Description
Traditionally, the field of project management begins with the "initiation" of a project. The most well known treatment of the project management process is included in the Project Management Institute's Project Management Body of Knowledge (PMBOK).
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Introducing Project Cost Management
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Chapter 7: Introducing Project Cost Management
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rojects cost. Have you ever worked with a client who had a huge vision for a project, but had little capital to invest into the vision? Or have you worked with a client who gasped when you revealed how much it would cost to complete their desired scope of work? Or have you been fortunate and had a customer who accepted the costs for the project at face value, made certain the funds were available, and sent you on your way to complete the work? As a general rule, management and customers are always concerned with how much a project is going to cost in relation to how much a project is going to earn. Most likely there is more negotiating, questioning, and evaluating for larger projects than for smaller ones. The relation between the project cost and the project scope should be direct: you get what you pay for. Think it’s possible to buy a mansion at ranch home prices? Not likely. Think it’s possible to run a worldwide marketing campaign at the cost of a postcard mailer? Not likely. A realistic expectation of what a project will cost will give great weight to the project’s scope. As the business need undergoes analysis, progressive elaboration and estimates are completed based on varying levels of detail, and eventually the cost of project will emerge. Often, however, the predicted costs and the actual costs vary. Poor planning, skewed assumptions, and overly optimistic estimates all contribute to this. A successful project manager must be able to plan, predict, budget, and control the costs of a project. Costs associated with projects are not just the costs of goods procured to complete the project. The cost of the labor may be one of the biggest expenses of a project. The project manager must rely on time estimates to predict the cost of the labor to complete the project work. In addition, the cost of the equipment and materials needed to complete the project work must be factored into the project expenses.This chapter examines the management of project costs, how to predict them, account for them, and then, with plan in hand, to control them. We’ll examine exactly how costs are planned for and taken into consideration by the performing organization and how the size of the project affects the cost estimating process.
Planning the Project Resources
As part of the planning process, the project manager must determine what resources are needed to complete the project. Resources include the people, equipment, and materials that will be utilized to complete the work. In addition, the project manager must identify the quantity of the needed resources and when the resources are needed for the project. The identification of the resources, the needed quantity, and the
Planning the Project Resources
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schedule of the resources are directly linked to the expected cost of the project work, as shown here:
Ill 7-1
Labor Materials Equipment
Project Costs
Consider a project to fully automate a new home: the lights, heating and cooling, appliances, and home security are all connected through a central computer operating system. The resources to complete the project work would include technicians, HVAC experts, electricians, and other people with the knowledge to install and configure the components. The resources in this case, however, would also include the network cabling to connect the components, diagnostic tools to monitor and test the installation, and the equipment and tools to physically install the components. In addition, services and sites are considered resources as well. Your project may require a vendor’s service, such as a commercial printer, a carpenter, or other service. If these services are not available for the project as planned, the project will suffer. Some projects require you to lease space; the leased space is considered a resource. In some instances, it most cost effective to hire a consultant or subject matter expert (SME) to identify details unique to the project work, If time is an issue in such as mandates, laws, standards, and so on. a complex project, rely on an SME to The expense of relying on the SME may be far provide input to the decision-making less than the cost of the time to research the process. If the project team is lacking unique details and requirements of the project. a needed project skill set, a seminar or The knowledge gained from the SME can offset training class is appropriate to get the the expenses that would otherwise result from not team member up to speed. having specialized knowledge of the project work.
Consider the Inputs to Resource Planning
Resource planning is the process of examining the project work and determining what resources, people, and equipment are needed to complete the project. Resource
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Chapter 7: Introducing Project Cost Management
planning also includes identifying the expected quantity of the needed resources so the predicted cost can be calculated. These are some familiar inputs to resource planning:
? Work breakdown structure
The WBS is a deliverables-orientated breakdown of the components of the project. It helps the project manager and the project team identify the components requiring specific people, equipment, and materials. The WBS is the primary input to resource planning. If similar projects have been completed, what resources were required on these projects? Historical information should be used if it’s available, as it is proven information rather than speculation. The scope statement serves as a key input to resource planning; the scope statement defines the project work. The scope statement should guide the resource planning process, as it identifies why the project was undertaken and the required work to complete the project. The required work, therefore, can help identify the required resources to complete the project. The project manager should identify what resources are available for the project. These include people, materials, and equipment. As the project passes through progressive elaboration, the identified pool of resources may vary. For example, in the early phases of a marketing campaign, the pool may include copywriters, designers, computer professionals, the individuals that operate the printing equipment, and photographers. As the project moves through its phases to completion, the resource pool may be limited to only those people who have worked on the project in the early phases. The performing organization’s policies regarding staff acquisition must be taken into consideration. In addition, any procurement policies to ascertain, lease, or rent equipment must be evaluated. The project manager should be aware of these requirements before planning the resources— time invested identifying resources may be lost if the process conflicts with the organizational policies. The duration of the activities are needed so the project manager and the project team can consider the costs and benefits of assigning more effort to reduce tasks duration where feasible, as seen here. The activity duration estimates should be readily available from the time management processes.
? Historical information
? Scope statement
? Resource pool description
? Organizational policies
? Activity duration estimates
Planning the Project Resources
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Cost of Labor
Ill 7-2
Additional labor Short duration
Project duration
Applying Expert Judgment
Armed with the inputs to resource planning, the project manager and the project team should be ready to identify and plan the need for the project resources. The project manager and the project team will examine the project work and the available resources and then apply reason, logic, and experience in evaluating the available resources in relation to the project requirements. A person or group can offer expert judgment on the project resource needs. The person or group offering the expert judgment should have the expertise, experience, or training needed to evaluate and analyze the resources that the project needs. Expert judgment can come from several sources:
? Internal subject matter experts, such as resources from other departments ? External subject matter experts, such as consultants ? Trade and professional associations ? Industry groups
Identifying Alternative Solutions
Alternatives-identification is any process that identifies other solutions to an identified problem. These approaches typically use brainstorming and lateral thinking. In this process, alternatives-identification may include buy-versus-build scenarios, outsourcing, cross training, and other activities. The idea of using alternatives-identification is to ensure that the identified resources are complete and that the cost of the resources are the best fit for the project work. Value analysis is an approach to find more affordable, less costly, methods of accomplishing the same work. For example, a project manager may change the sequencing of activities to shorten the project duration, while saving labor costs by assigning high-cost resources only to the activities that demand it.
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Chapter 7: Introducing Project Cost Management
Relying on Project Management Software
Project management software can help the project manager identify and organize the resource pools. Project management software can be configured to organize common resources, talents, skill sets, calendars, rates, contact information, and more. While there are many different project management applications available, the ability to easily use and update the information an application stores is critical. Figure 7-1 is a screen shot of Microsoft Project accessing resources from a central repository.
Identifying Resource Requirements
Once the project manager and the project team have completed resource planning, the required resources to complete the project will have been identified. The resource identification is specific to the lowest level of the WBS. The identified resources will need to be obtained through staff acquisition or through procurement. We’ll cover staff acquisition in Chapter 9 and procurement in Chapter 12. Figure 7-2 is a recap of all the inputs, tools, and techniques, and outputs of resource planning.
FIGURE 7-1
Project management software can assist in resource planning.
Cost Estimating
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FIGURE 7-2
Resource planning identifies all of the required resources.
Inputs WBS Historical information Scope statement Resource pool description Organization policies Duration estimates Tools and Techniques Expert judgment Alternatives identification Project management software
Resource Requirements
Cost Estimating
Cost estimating is the process of calculating the costs of the identified resources needed to complete the project work. The person or group doing the estimating must consider the possible fluctuations, conditions, and other causes of variances that could affect the total cost of the estimate. There is a distinct difference between cost estimating and pricing. A cost estimate is the cost of the resources required to complete the project work. Pricing, however, includes a profit margin. In other words, a company performing projects for other organizations may do a cost estimate to see how much the project is going to cost to complete. Then, with this cost information, they’ll factor a profit into the project work, as shown here:
Ill 7-3
Project cost
Profit margin Actual
Project duration
More and more companies are requiring the project manager to calculate the project costs and then factor the ROI, and other benefit models, into the project product. The goal is to see the value of the project once its deliverables are in operations.
