in monetary units, such as dollars. Project cost management includes the processes required to ensure that the project is completed within an approved budget.

5. 5 Project Cost Management Processes Cost estimating: Developing an approximation or estimate of the costs of the resources needed to complete a project. Cost budgeting: Allocating the overall cost estimate to individual work items to establish a baseline for measuring performance. Cost control: Controlling changes to the project budget.

6. Basic Principles of Cost Management Profits are revenues minus expenditures Profit margin is the ratio of revenues to profits $2 profit per $100 revenue  2% profit margin Life cycle costing considers the total cost of ownership, or development plus support costs, for a project A project could take 2 years to build and be in place for 10 years; costs and benefits must be estimated for the entire lifetime of the project 6 Information Technology Project Management, Fifth Edition, Copyright 2007

7. 7 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.

8. 8 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).

9. 9 Cost Estimating Project managers must take cost estimates seriously if they want to complete projects within budget constraints. It’s important to know the types of cost estimates, how to prepare cost estimates, and typical problems associated with IT cost estimates.

10. Cost Estimating A rough order of magnitude (ROM) estimate provides an estimate of what a project will cost. Also referred to as a ballpark estimate, a guesstimate, a swag, or a broad gauge. Done very early in a project, often three or more years prior to project completion, or even before a project is officially started to help PMs make project selection decisions. Accuracy is typically -50 percent to +100 percent, meaning the project’s actual costs could be 50 percent below the ROM estimate or 100 percent above. A ROM estimate that actually cost $100,000 would range between $50,000 to $200,000. The accuracy range is often much wider for IT projects. Often IT project estimates for software development are doubled because of the history of cost overruns 10 Information Technology Project Management, Fifth Edition, Copyright 2007

11. Cost Estimating A budgetary estimate is used to allocate money into an organization’s budget. Many organizations develop budgets at least two years into the future. Budgetary estimates are made one to two years prior to project completion. The accuracy of budgetary estimates is typically - 10% to +25% A budgetary estimate that actually costs $100,000 would range between $90,000 to $125,000. 11 Information Technology Project Management, Fifth Edition, Copyright 2007

12. Cost Estimating A definitive estimate provides an accurate estimate of project costs (most accurate of the three types). Definitive estimates are used for making many purchasing decisions for which accurate estimates are required and for estimating final project costs. For example, if a project involves purchasing 1000 personal computers from an outside supplier in the next three months, a definitive estimate would be required to aid in evaluating supplier proposals and allocating the funds to pay the chosen supplier. Definitive estimates are made one year or less prior to project completion Accuracy range is normally -5% to +10% 12 Information Technology Project Management, Fifth Edition, Copyright 2007

13. Types of Cost Estimates 13 Information Technology Project Management, Fifth Edition, Copyright 2007 It is important to provide supporting details (assumptions, project scope, WBS, etc) used in computing estimates so that it will be easier to prepare updates as needed or similar estimates on other projects.

14. 14 Methods of Cost Estimating

15. 15 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.

16. 16 Cost Estimation Tools and Techniques Basic tools and techniques for cost estimates : Analogous or top-down estimates: Use the actual cost of a previous, similar project as the basis for estimating the cost of the current project. Bottom-up estimates: Involve estimating individual work items or activities and summing them to get a project total. Parametric modeling: Uses project characteristics (parameters) in a mathematical model to estimate project costs. Computerized tools: Tools, such as spreadsheets and project management software, that can make working with different cost estimates and cost estimation tools easier.

17. Information Technology Project Management, Fifth Edition, Copyright 2007 17 Cost estimating inputs, tools and outputs

18. 18 Constructive Cost Model (COCOMO) Barry Boehm helped develop the COCOMO models for estimating software development costs. Parameters include: Function points: Technology-independent assessments of the functions involved in developing a system. Source Lines of Code (SLOC): A human-written line of code that is not a blank line or comment. Boehm suggests that only parametric models do not suffer from the limits of human decision-making.

19. 19 Typical Problems with IT Cost Estimates Developing an estimate for a large software project is a complex task that requires a significant amount of effort. People who develop estimates often do not have much experience. Human beings are biased toward underestimation. Management might ask for an estimate, but really desire a bid to win a major contract or get internal funding.

