Cost Management is the most important among all the project management knowledge areas. In general there are many activities in a project, many resources and materials are used in project related activities, as well as tools and equipment are used to complete the project scope. [i] Let’s see what is project cost management and why it’s so important? In short project cost management is the process of estimating, budgeting and controlling costs throughout the project life cycle.
Generally speaking, a successful project considers the following [ii]:
- it delivers on the requirements and scope;
- its execution quality is of a high standard;
- it is completed within schedule and within budget.
Project cost management is a function which contains the processes necessary to maintain effective financial control of projects (evaluating, estimating, budgeting, monitoring, analyzing, forecasting and reporting the cost information).[iii]
The main output of cost management is Project Budget. After the scope of the project is clear and project activities are defined, each project result and each project activity will have a corresponding cost. For instance, project resources will carry out activities, and they have certain costs to projects such as renting expenses, operational expenses, salaries, etc., and also there will be tools, materials or equipment that need to be used during the project as well. So, these will require a budget as well.
After the budget is defined and approved, the project manager will keep an eye on measuring and monitoring the cost performance of the project to meet the approved project budget.
There is no any difficulty to understand the importance of cost management. For example, when we decide to build a house, the first thing to do is set the budget, because without a predefined budget, it becomes impossible to assess whether you are progressing in the right direction once the project is underway. For instance, in large organizations, the scale of this problem is further enlarged due to concurrent running of multiple projects, change in initial presumptions, and the addition of unexpected costs. That’s where cost management can help.
By implementing efficient cost management practices, project managers can [ii]:
- Set clear expectations with stakeholders,
- Control scope creep due to transparencies established with the customer,
- Track progress and respond with corrective action at a quick pace,
- Maintain expected margin, increase ROI, and avoid losing money on the project,
- Generate data to benchmark for future projects and track long-term cost trends.
The Four Steps in Project Cost Management
While cost management is viewed as an ongoing process, it helps to divide the function into four steps:
- Project resource planning;
- Project cost estimation;
- Project Cost budgeting;
- Project cost control.
They are mostly sequential, but it is possible that some resource changes happen in the middle of the project, which will force the budgets to be adjusted. Besides, the variances observed during the control process can call for estimate revisions. Let’s talk about these steps more detailed.
- Project Resource Planning
Resource planning is the process of identifying the resources which are required to execute a project and take it to completion and it’s doing at the beginning of a project, before any actual work begins. Resources can be both people (employees and contractors) and equipment (infrastructure, large construction vehicles, and other specialized equipment in limited supply). Before getting started, project managers first need to have the work-breakdown structure (WBS) ready. It helps to understand how many people, with what kind of skills are needed to finish this task, and what sort of equipment or material is required to finish this task? This task-level approach makes possible for project managers to come up with an accurate and complete inventory of all resources, which can be as an input into the next step of estimating costs.
During this process it’s important to consider these few tips:
- Before determining sub-tasks and the corresponding resources consider historical data, past schedules and effort.
- Take feedback from SMEs (Subject Matter Experts) and team members, because a collaborative approach works well especially in projects that do not have past data to use.
- Estimate the impact of time on resource requirements. For instance, a resource may be available only after a few months, after a project timeline is dragged. This could have an impact on cost estimation.
- Although this step occurs at the planning stage, project managers must be mindful of the realities. For example, you may identify the need for a resource with a specific expertise, but if such a resource is not available in the organization, you have to consider hiring a contractor or training your team to get them up to speed. All these real variables affect cost management.
- Project Cost Estimation
Cost estimation is the second step in cost management. It is the process of quantifying the costs connected with all the resources which are required to complete the project.
For performing cost calculations, we need the following information:
- Resource requirements (result of the previous step);
- Price of each resource (e.g., staffing cost per hour, supplier hiring costs, server acquisition costs, material rates per unit, etc.);
- Duration that each resource is required;
- List of assumptions;
- Potential risks;
- Past project costs and industry benchmarks;
- Insight into the company’s financial condition and reporting structures. [ii]
The process of estimation is arguably the most difficult process involved in cost management as precision is the key here. In this step project managers have to consider factors such as fixed and variable costs, overheads, inflation, and the time value of money.
The greater the variation between estimation and actual costs, the less is chance for a project to succeed. Despite there are many estimation models to choose from for doing cost estimation, you can study historical cost data from similar projects.
When doing cost estimation exercise for your project, its better to consider the costs can be classified in different ways:
- Fixed and Variable costs. For instance, office rent for a project is a fixed cost. Mindless of how many project resources will work, you need an office, and this cost will be in your project budget.
- On the other side, material costs, expenses for project personnel will be variable depending on the number of people or materials. [i]
- Project Cost Budgeting
Project cost budgeting can be the part of estimation or as a separate process. Budgeting is the process of distributing costs to a determined part of the project, such as individual tasks or modules, for a particular time period. Budgets include contingency reserves allocated to manage unexpected costs.
For instance, suppose that the total costs estimated for a five-year project is USD 2,000,000. However, since the budget allocation is time-dependent, the project manager decides to consider only the first two quarters for now. They identify the work items that need to be completed and allocate a budget of, say, USD 35,000 for this time frame, and these work items. Budgeting creates a cost baseline connected which we can carry on measure and estimate the project cost performance. If not the budgeting, the total estimated cost would remain an abstract figure, and it would be difficult to measure midway. Evaluation of project performance gives an opportunity to estimate how much budget needs to be released for future phases of the project.
Another reason to strengthening budgets is that organizations often lean on expected future cash flows for their funding. During the initial phases, the project manager has a limited financial pool and must set goals accordingly. It’s like building the foundation and one floor of the house in the first few months and later completing the rest of the project, as you save more.
- Project Cost Control
Cost control is the fourth and last process of the cost management. This process mainly aims to control the project expenses and execute the project on defined budget.
Project cost control is the process of measuring cost deviations from the baseline and taking relevant action, such as increasing the budget allocated or reducing the scope of work, to close that gap. Cost control is an ongoing process done throughout the entire lifecycle of a project. The emphasis here is on both timely and accurate reporting as measurement.
Along with the cost baseline, the cost management plan is an important input for cost control. This plan includes details such as how project performance will be measured, what the variance threshold is, what actions will be taken if the threshold is breached, and the list of people and roles that have the executive decision-making authority.