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Considering the Cost Estimating Inputs
Cost estimating relies on several project components from the Initiation and Planning process groups. This process also relies on historical information and policies from the performing organization.
Using the Work Breakdown Structure
Of course the WBS is included—it’s an input to five major planning processes: cost estimating, cost budgeting, resource planning, risk management planning, and activity definition.
Relying on the Resource Requirements
The only output of resource planning serves as a key input to cost estimating. The project will have some requirement for resources—the skills of the labor, the ability of materials, or the function of equipment must all be accounted for.
Calculating Resource Rates
The estimator has to know how much each resource costs. The cost should be in some unit of time or measure—such as cost per hour, cost per metric ton, or cost per use. If the rates of the resources are not known, the rates themselves may also have to be estimated. Of course, skewed rates on the estimates will result in a skewed estimate for the project. There are four categories of cost:
? Direct costs
These costs are attributed directly to the project work and cannot be shared among projects (airfare, hotels, and long distance phone charges, and so on). These costs vary depending on the conditions applied in the project (number of meeting participants, supply and demand of materials, and so on). These costs remain constant throughout the project (the cost of a piece of rented equipment for the project, the cost of a consultant brought onto the project, and so on). These costs are representative of more than one project (utilities for the performing organization, access to a training room, project management software license, and so on).
? Variable costs
? Fixed costs
? Indirect costs
Cost Estimating
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Estimating Activity Durations
Estimate of the duration of the activities, which predict the length of the project, are needed for decisions on financing the project. The length of the activities will help the performing organization calculate what the total cost of the project will be, including n the finance charges. Recall the formula for present value? It’s PV= FV/(1+R) ; PV is the present value, FV is the future value, R is the interest rate, and n is the number of time periods. The future value of the monies the project will earn may need to be measured against the present value to determine if the project is worth financing, as shown here:
Ill 7-4
Finance Charges Future Value = $450,000 Present Value = $317,000
Calculations of the duration of activities are needed in order to extrapolate the total cost of the work packages. For example, if an activity is estimated to last 14 hours and Suzanne’s cost per hour is $80, then the cost of the work package is $1,120. The duration shows management how long the project is expected to last and which activities will cost the most and provides the opportunity to re-sequence activities to shorten the project duration—which consequently shortens the finance period for the project. Another aspect the project manager and management may have to determine is the long-term worth of a product in regard to tax deductions. There are three approaches to deduct the product’s cost:
? Straight-line depreciation allows the organization to write off the same
amount each year. The formula for straight-line depreciation is Purchase Value minus Salvage Value divided by Number of Years in Use. For example, if the purchase price of a photocopier is $7,000 and the salvage value of the photocopier in five years is $2,000, the formula would read: 7,000–2,000/5= $1,000.
? Double-declining balance is considered accelerated depreciation. This
method allows the organization to double the percentage written off in the first year. In our above example, a single deduction was $1000 per year, which is twenty percent of the total deduction across the five years. With double-declining, the customer would subtract 40 percent the first year, and then 40 percent of the remaining value each subsequent year. In our example, the deducted amount for year one would be $2000. For year two it’d be $1200, and year three it would be $720. This is a great method for equipment that you don’t anticipate to have around for a very long time—such as computer equipment.
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Chapter 7: Introducing Project Cost Management
? Sum of the years depreciation is like a magic trick. It works by writing
out the number of years the equipment is in production and adding each year to the year before. In our example it was five years, so we’d do this: 5+4+3+2+1=15 (note the largest to smallest). The sum of the years, 15, becomes our denominator; the five, for the first year, is our numerator. So for the first year, we’d deduct 5/15ths (or one third) of the photocopier cost after the salvage amount, which would be $1650. The second year the four would be the numerator and we’d deduct $1250, and so on. Each year we’d deduct a slightly smaller percentage than the year before.
Using Estimating Publications
You may encounter a general question on straight-line versus double-declining depreciation on the PMP Exam. You should be familiar with the concept, but don’t invest too much time memorizing these formulas for the exam. There are, for different industries, commercial estimating publications. These references can help the project estimator confirm and predict the accuracy of estimates. If a project manager elects to use one of these commercial databases, the estimate should include a pointer to this document for future reference and verification.
Using Historical Information
Historical information is proven information and can come from several places:
? Project files
Past projects within the performing organization can be used as a reference to predict costs and time. Caution must be taken that the records referenced are accurate, somewhat current, and reflective of what was actually experienced in the historical project. These databases provide estimates of what the project should cost based on the variables of the project, resources, and other conditions.
? Team members
? Commercial cost-estimating databases
The project team members’ recollections of what things cost should not be trusted as fact. It’s advice and input, but documented information is always better.
Team members may have specific experience with the project costs or estimates. Recollections may be useful, but are highly unreliable when compared to documented results.
Cost Estimating
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Referencing the Chart of Accounts
This is a coding system used by the performing organization’s accounting system to account for the project work. Estimates within the project must be mapped to the correct code of accounts so that the organization’s ledger reflects the actual work performed, the cost of the work performed, and any billing (internal or external) that was charged to the customer for the completed work.
Acknowledging the Cost of Risk
The impact of risks, for positive or negative effect, must be evaluated and considered in the cost estimates. Risks, which we’ll cover in Chapter 11, can impact the cost of the project. For example, should a risk come into play, the mitigation of the risk may require adding several activities to squelch the risk. The expense of the activities would add cost to the project.
Estimating Project Costs
Management, customers, and other interested stakeholders are all going to be interested in what the project is going to cost to complete. There are several approaches to cost estimating, which we’ll discuss in one moment. First, however, understand that cost estimates have a way of following the project manager around—especially the lowest initial cost estimate. The estimates you’ll want to know for the PMP exam, and for your career, are reflective of the accuracy of the information the estimate is based upon. The more accurate the information, the better the cost estimate will be.
Using Analogous Estimating
Analogous estimating relies on historical information to predict the cost of the current project. It is also known as top-down estimating. The process of analogous estimating takes the actual cost of a historical project as a basis for the current project. The cost of the historical project is applied to the cost of the current project, taking into account the scope and size of the current project as well as other known variables. Analogous estimating is a form of expert judgment. This estimating approach takes less time to complete than other estimating models, but is also less accurate. This top-down approach is good for fast estimates to get a general idea of what the project may cost.
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Chapter 7: Introducing Project Cost Management
Here’s an example of analogous estimating: the Carlton Park Project was to grade and pave a sidewalk around a pond in the community park. The sidewalk of Carlton Park was 1048 feet by 6 feet, used a textured surface, had some curves around trees, and cost $25,287 to complete. The current project, King Park, will have a similar surface and will cover 4,500 feet by 6 feet. The analogous estimate for this project, based on the work in Carlton Park, is $$108,500. This is based on the price per foot of material at $4.021 – note that $4.021 is not the same as $4.21.
Using Parametric Modeling
Parametric modeling uses a mathematical model based on known parameters to predict the cost of a project. The parameters in the model can vary based on the type of work being completed. A parameter can be cost per cubic yard, cost per unit, and so on. A complex parameter can be cost per unit with adjustment factors based on the conditions of the project. In addition, the adjustment factors may have additional modifying factors depending on additional conditions. To use parametric modeling, the factors the model is based on must be accurate. The factors within the model are quantifiable and don’t vary much based on the effort applied to the activity. And finally, the model must be scalable between project sizes. The parametric model using a scalable cost-per-unit approach is depicted here:.
Ill 7-5
Cost per unit = $78
Project A
Project B
There are two types of parametric estimating:
? Regression analysis
This is a statistical approach to predict what future values may be, based on historical values. Regression analysis creates quantitative predictions based on variables within one value to predict variables in another. This form of estimating relies solely on pure statistical math to reveal relationships between variables and predict future values.