20. 20 Surveyor Pro Project Cost Estimate

21. 21 Surveyor Pro Software Development Estimate

22. 22 Cost Budgeting Cost budgeting involves allocating the project cost estimate to individual work items over time. The WBS is a required input for the cost budgeting process because it defines the work items. Important goal is to produce a cost baseline: A time-phased budget that project managers use to measure and monitor cost performance.

23. Information Technology Project Management, Fifth Edition, Copyright 2007 23 Outputs cost Baseline Project Funding Requirements Cost Management Plan(updates) Requested Changes Tools and Techniques Cost Aggregation Reserve Analysis Parametric Estimating Funding Limit Reconciliation Inputs Project Scope Statement Work Breakdown structure WBS Dictionary Activity Cost Estimates Activity Cost Estimates – supporting details Project schedule Resource Calendar Contract Cost Management Plan Cost budgeting inputs, tools and outputs

24. 24 Surveyor Pro Project Cost Baseline

25. 25 Cost Control Project cost control includes: Monitoring cost performance. Ensuring that only appropriate project changes are included in a revised cost baseline. Informing project stakeholders of authorized changes to the project that will affect costs. Many organizations around the globe have problems with cost control.

26. Cost Control Performance measurement is another important tool for cost control There are many general accounting approaches for measuring cost performance but earned value management is a tool unique to project management 26 Information Technology Project Management, Fifth Edition, Copyright 2007

27. Earned Value Management (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 Was a WBS item completed or approximately how much of the work was completed Actual start and end dates Actual cost 27 Information Technology Project Management, Fifth Edition, Copyright 2007

28. Earned Value Management Terms The planned value (PV), formerly called the budgeted cost of work scheduled (BCWS), also called the budget, is that portion of the approved total cost estimate planned to be spent on an activity during a given period Actual cost (AC), formerly called actual cost of work performed (ACWP), is the total of direct and indirect costs incurred in accomplishing work on an activity during a given period $20,000 AC to accomplish task over two weeks - $15K AC week 1and $5K week 2 The earned value (EV), formerly called the budgeted cost of work performed (BCWP), is an estimate of the value of the physical work actually completed EV is based on the original planned costs for the project or activity and the rate at which the team is completing work on the project or activity to date 28 Information Technology Project Management, Fifth Edition, Copyright 2007

29. 29 Rate of Performance 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. Brenda Taylor, Senior Project Manager in South Africa, suggests using this approach for estimating earned value. For example, suppose the server installation was halfway completed by the end of week 1. The rate of performance would be 50 percent (50/100) because by the end of week 1, the planned schedule reflects that the task should be 100 percent complete and only 50 percent of that work has been completed.

30. Earned Value Formulas 30 Information Technology Project Management, Fifth Edition, Copyright 2007 SV = EV – PV + ve good CV = EV – AC + ve good SPI = EV/PV greater than 1 is good CPI = EV/AC greater than 1 is good EAC = AC + BAC – EV budgeted, atypical, no variation in future EAC = BAC/CCPI no variation in BAC, same rate spending

31. Earned Value Formulas Project Cost Management 31 EAC = AC + (BAC-EV)/CCPI typical, same variation in future TCPI = (BAC – EV)/(BAC-AC) must meet BAC TCP I = (BAC – EV)/(EAC-AC) not meet BAC, CPI decreased VAC = BAC - EAC ETC = EAC – AC

32. Earned Value Formulas Project Cost Management 32 % Complete = EV/BAC EV = Total months completed / Total months project x Total cost PV = Planned % complete x Project budget AC = Actual % complete x Project budget

33. Project Cost Management 33 Earned Value Formulas (recapitulation)

34. Earned Value Calculations for One Activity After Week One 34 Information Technology Project Management, Fifth Edition, Copyright 2007

35. Earned Value Formulas Negative numbers for cost and schedule variance indicate problems in those areas If CV is negative it means that performing the work cost more than planned A negative SV means that it took longer than planned to perform the work CPI can be used to estimate the projected cost of completing the project based on performance to date (EAC) =1:the planned and actual costs are the same; 1: under budget SPI can be used to estimate the projected time to complete the project =1: on schedule; 1 ahead of schedule 35 Information Technology Project Management, Fifth Edition, Copyright 2007

