Understanding Project Cost Management

January 1, 2014 Marcus Varner

To continue my series on the nine project management knowledge areas, I would like to discuss the topic of project cost management. Cost management involves knowing the financial and human resources required to complete a project within an approved budget.

The PMBOK describes three areas or processes for effective cost management:

Estimating the Costs

The first step in cost management is to estimate the costs of each activity in the project. Costs include both human resource and physical resource costs. Because this step often occurs in the planning phase, it is important to understand that the estimated costs are your "best guesses" at the actual costs of each activity.

To get a good guess at the costs you can use one of the following techniques:

  • Analogous Estimating: estimates are based on past projects. It uses actual costs from a similar finished project to estimate the costs of the new project. The accuracy of these estimates will depend on the similarities between the new project and the old project.
  • Parametric Modeling: estimates are based on mathematical formulas, typically following a Regression Analysis or Learning Curve model. The accuracy of these estimates depends on the assumptions made.
  • Bottom-up Estimating: estimates are based on individual work item cost and duration estimates. This involves estimating the smallest activities and then adding them up to create an estimate for the whole project.

Determining the Budget

Using your best-guess estimates, the next step is to create a realistic project budget. In this step, you will determine the cost baseline and the funding requirements for the project. A good project budget will help you make key decisions with respect to the project schedule and resource allocation constraints.

To determine the project budget, the PMBOK suggests using several techniques:

  • Cost Aggregation: requires you to aggregate or combine costs from an activity level to a work package level. The final sum of the cost estimates is applied to the cost baseline.
  • Reserve Analysis: requires you to create a buffer or reserve to protect against cost overruns. The degree of protection should be equivalent to the risk foreseen in the project. The buffer is part of the project budget, but not included in the project baseline.
  • Historical Data: requires you to think about estimates from closed projects to determine the budget of the new project. This is very similar to analogous estimation described earlier.
  • Funding Limit Reconciliation: requires you to adhere to the constraints imposed by the funding limit. The funding limit is based on the limited amount of cash dedicated to your project. To avoid large variations in the expenditure of project funds, you may need to revise the project schedule or the use of project resources.

Controlling the Costs

Good project managers will carefully monitor the cost of their projects. This includes watching to see where actual cost has varied from estimated cost. Cost control also involves informing the stakeholders of cost discrepancies that vary too much from the budgeted cost.

To effectively control project costs, you will need to regularly monitor and measure the performance of the budget and revise forecasts as required. The PMBOK suggests several tools and techniques to help control costs:

  • Earned Value Management: uses a set of formulas to help measure the progress of a project against the plan.
    • Forecasting: uses the current financial situation to project future costs. The forecast is based on budgeted cost, total estimated cost, cost commitments, cost to date, and any over or under budgeted costs.
    • To-Complete Performance Index (TCPI): represents the level of project performance that future work needs to be implemented to meet the budget.
    • Variance Analysis: involves analyzing the difference or variance between the budgeted costs and the actual costs to indicate whether the project is on budget.
    • Performance Reviews: used to check the health of a project. Includes an analysis of project costs, schedule, scope, quality, and team morale. By learning how to estimate costs, determine budgets, and control costs, you can be a better project manager and leader. Effective cost management will you help you get projects done on time and under budget, the golden ticket for any successful project manager.

About the Author

Marcus Varner

Marcus is a content strategist and producer who loves helping brands craft content that improves customers' lives, builds brand credibility, and demands to be shared. For the last 10 years, Marcus has worked in every type of content—from writing to video production to design—and is currently a senior content marketing manager at Workfront, where he oversees all corporate- and awareness-level level content. When he's not producing content, he's consuming it, in the form of books, movies, and podcasts.

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