Analyzing Cost Estimating Results
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? Learning curve
This approach is simple: the cost per unit decreases the more units workers complete; this is because workers learn as they complete the required work. The more an individual completes an activity, the easier it is to complete. The estimate is considered parametric, as the formula is based on repetitive activities, such as wiring telephone jacks, painting hotel rooms, or other activities that are completed over and over within a project. The cost per unit decreases as the experience increases because the time to complete the work is shortened.
Using Bottom-Up Estimating
Don’t worry too much about regression analysis for the exam. Learning curve is a topic you’ll more likely have questions on. Bottom-up estimating starts from zero, accounts for each component of the WBS, and arrives at a sum for the project. It is completed with the project team and can be one of the most timeconsuming methods to predict project costs. While this method is more expensive, because of the time invested to create the estimate, it is also one of the most accurate. A fringe benefit of completing a bottomup estimate is the project team may buy-into the project work as they see they cost and value of each cost within the project.
Using Computer Software
While the PMP examination is vendor-neutral, a general knowledge of how computer software can assist the project manageris needed. There are several different computer programs that can streamline and make accurate estimates for the project work. These tools can include project management software, spreadsheet programs, and simulations.
Analyzing Cost Estimating Results
The output of cost estimating is the actual cost estimates of the resources required to the complete the project work. The estimate is typically quantitative and can be presented in detail against the WBS components or summarized in terms of a grand total, by phases of the project, or by major deliverables. Each resource in the project must be accounted for and assigned to a cost category. Categories include the following:
? Labor costs ? Material costs
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Chapter 7: Introducing Project Cost Management
? Travel costs ? Supplies ? Hardware costs ? Software costs ? Special categories (inflation, cost reserve, and so on)
The cost of the project is expressed in monetary terms, such as dollars, euros, or yen, so management can compare projects based on costs. It may be acceptable, depending on the demands of the performing organization, to provide estimates in staffing hours or days of work to complete the project along with the estimated costs. As projects have risks, the cost of the risks should be identified along with the cost of the risk responses. The project manager should list the risks, their expected risk event value, and the response to the risk should it come into play. We’ll cover risk management in detail in Chapter 11.
Refining the Cost Estimates
Cost estimates can also pass through progress elaboration. As more details are acquired as the project progresses, the estimates are refined. Industry guidelines and organizational policies may define how the estimates are refined, but there are three generally accepted categories of estimating accuracy:
? Rough order of magnitude
This estimate is “rough” and is used during the Initiating processes and in top-down estimates. The range of variance for the estimate can be –25 percent to +75 percent. This estimate is also somewhat broad and is used early in the Planning processes and also in top-down estimates. The range of variance for the estimate can be –10 percent to +25 percent. This estimate type is one of the most accurate. It is used late in the Planning processes and is associated with bottom-up estimating. The range of variance for the estimate can be –5 percent to +10 percent.
? Budget estimate
? Definitive estimates
Considering the Supporting Detail
Once the estimates have been completed, supporting detail must be organized and documented to show how the estimates were created. This material, even the notes
Completing Cost Budgeting
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that contributed to the estimates, may provide valuable information later in the project. Specifically, the supporting detail includes the following:
? Information on the project scope work
This may be provided by
referencing the WBS.
? Information on the approach used in developing the cost estimates
This can include how the estimate was accomplished and the parties involved with the estimate.
? Information on the range of variance in the estimate
For example, based on the estimating method used, the project cost may be $220,000 ± $15,000. This project cost may be as low as $205,000 or as high as $235,000.
Developing the Cost Management Plan
The cost management plan details how variances from the project costs will be managed. The performing organization may have policies and procedures on the expected reactions to cost variances within the project. For example, variances over a set dollar amount may prompt the project manager to create a Variance Report, meet with management, or even initiate an audit.
Completing Cost Budgeting
Cost budgeting is the process of assigning a cost to an individual work package. The goal of this process is to assign costs to the work in the project so that the work may be measured for performance. This is the creation of the cost baseline, as shown here:
Ill 7-6
Project cost
Cost to date BAC=$400,000
Cost baseline Variance Project schedule
Cost budgeting and cost estimates may go hand-in-hand, but estimating should be completed before a budget is requested—or assigned. Cost budgeting applies the cost estimates over time. This results in a time-phased estimate for cost, allowing an organization to predict cash flow needs. The difference between cost estimates and cost budgeting is that cost estimates show costs by category, whereas a cost budget shows costs across time.
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Chapter 7: Introducing Project Cost Management
Consider the Inputs to Cost Budgeting
Because cost budgeting and cost estimating are so closely related, you can expect many of the same inputs for both. Here are the inputs to cost budgeting:
? Cost estimates
These serve as key inputs; they’re the predicted cost for the
project work.
? Work breakdown structure ? Project schedule
It’s a key input to this process, as it is the deliverables of the project—it’s what the project is buying. The project schedule is needed to determine when the monies in the budget will be spent. The schedule should reflect the sequenced activities against a projected timeline. This allows management not only to plan financially, but also to compare expected cash inflows against the cash outflows the project will demand. The risk management plan is considered because of information it provides of the probability of identified risks and their associated costs. In addition, the risks may have an expected risk value that contributes to the contingency reserve for the project.
? Risk management plan
Developing the Project Budget
The tools and techniques used to create the project cost estimates are also used to create the project budget. Here’s a quick reminder of the four components:
? Analogous budgeting.
This is a form of expert judgment that uses a topdown approach to predict costs. It is generally less accurate than other budgeting techniques. This approach uses a parametric model to extrapolate what costs will be for a project (for example, cost per hour and cost per unit). It can include variables and points based on conditions. This approach is the most reliable, though it also takes the longest to create. It starts at zero and requires each work package to be accounted for. The same software programs used in estimating can help predict the project budget with some accuracy.
? Parametric modeling.
? Bottom-up budgeting
? Computerized tools
Implementing Cost Control
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Creating the Cost Baseline
A project’s cost baseline shows what is expected to be spent on the project. It’s usually shown in an S-curve, as in Figure 7-3. The idea of the cost baseline allows the project manager and management to predict when the project will be spending monies and over what time period. The purpose of the cost baseline is to measure and predict project performance. Large projects that have multiple deliverables may have multiple cost baselines to illustrate the costs within each phase. Additionally, larger projects may have cost baselines to predict spending plans, cash flows of the project, and overall project performance. The purpose of a cost baseline is to measure performance, and a baseline will predict the expenses over the life of the project. Any discrepancies early on in the predicted baseline and the actual costs serve as a signal that the project is slipping.
Implementing Cost Control
Cost control focuses on the ability of costs to change and on the ways of allowing or preventing cost change from happening. When a change does occur, the project manager must document the change and the reason why the change has occurred and, if necessary, create a variance report. Cost control is concerned with understanding why the cost variances, both good and bad, have occurred. The “why” behind the variances allows the project manager to make appropriate decisions on future project actions. Ignoring the project cost variances may cause the project to suffer from budget shortages, additional risks, or scheduling problems. When cost variances happen they must be examined, recorded, and investigated. Cost control allows the project manager to confront the problem, find a solution, and then act accordingly. Specifically, cost control focuses on these activities:
? Controlling causes of change to ensure the changes are actually needed ? Controlling and documenting changes to the cost baseline as they happen
FIGURE 7-3
Project cost
Cost baselines show predicted project and phase performance.