36. 36 Cost control inputs, tools and outputs

37. Earned Value Chart for Project after Five Months 37 Information Technology Project Management, Fifth Edition, Copyright 2007 EAC = $122,308 = BAC/CPI = $100,000/.81761 ETC = 12.74 months = Original Time Estimate/SPI = 12 months/.94203

38. 38 Earned Value: Example Cost (Person-Hours) Time (Date) Planned Value Planned Value: what your plan called for sending on the tasks planned to be completed by this date. Today Earned Value Earned Value: value (cost) of what you have accomplished to date, per the base plan. Actual Cost Actual Cost: what you have actually spent to this point in time. Budgeted (Planned) Spending Actual Spending Earned Value

39. 39 Earned Value: Example Cost (Person-Hours) Time (Date) Today Budgeted (Planned) Spending Actual Spending Earned Value Behind Schedule Over Budget

40. 40 Quiz The EV measurement of work you planned to have accomplished at a given point in time : a. BCWP b. ACSP c. BCWS d. ACWS True or False: At any point in time, the SPI tells you exactly how far ahead or behind schedule you are on your project. a. TRUE b. FALSE

41. 41 Quiz If BCWP is 20 pm and ACWP is 15 pm, CPI: a..75 b. 1.33 c. 1.0 d. 0 If BCWP is 27 pm BCWS is 25 pm, you are probably: a. On schedule b. Ahead of schedule c. Behind schedule d. None of the above

42. 42 Earned Value & Variance: Example(1) On Day X: PLANNED VALUE (BCWS) = 18 + 10 + 16 + 6 = 50 EARNED VALUE (BCWP) = 18 + 8 + 14 + 0 = 40 ACTUAL COST (ACWP) = 45 (from your project tracking) Therefore: Schedule Variance Schedule Variance = BCWP – BCWS = 40 - 50 = -10 (behind schedule) Schedule Performance Index Schedule Performance Index = 40 / 50 = 0.8, or 80% of plan (a B-, at best) Cost Variance Cost Variance = BCWP - ACWP = 40 - 45 = -5 Cost Performance Index Cost Performance Index = 40/45 =.89, 18 8 14

43. 43 Example(2) Project per documented plan Plans to spend $100 in each of first 4 weeks (baseline budget, per documented plan) Actuals, at end of week 4 show: $325 spent Suppose BCWP is $300 BCWS = $400 ($100 x 4) ACWP = $325 What conclusions can you draw? Under budget? Is project on schedule?

44. 44 Example(2) Project What conclusions now? SV = BCWP – BCWS - SV = $300 - $400 = -$100 Behind schedule Behind schedule, CV = BCWP – ACWP = $300 - $325 Over budget Over budget by $25

45. Example (3) You have a project that is scheduled to be completed in 10 days at a budgeted cost of $100,000. At the end of day 6 you do an analysis and you determine the job is 70% complete, 60% is planned and you have spent $65,000. 1. Is the project ahead, behind schedule or on schedule? EV = 70% *100000 =70000 PV = 60%*100000 =60000 AC = 65000 Project Cost Management 45

46. Example (3) SV= EV – PV = 70000 -60000 =10000 SPI = EV/PV = 70000 / 60000 = 1.16  Project is ahead schedule 2. Is the project expected to complete on budget, under or over budget? Under budget ? CV= EV – AC = 70000 -65000 =5000 CPI = EV/AC = 70000 / 65000 = 1.07  Project is under budget Project Cost Management 46

47. Project Portfolio Management Many organizations collect and control an entire suite of projects or investments as one set of interrelated activities in a portfolio Five levels for project portfolio management 1. Put all your projects in one database 2. Prioritize the projects in your database 3. Divide your projects into two or three budgets based on type of investment 4. Automate the repository 5. Apply modern portfolio theory, including risk-return tools that map project risk on a curve 47 Information Technology Project Management, Fifth Edition, Copyright 2007

48. Project Cost Management 48

49. 49 Using Software to Assist in Cost Management Spreadsheets are a common tool for resource planning, cost estimating, cost budgeting, and cost control. Many companies use more sophisticated and centralized financial applications software for cost information. Project management software has many cost- related features, especially enterprise PM software.

50. 50 Sample Project Portfolio Management Screen Showing Project Health