Project cost
BAC=$400,000
BAC=$220,000
Project cost baseline Project schedule
Project cost baseline Project schedule
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Chapter 7: Introducing Project Cost Management
? Controlling changes in the project and their influence on cost ? Performing cost monitoring to recognize and understand cost variances ? Recording appropriate cost changes in the cost baseline ? Preventing unauthorized changes to the cost baseline ? Communicating the cost changes to the proper stakeholders ? Working to bring and maintain costs within an acceptable range
Considering Cost Control Inputs
To implement cost control, the project manager must rely on several documents and processes:
? Cost baseline
The cost baseline is the expected cost the project will incur. This time-phased budget reflects the amount that will be spent throughout the project. Recall that the cost baseline is a tool used to measure project performance. These reports focus on project cost performance, project scope, and planned performance versus actual performance. The reports may vary according to stakeholder needs. We’ll discuss performance reporting in detail in Chapter 10. When changes to the project scope are requested, an analysis of the associated costs to complete the proposed change is required. In some instances, such as removing a portion of the project deliverable, a change request may reduce the project cost. The cost management plan dictates how cost variances will be managed.
? Performance reports
? Change requests
? Cost management plan
Creating a Cost Change Control System
Sometimes a project manager must add, or remove, costs from a project. The Cost Change Control System is part of the Integrated Change Control System and documents the procedures to request, approve, and incorporate changes to project costs. When a cost change enters the system, there is appropriate paperwork, a tracking system, and procedures the project manager must follow to obtain approval on the proposed change. Figure 7-4 demonstrates a typical workflow for cost change approval. If a change gets approved, the cost baseline is updated to reflect the approved changes. If a request gets denied, the denial must be documented for future potential reference.
Implementing Cost Control
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FIGURE 7-4
A Cost Change Control System tracks and documents cost change issues.
Cost charge
Cost change request
Has cost changed already occurred?
Tracking system
Yes
No
Documentation: Cause Cost Parties involved Decision
Cost change approved?
Yes
No
Measuring Project Performance
Earned Value Management (EVM) is the process of measuring performance of project work against a plan to identify variances. It can also be useful in predicting future variances and the final costs at completion. It is a system of mathematical formulas that compares work performed against work planned and measures the actual cost of the work performed. EVM is an important part of cost control as it allows a project manager to predict future variances from the expenses to date within the project. EVM, in regard to cost management, is concerned with the relationships between three formulas that reflect project performance. Figure 7-5 demonstrates the relation between these EVM values:
? Planned Value (PV)
Planned Value is the work scheduled and the authorized budget to accomplish that work. For example, if a project has a budget of $100,000 and month six represents 50 percent of the project work,
BAC = $100,000 Total project 25% Complete
FIGURE 7-5
Earned value management measures project performance.
Month 6 = 50%
Earned Value %COMP X BAC $25,000
Actual Costs How much was actually spent? $27,000
Planned Value What the project should be worth at this point in the schedule. $50,000
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Chapter 7: Introducing Project Cost Management
the PV for month six is $50,000. Planned Value used to be known as the Budget Cost of Work Schedule (BCWS), and you may see this term on the PMP Exam.
? Earned Value (EV)
Earned Value is the physical work completed to date and the authorized budget for that work. For example, if a project has a budget of $100,000 and the work completed to date represents 25 percent of the entire project work, its EV is $25,000. Earned Value used to be known as the Budgeted Cost of Work Performed (BCWP). Actual Cost is the actual amount of monies the project has required to date. For example, if a project has a budget of $100,000 and $35,000 has been spent on the project to date, the AC of the project would be $35,000. Actual Cost used to be known as Actual Cost of Work Performed (ACWP).
? Actual Cost (AC)
These three values are key information about the worth of the project to date (EV), the cost of the project work to date (AC), and the planned value of the work to date (PV). These values will be revisited later in this chapter and in Chapter 10.
Additional Planning
Planning is an iterative process. Throughout the project there will be demands for additional planning—and an output of cost control is one of those demands. Consider a project that must complete by a given date and that also has a set budget. The balance between the schedule and the cost must be kept. The project manager can’t assign a large crew to complete the project work if the budget won’t allow it. The project manager must, through planning, get as creative as possible to figure out an approach to accomplish the project without exceeding the budget. The balance between cost and schedule is an ongoing battle. While it’s usually easier to get more time than money, this isn’t always the case. Consider deadlines that can’t move, or the company may face fines and penalties, or a deadline that centers on a tradeshow, an expo, or the start of the school year.
Using Computers
It’s hard to imagine a project, especially larger projects, moving forward without the use of computers. project managers can rely on project management software
Considering the Cost Control Results
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and spreadsheet programs to assist them in calculating actual costs, earned value, and planned value. It’s not hard to create a spreadsheet with the appropriate earned value formulas. Once the spreadsheet has been created, you can save it as a template and use on multiple projects. If you want, and your software allows it, you can tie in multiple earned value spreadsheets to a master file to track all of your projects at a glance.
Considering the Cost Control Results
Cost control is an ongoing process throughout the project. The project manager must actively monitor the project for variances to costs. Specifically, the project manager always does the following:
? Monitor cost variances and then understand why variances have occurred ? Update the cost baseline as needed based on approved changes ? Work with the conditions and stakeholders to prevent unnecessary changes
to the cost baseline
? Communicate to the appropriate stakeholders cost changes as they occur ? Maintain costs within an acceptable and agreed range
Revising the Cost Estimates
As the project progresses and more detail comes available, there may be a need to update the cost estimates. A revision to the cost estimates requires communication with the key stakeholders to share why the costs were revised. A revision to the cost estimates may have a ripple effect: other parts of the project may need to be adjusted to account for the changes in cost, the sequence of events may be reordered, and resources may have to be changed. In some instances, the revision of the estimates may be expected, as with phased-gate estimating in a long project.
Updating the Budget
Updating the budget is slightly different than revising a cost estimate. Budget updates allow the cost baseline to be changed. The cost baseline is the “before project snapshot”
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Chapter 7: Introducing Project Cost Management
of what the total project scope and the individual WBS components should cost. Should the project scope grow, as shown here, the cost will also likely change to be able to fulfill the new scope.
Added Time
Ill 7-7
de Ad t os dC
Time Original Project
Cost
Scope
Added Scope
If a project undergoes drastic changes—due to large changes to the project scope, false assumptions, or new demands from the customer—it may be necessary to rebaseline the project cost. Rebaselining is done only in drastic changes, as it essentially resets the project. All historical information up to the rebaseline is cleared, and the project starts fresh.
Applying Corrective Actions
Throughout a project, the project manager will apply corrective actions. Corrective actions are any actions applied to project performance to bring the project back into alignment with the project plan. Corrective actions can be scheduling changes, a shift in resources, a different approach to completing the project work—any action, even nudges or shoves, to bring the project back to its expected level of performance.
Preparing for the Estimate at Completion
The Estimate at Completion (EAC) is a hypothesis of what the total cost of the project will be. Before the project begins, the project manager completes an estimate for the project deliverables based on the WBS. As the project progresses, there will be in most projects some variances between what the cost estimate was and what the actual cost is. The difference between these estimates is the variance for the deliverable.
Considering the Cost Control Results
23
EAC is part of the Earned Value Management approach. We’ve talked about Earned Value, Planned Value, and Actual Costs earlier in this chapter. To complete this discussion on EAC, we’ll need another formula from the EVM family. We’ll discuss the entire EVM process in Chapter 10; for now, the one we’re after is the Cost Performance Index (CPI).
Calculating the CPI
CPI is a value that demonstrates how the project costs are performing. CPI is a value that reveals how much money the project is losing. Or, if you’re an optimist, how much money the project is making. For example, a project with a CPI of .93 is losing seven cents on the dollar, assuming US dollars. Or, for the optimist, it’s making .93 cents on the dollar. The fact of the matter is, a project with this CPI value is likely to be over budget because for every dollar spent seven cents evaporates. This shows the CPI in action:
Ill 7-8
BAC = $100,000 Total project 25% Complete CPI=EV/AC CPI=25,000/27,000 CPI=.93
Earned Value %COMP X BAC $25,000
Actual Costs How much was actually spent? $27,000
CPI is a value that shows how the project costs are performing to plan. It relates the work you have accomplished to the amount you have spent to accomplish it. A project with a CPI of .93 means you are spending 1.00 for every .93 worth of work accomplished. Therefore, a CPI under 1.00 means the project is performing poorly against the plan. However, a CPI over 1.00 does not necessarily mean that the project is performing well. It could mean that estimates were inflated or that an expenditure for equipment is late or sitting in accounts payable and has not yet been entered into the project accounting cycle. If you don’t want to think of the CPI value as making or losing money, that’s fine too. Just know the CPI value should be as close to 1.00 as possible. Oh, and don’t celebrate too loudly if the CPI is greater than 1.00. A CPI greater than 1.00 may just reflect poor, bloated estimates, rather than an over-performing project.
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Chapter 7: Introducing Project Cost Management
Calculating Estimate at Completion
Now that the CPI is known, the project manager can calculate the Estimate at Completion. There are actually a few different ways to calculate the EAC. The project manager should choose the approach that best matches what has been experienced in the project. . 7-6 shows all of the EAC formulas in action. The next sections describe the different formulas and the conditions in which to use them.
Experiencing Expected Conditions
If the project is going as planned with little variances, the project manager can use the most basic EAC formula to predict the EAC. Here’s the formula for this condition: EAC=Budget at Completion (BAC)/Cost Performance Index (CPI); you can also write this formula as EAC=BAC/CPI. For example, if the project’s BAC is $575,000 and the CPI is .91, the EAC for this project is $631,868. Those nine cents on every dollar sure do add up!
Accounting for Flawed Estimates
Know this formula for calculating the EAC. It’s the most common of the formulas presented. Imagine a project to install a new operating system on 1000 workstations. One of the assumptions the project team made was that each workstation had the correct hardware to install the operating system automatically. As it turns out, this assumption was wrong, and now the project team must change their approach to installing the operating system. Because the assumption to install the operating system was flawed, a new estimate to complete the project is needed. This new estimate to complete the work is known as the “Estimate to Complete (ETC).” The ETC represents how much more money is needed to complete the project work, and its formula is ETC=EAC-AC.
EAC= BAC CPI EAC=AC+ETC EAC= $575,000 .91 EAC=$20,000+175,000 EAC= $631,868 EAC=$195,000
FIGURE 7-6
There are many approaches to calculating the EAC
EAC=AC+BAC-EV EAC= AC+(BAC-EV) CPI
EAC=$7,000+24,000-$2,450 EAC= $45,000+($250,000-37,500) .83
EAC=$29,050 EAC+$301,024
Considering the Cost Control Results
25
In this scenario of a flawed assumption, the project manager will use a slightly different formula to predict the EAC: EAC = AC +ETC. For example, if the project’s original BAC was $100,000 and the project team had spent $20,000 before realizing the project assumption was flawed, they’d have to create a new estimate to complete the remaining work. Let’s pretend the ETC the project team arrived at was $175,000. The formula EAC=AC+ETC would result in $20,000+$175,000=$195,000. This is because the project had spent $20,000, and $175,000 more is needed to complete the work.
Accounting for Anomalies
Monies that have been spent on a project are called sunk costs. In evaluating whether a project should continue or not, the sunk costs should not be considered—they are gone forever. Sometimes in a project weird stuff happens. These anomalies, or weird stuff, can cause project costs to skew. For example, consider a project to construct a wooden fence around a property line. One of the project team members makes a mistake while installing the wooden fence and reverses the face of the fencing material. In other words, the material for the outside of the fence faces the wrong direction. The project now has to invest additional time to remove the fence material, correct the problem, and replace any wood that may have been damaged in the incorrect installation. This anomaly likely won’t happen again, but it will add costs to the project. For these instances, when events happen but the project manager doesn’t expect similar events to happen again, this EAC formula should be used: EAC=AC+BACEV. Let’s try this out with our fencing project. The project’s AC so far was $7,000; the BAC was $24,500; the EV is only $2,450, as the project has barely started. The formula would read: EAC=$7,000+$24,500-$2,450 and result in an EAC of $29,050— a costly mistake.
Accounting for Permanent Variances
This last EAC formula is used when existing variances in the project are expected to be typical of the remaining variances in the project. For example, a project manager has overestimated the competence of the workers to complete the project work. Because the project team is not performing at the level the project manager had expected, work is completed late and in a faulty manner. Rework has been a common theme for this project.
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Chapter 7: Introducing Project Cost Management
The EAC formula for these instances is: EAC=AC+((BAC-EV)/CPI). In our example, let’s say the AC is $45,000; the BAC is $250,000; the EV is $37,5000; and our CPI is calculated to be .83. The EAC formula for this project is EAC= $45,000+(($250,000-$37,500)/.83). The result of the formula (following the order of operations) is $301,024.
Closing out the Project
Cost control requires accountability for the funds spent. As part of project closeout, phase closeout, or even project cancellation, there must be identified processes and procedures on how to shut down the project. A formal audit may be called for to review the time, costs, materials, and budget of the project. In some instances, a review may happen with management or the Project Sponsor to account for the project budget and how well cost control was managed within the project.
Updating Lessons Learned
As part of Cost Control, the project manager should update the Lessons Learned document to reflect the decisions behind the actions taken. For example, the project manager should identify:
? Changes to cost baseline and why they were approved ? Corrective actions and why they were implemented ? Cost control challenges and issues and how they were resolved ? Other cost control information that may be beneficial for other projects
CERTIFICATION SUMMARY
There are several contributing factors to cost on any project: the expense of the labor to complete the project, the expense of materials needed to complete the project, and the expense of the equipment needed to complete a project. These expenses must be estimated, planned for, and monitored for a project to finish on budget. Management and customers will want to know how much a project is going to cost so they can determine if the project is worth doing, if the project deliverable will be worth the cost, and if the project will be profitable. The estimates for project costs can come in several forms:
Considering the Cost Control Results
27
? Analogous estimating: uses similar historical information to predict the cost
of the current project.
? Parametric modeling: uses a parameter, such as cost per metric ton, to predict
project costs.
? Bottom-up estimating: starts from zero and adds the expenses from bottom-up. ? Top-down estimating: uses a similar project as a cost baseline and factors in
current project conditions to predict costs. The resources needed to complete a project may be one of the biggest expenses in the project’s budget. The activities the resources complete must be worthy of the resource’s time. In other words, the project manager does not want to assign a $125 per hour engineer to filing activity that a $15 per hour administrative assistant is qualified to do. Accurate assignment of project resources to project activities helps prevent waste. Projects also have four different kinds of cost:
? Direct costs: these are costs that attributed directly to the project and cannot
be shared with operations or other projects.
? Variable costs: costs that vary depending on the conditions within the project. ? Fixed costs: costs that remain the same throughout the project. ? Indirect costs: these costs can be shared across multiple projects that use the
same resources – such as training room or piece of equipment. There is one last cost, called opportunity costs. This is a special cost because it really doesn’t cost the organization anything out of pocket, but rather the cost of a lost opportunity. Opportunity costs are an expense companies that complete projects for other organizations realize. When an organization that completes projects for others must forgo one project in order to complete the other, the value of the forgone project is the opportunity cost. For example, a company has two projects it can complete but it must choose only one of them. Project A is worth $75,000 and Project B is worth $50,000. If the company chooses Project A the opportunity cost is $50,000 because the company misses out on the opportunity.
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Chapter 7: Introducing Project Cost Management
KEY TERMS
If you’re serious about passing the PMP exams, memorize these terms and their definitions. For maximum value, create your own flashcards based on these definitions and review daily.
Actual costs
Analogous estimating Bottom up estimating Budget at completion Chart of accounts Cost baseline Cost budgeting Cost change control
Cost control
Cost estimating Cost management plan Cost Performance Index Earned value Earned value management Estimate at completion Estimate to complete
Estimating publications
Parametric modeling Planned value Risk Top-down estimating Variance
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TWO MINUTE DRILL
Resources and the Project Work ? The project manager must know what resources are needed to complete the
project work. How will the project ever be completed without the resources? The project manager must know the people, the equipment, materials, and other resources needed to make the vision of the project a reality.
? The resources also must be known so the project manager may predict,
monitor, and control what the project costs are expected to be. The relation between the project vision and the needed resources can help the project manager work within the predicted costs.
? Resources to complete a project also include services, leases, real estate, and
other components that contribute to the project work being completed.
Creating Project Estimates ? The identified resource requirements and the WBS are two key tools
to identify what resources are needed for what component of the project. The cost of the resources help the project manager calculate the estimated costs based on the duration of the project activities or the amount of materials applied to the project.
? Analogous estimating uses a similar project to predict what the costs of the
current project should be. It is less accurate, but easier and faster to complete than other methods.
? Bottom-up estimating starts with zero, and each component of the WBS is
accounted for to reach a grand total of the project. It is the most accurate method, but it takes longer to complete.
? Parametric estimating uses a parameter for units of goods and time to
calculate what the project will cost. For example, cost per hour, cost per metric ton, or cost per cubic yard.
Management Project Costs ? The cost management plan documents how the project manager will react
to cost variances within the project. The performing organization will likely have policies and procedures on unacceptable variances.
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Chapter 7: Introducing Project Cost Management
? Variances that cross a given threshold may require the project manager to
create a variance report to explain the variance, why it has happened, and what corrective action has been applied to prevent the variance from recurring.
? Cost control is the process of monitoring and documenting cost changes,
whether they are allowed to occur or prevented from occurring. The project manager studies the cost changes to understand why the change has happened and then makes corrective actions to the project if needed.
Applying Earned Value Management
Earned value management is a method to measure project performance. The formulas we covered in this chapter are:
? ? ? ? ? ? ?
BAC=Our predicted budget at completion EV=%Complete X BAC PV= What the project should be worth at this point in the schedule AC=The actual costs of the project work to date CPI=EV/AC EAC=BAC/CPI ETC=EAC-AC
Considering the Cost Control Results
31
INSIDE THE EXAM
The PMP examination requires the exam candidate to know how to estimate, budget, and manage costs. The WBS is an input to estimating costs, as it reflects the whole of the project. When creating the estimates, rely on documented historical information over team member’s recollections. There are three estimating approaches:
? Analogous
to +75 percent and is used in the initiation process and in top-down estimating.
? Budget estimate
The accuracy of the estimate is –10 percent to +25 percent. This is used early in the planning process and also in top-down estimating. The accuracy of the estimate is –5 percent to +10 percent. This is used late in the planning process and in bottom-up estimating.
A top-down approach that is less costly and less accurate than others and provides just an idea of what the project will cost. Starts with zero and adds up all the expenses. This is more costly and takes longer, but gains team buy-in to the project. Uses a parameter for labor and goods to calculate the cost of the project.
? Definitive estimate
? Bottom-up
? Parametric modeling
The accuracy of the estimates is based on available information. As the project manager and the project team progressively elaborate the project plan, more details become available. The more details a project has, the more accurate the estimate. Know these facts on estimating:
? Rough order of magnitude
The accuracy of the estimate is –25 percent
The resources on a project can include people, materials, and equipment. If the people on a project do not have the necessary skill set to complete the work, either hire an SME to guide the project implementation, outsource the project work, or train the current people for the needed skills. Earned value management is a tool to measure project performance. Earned value is the budget at completion multiplied by the percentage of the project work that has been completed. The Cost Performance Index shows how well the project is performing financially. It is calculated by dividing EV by the actual costs spent on the project. Use the most common formula for finding the estimate at completion, EAC=BAC/CPI.
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Chapter 7: Introducing Project Cost Management
SELF TEST
1. Which one of the following best describes analogous estimating? A. B. C. D. Regression analysis Bottom up estimating Less accurate More accurate
2. You are the project manager for GHG Project. You are about to create the cost estimates for the project. Which input to this process will help you the most? A. B. C. D. Parametric modeling WBS Project scope Requirements document
3. You are the project manager for the JKH Project. You have elected to use parametric modeling in your cost estimating for the project. Which one of the following is an example of parametric modeling? A. B. C. D. $750 per ton Historical information from a similar project Estimates built from bottom-up based on the WBS Estimates based on top-down budgeting
4. You are the project manager for a new technology implementation project. Management has requested that your estimates be as exact as possible. Which one of the following methods of estimating will provide the most accurate estimate? A. B. C. D. Top-down estimating Top-down budgeting Bottom-up estimating Parametric modeling
5. Your company has been hired to install the tile in 1000 hotel rooms. All rooms will be identical in nature and will require the same amount of materials. You calculate the time to install the tile in each hotel room as six hours. The cost for labor for each room is calculated at $700. Your Project Sponsor disagrees with your labor estimate. Why?
Self Test
33
A. You haven’t completed one hotel room yet so you don’t know how long the work will actually take. B. You have not factored in all of the effort applied to the work. C. You have not considered the law of diminishing returns. D. You have not considered the learning curve. 6. You are the project manager for a construction project to build 17 cabins. All of the cabins will be identical in nature. The contract for the project is set at a fixed cost, the incentive being the faster the project work is completed, the more the profitable the job. Management has requested that you study the work method to determine a faster, less costly, and better method to complete the project. This is an example of which one of the following? A. B. C. D. Time constraint Schedule constraint Value analysis Learning curve
7. You are the project manager for a technical implementation project. The customer has requested that you factor in the after-the-project costs, such as maintenance and service. This is an example of which one of the following? A. B. C. D. A. B. C. D. Life cycle costs Scope creep Project spin off Operations Rough order of magnitude Budget estimate Definitive estimate WBS estimate
8. Which one of the following provides the least accurate in estimating?
9. Which one of the following is true? A. The cost management plan controls how change management affects the BAC. B. The cost management plan controls how cost variances will be managed. C. The cost management plan controls how the project manager may update the cost estimates. D. The cost management plan controls how the BAC may be adjusted.
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Chapter 7: Introducing Project Cost Management
10. You have just started a project for a manufacturer. Project team members report they are 30 percent done with the project. You agree with their completion status but do not change any of the progress in your report to the customer. This is an example of which one of the following? A. B. C. D. 50/50 rule 0/100 rule Percent Complete Rule Poor project management
11. You and your project team are about to enter a meeting to determine project costs. You have elected to use bottom-up estimating and will base your estimates on the WBS. Which one of the following is not an attribute of bottom-up estimating? A. B. C. D. People doing the work create the estimates Creates a more accurate estimate More expensive to do than other methods Less expensive to do than other methods
12. What is the present value if the organization expects to make $100,000 four years from now and the annual interest rate is six percent? A. B. C. D. $100,000 $58,000 $25,000 Zero
13. You are the project manager for the construction of a new hotel. Before you begin the cost budgeting process, what is needed? A. B. C. D. Costs estimates and project schedule Cost estimates and supporting detail EAC and BAC Parametric model used to arrive at the costs submitted
14. You are the project manager of the MNJ Project. Your project is falling behind schedule and you have already spent $130,000 of your $150,000 budget. What do you call the $130,000? A. B. C. D. Planned value Present value Sunk costs Capital expenditure
Self Test
35
15. You are the project manager of the JHD Project. Your project will cost your organization $250,000 to complete over the next eight months. Once the project is completed, the deliverables will begin earning the company $3500 per month. The time to recover the costs of the project is which one of the following? A. B. C. D. Not enough information to know Eight months 72 months 5 years
16. You are the project manager for the consulting company. Your company has two possible projects to manage, but they can only choose one. Project KJH is worth $17,000, while Project ADS is worth $22,000. Management elects to choose Project ADS. The opportunity cost of this choice is which one of the following? A. B. C. D. $5,000 $17,000 $22,000 Zero, as project ADS is worth more than Project KJH
17. You are the project manager for the CSR Training Project, and 21,000 customer service reps are invited to attend the training session. Attendance is optional. You have calculated the costs of the training facility, but the workbook expense depends on how many students register to the class. For every 5000 workbooks created the cost is reduced a percentage of the original printing cost. The workbook expense is an example of which one of the following? A. B. C. D. Fixed costs Parametric costs Variable costs Indirect costs
18. You are the project manager of a construction project scheduled to last 24 months. You have elected to rent a piece of equipment for the duration of a project, even though you will need the equipment only periodically throughout the project. The costs of the equipment rental per month are $890. This is an example of __________________________. A. B. C. D. Fixed costs Parametric costs Variable costs Indirect costs
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Chapter 7: Introducing Project Cost Management
19. You are the project manager for the Hardware Inventory Project. You have a piece of equipment that was purchased recently for $10,000 and is expected to last five years in production. At the end of the five years the expected worth of the equipment is $1,000. Using straight-line deprecation, what is the amount that can be written off each year? A. B. C. D. Zero $1,000 $1,800 $2,000
20. You are the project manager of the LKG Project. The project has a budget of $290,000 and is expected to last three years. The project is now ten percent complete and is on schedule. What is the BAC? A. B. C. D. $29,000 $290,000 $96,666 $9,666
21. Your project has a budget of $130,000 and is expect to last ten months, with the work and budget spread evenly across all months. The project is now in month three, the work is on schedule, but you have spent $65,000 of the project budget. What is your variance? A. B. C. D. $65,000 $39,000 $26,000 $64,999
22. You are the project manager of the Carpet Installation Project for a new building. Your BAC is $600,000. You are now 40 percent done with the project, though your plan called for you to be 45 percent done with the work at this time. What is your earned value? A. B. C. D. $240,000 $270,000 $30,000 –$30,000
23. You are the project manager of the Carpet Installation Project for a new building. Your BAC is $600,000. You have spent $270,000 of your budget. You are now 40 percent done with the project, though your plan called for you to be 45 percent done with the work at this time. What is your CPI?
Self Test
37
A. B. C. D.
100 89 .89 .79
24. You are the project manager for the Facility Installation Project. The project calls for 1500 units to be installed into a new baseball stadium. Your team wants to know why you have not assigned the same amount of time for the last 800 units as you had for the first five hundred units. You tell them it is because of the learning curve. Which one of the following best describes this theory? A. B. C. D. Production increases as workers become more efficient with the installation procedure. Efficiency increases as workers become more familiar with the installation procedure. Costs decreases as workers complete more of the installation procedure. Time decreases as workers complete more of the installation procedure in the final phases of a project. Historical information from a recently completed project An SME’s opinion Recollections of team members that have worked on similar projects Vendor’s white papers
25. Of the following, which one is the most reliable source of information for estimating project costs? A. B. C. D.
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Chapter 7: Introducing Project Cost Management
SELF TEST ANSWERS
1. þ C. Analogous estimating is less accurate than other estimating methods. ý A is incorrect, as regression analysis is a type of parametric modeling. B is incorrect, as bottom-up estimating starts with zero and adds up the project costs. D is incorrect, as analogous estimating is not more accurate. 2. þ B. The WBS is the input that can help you the most with the cost estimates. ý A is incorrect, as parametric modeling is a form of estimating, not an input. C is incorrect, as the project scope is not an input to the estimating process. D is incorrect, as the requirements document is also not an input to the estimating process. 3. þ A is correct; $750 per ton is an example of parametric modeling. ý B is incorrect, as historical information is analogous, not parametric. C and D are incorrect, as these do not describe parametric modeling. 4. þ C. Bottom up estimating provides the most accurate estimates. The project manager starts at zero, the bottom, and accounts for each cost within the project. ý A, B, and D are all incorrect as they do not reflect the most accurate method to create an estimate. 5. þ D is the best choice. As the project team completes more and more units, the time to complete a hotel room should take less and less time. ý Choices A, B, and C are incorrect as they do not answer the question as fully as answer A. 6. þ C. Value analysis is a systematic approach to find less costly ways to complete the same work. ý A and B are not correct, as this situation does not describe a specific time or cost constraint. D is incorrect, as the learning curve happens as the project team completes the work. Value analysis is a study of a process to complete the work faster and more affordably. 7. þ A. The after-project costs are known as the life cycle costs. ý Choices B and C are incorrect, though tempting, because the do not describe the process of calculating the ongoing expenses of the product the project is creating. D is incorrect; operations do not fully describe the expenses unique to the product. 8. þ A. The rough order of magnitude is the least accurate approach, as it may vary from –25 percent to +75 percent. ý Choices B and C are more accurate estimates than the rough order of magnitude. Choice D is not a valid answer for this question. 9. þ B. The cost management plan controls how cost variances will be managed. ý Choices A, C, and D are incorrect descriptions of the cost management plan.
Self Test Answers
39
10. þ B. This is an example of the 0/100 rule. This completion method allows for zero percent credit on an activity until it is 100 percent complete. ý Choice A allows for 50 percent completion when the work begins and 50 percent when the work is completed. Choices C and D are incorrect responses, as they do not describe the scenario. 11. þ D. Using bottom-up estimating is not less expensive to do. ý A, B, and C are not correct choices, as these are attributes of a bottom-up estimating process. 12. þ B. The present value of $100,000 four years from now can be calculated through this formula: Present Value = FV/(1+R)n. FV is the future value, R is the interest rate, and n is the number of time periods. ý Choices A, C, and D are all incorrect answers, as they do not reflect the present value. 13. þ A. Cost estimates and the project schedule are inputs to the cost budgeting process. ý Choices B, C, and D are all incorrect as they are not inputs to cost budgeting. 14. þ C. Sunk costs are monies that have been spent. ý A is incorrect, as planned value is the amount the project should be worth at this point in the schedule. B is incorrect; present value is the current value of future monies. D is incorrect; a capital expenditure is money spent to purchase a long-term asset, such as a building. 15. þ C. The time to recoup the monies from the project is 72 months. This is calculated by dividing the ROI of $3500 per month into the project cost. ý A is an incorrect answer. B is incorrect; eight months is the amount of time left in the project schedule. D, five years, is also incorrect. 16. þ B. The opportunity cost is the amount of the project that was not chosen. ý A is incorrect; $5000 is the difference between the two projects, it is not the opportunity cost. C is incorrect, as $22,000 is the amount of the project that was selected. D is an incorrect answer. 17. þ C. This is an example of variable costs. The more students that register to take the class the more the cost of the books will be. ý A is incorrect, as the cost of the book varies depending on the number of students that register for the class. B is incorrect, as the cost of each book diminishes as more books are created. A parametric cost would remain the same regardless of how many books were created. D is not correct, as this is not an example of an indirect cost.
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Chapter 7: Introducing Project Cost Management
18. þ A. This is a fixed cost expense of $890 per month—regardless of how often the piece of equipment is used. ý B is incorrect, as a parametric cost is a value used to calculate cost per use, cost per metric ton, or cost per unit. While it may appear B is a correct choice, there is no historical information mentioned to base the parametric model on. C is incorrect, as the cost does not vary within the project. D is also incorrect; this is a cost attributed directly to the project work. 19. þ C. The straight-line depreciation takes the purchase value of the item, minus the salvage price of the item, divided by the number of time periods. In this instance, it’d be $10,000 minus $1000, or $9000. The $9000 is divided by five years and equates to $1800 per year. ý A, C, and D are all incorrect, as they do not reflect the correct calculation. 20. þ B. The BAC is the budget at completion, which is $290,000. ý A is incorrect, as it describes the earned value for the project. C and D are both incorrect values. 21. þ C. $26,000 is the variance. This is calculated by subtracting the actual costs of $65,000 from the earned value of $39,000. EV is calculated by taking the 30 percent completion of the project against the BAC. The project is considered to be 30 percent complete because it’s slated for ten months, is currently in month three, and is on schedule. ý A, B, and D are all incorrect calculations for the problem. 22. þ A. The earned value is calculated by multiplying the percentage of completion, 40 percent, by the BAC, which is $600,000, for a value of $240,000. ý B, C, and D are incorrect calculations of the earned value formula. 23. þ C is the correct answer. The EV of $240,000 is divided by the AC of $270,000 for a value of .89. ý A and D are incorrect calculations. B is incorrect, as the value needs a decimal. 24. þ B. The learning curve allows the cost to decrease as a result of decreased installation time as workers complete more of the installation procedure. ý Choices A, C, and D are all incorrect choices, as the do not correctly describe the learning curve in relation to time and cost. 25. þ A. Of the choices presented, historical information from a recently completed project is the most reliable source of information. ý B, while valuable, is not as proven as historical information. C is incorrect, as recollections are the least reliable source of information. D is also incorrect, though it may prove valuable in the planning process.
doc_561355091.pdf
Traditionally, the field of project management begins with the "initiation" of a project. The most well known treatment of the project management process is included in the Project Management Institute's Project Management Body of Knowledge (PMBOK).
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Introducing Project Cost Management
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Chapter 7: Introducing Project Cost Management
P
rojects cost. Have you ever worked with a client who had a huge vision for a project, but had little capital to invest into the vision? Or have you worked with a client who gasped when you revealed how much it would cost to complete their desired scope of work? Or have you been fortunate and had a customer who accepted the costs for the project at face value, made certain the funds were available, and sent you on your way to complete the work? As a general rule, management and customers are always concerned with how much a project is going to cost in relation to how much a project is going to earn. Most likely there is more negotiating, questioning, and evaluating for larger projects than for smaller ones. The relation between the project cost and the project scope should be direct: you get what you pay for. Think it’s possible to buy a mansion at ranch home prices? Not likely. Think it’s possible to run a worldwide marketing campaign at the cost of a postcard mailer? Not likely. A realistic expectation of what a project will cost will give great weight to the project’s scope. As the business need undergoes analysis, progressive elaboration and estimates are completed based on varying levels of detail, and eventually the cost of project will emerge. Often, however, the predicted costs and the actual costs vary. Poor planning, skewed assumptions, and overly optimistic estimates all contribute to this. A successful project manager must be able to plan, predict, budget, and control the costs of a project. Costs associated with projects are not just the costs of goods procured to complete the project. The cost of the labor may be one of the biggest expenses of a project. The project manager must rely on time estimates to predict the cost of the labor to complete the project work. In addition, the cost of the equipment and materials needed to complete the project work must be factored into the project expenses.This chapter examines the management of project costs, how to predict them, account for them, and then, with plan in hand, to control them. We’ll examine exactly how costs are planned for and taken into consideration by the performing organization and how the size of the project affects the cost estimating process.
Planning the Project Resources
As part of the planning process, the project manager must determine what resources are needed to complete the project. Resources include the people, equipment, and materials that will be utilized to complete the work. In addition, the project manager must identify the quantity of the needed resources and when the resources are needed for the project. The identification of the resources, the needed quantity, and the
Planning the Project Resources
3
schedule of the resources are directly linked to the expected cost of the project work, as shown here:
Ill 7-1
Labor Materials Equipment
Project Costs
Consider a project to fully automate a new home: the lights, heating and cooling, appliances, and home security are all connected through a central computer operating system. The resources to complete the project work would include technicians, HVAC experts, electricians, and other people with the knowledge to install and configure the components. The resources in this case, however, would also include the network cabling to connect the components, diagnostic tools to monitor and test the installation, and the equipment and tools to physically install the components. In addition, services and sites are considered resources as well. Your project may require a vendor’s service, such as a commercial printer, a carpenter, or other service. If these services are not available for the project as planned, the project will suffer. Some projects require you to lease space; the leased space is considered a resource. In some instances, it most cost effective to hire a consultant or subject matter expert (SME) to identify details unique to the project work, If time is an issue in such as mandates, laws, standards, and so on. a complex project, rely on an SME to The expense of relying on the SME may be far provide input to the decision-making less than the cost of the time to research the process. If the project team is lacking unique details and requirements of the project. a needed project skill set, a seminar or The knowledge gained from the SME can offset training class is appropriate to get the the expenses that would otherwise result from not team member up to speed. having specialized knowledge of the project work.
Consider the Inputs to Resource Planning
Resource planning is the process of examining the project work and determining what resources, people, and equipment are needed to complete the project. Resource
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Chapter 7: Introducing Project Cost Management
planning also includes identifying the expected quantity of the needed resources so the predicted cost can be calculated. These are some familiar inputs to resource planning:
? Work breakdown structure
The WBS is a deliverables-orientated breakdown of the components of the project. It helps the project manager and the project team identify the components requiring specific people, equipment, and materials. The WBS is the primary input to resource planning. If similar projects have been completed, what resources were required on these projects? Historical information should be used if it’s available, as it is proven information rather than speculation. The scope statement serves as a key input to resource planning; the scope statement defines the project work. The scope statement should guide the resource planning process, as it identifies why the project was undertaken and the required work to complete the project. The required work, therefore, can help identify the required resources to complete the project. The project manager should identify what resources are available for the project. These include people, materials, and equipment. As the project passes through progressive elaboration, the identified pool of resources may vary. For example, in the early phases of a marketing campaign, the pool may include copywriters, designers, computer professionals, the individuals that operate the printing equipment, and photographers. As the project moves through its phases to completion, the resource pool may be limited to only those people who have worked on the project in the early phases. The performing organization’s policies regarding staff acquisition must be taken into consideration. In addition, any procurement policies to ascertain, lease, or rent equipment must be evaluated. The project manager should be aware of these requirements before planning the resources— time invested identifying resources may be lost if the process conflicts with the organizational policies. The duration of the activities are needed so the project manager and the project team can consider the costs and benefits of assigning more effort to reduce tasks duration where feasible, as seen here. The activity duration estimates should be readily available from the time management processes.
? Historical information
? Scope statement
? Resource pool description
? Organizational policies
? Activity duration estimates
Planning the Project Resources
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Cost of Labor
Ill 7-2
Additional labor Short duration
Project duration
Applying Expert Judgment
Armed with the inputs to resource planning, the project manager and the project team should be ready to identify and plan the need for the project resources. The project manager and the project team will examine the project work and the available resources and then apply reason, logic, and experience in evaluating the available resources in relation to the project requirements. A person or group can offer expert judgment on the project resource needs. The person or group offering the expert judgment should have the expertise, experience, or training needed to evaluate and analyze the resources that the project needs. Expert judgment can come from several sources:
? Internal subject matter experts, such as resources from other departments ? External subject matter experts, such as consultants ? Trade and professional associations ? Industry groups
Identifying Alternative Solutions
Alternatives-identification is any process that identifies other solutions to an identified problem. These approaches typically use brainstorming and lateral thinking. In this process, alternatives-identification may include buy-versus-build scenarios, outsourcing, cross training, and other activities. The idea of using alternatives-identification is to ensure that the identified resources are complete and that the cost of the resources are the best fit for the project work. Value analysis is an approach to find more affordable, less costly, methods of accomplishing the same work. For example, a project manager may change the sequencing of activities to shorten the project duration, while saving labor costs by assigning high-cost resources only to the activities that demand it.
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Chapter 7: Introducing Project Cost Management
Relying on Project Management Software
Project management software can help the project manager identify and organize the resource pools. Project management software can be configured to organize common resources, talents, skill sets, calendars, rates, contact information, and more. While there are many different project management applications available, the ability to easily use and update the information an application stores is critical. Figure 7-1 is a screen shot of Microsoft Project accessing resources from a central repository.
Identifying Resource Requirements
Once the project manager and the project team have completed resource planning, the required resources to complete the project will have been identified. The resource identification is specific to the lowest level of the WBS. The identified resources will need to be obtained through staff acquisition or through procurement. We’ll cover staff acquisition in Chapter 9 and procurement in Chapter 12. Figure 7-2 is a recap of all the inputs, tools, and techniques, and outputs of resource planning.
FIGURE 7-1
Project management software can assist in resource planning.
Cost Estimating
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FIGURE 7-2
Resource planning identifies all of the required resources.
Inputs WBS Historical information Scope statement Resource pool description Organization policies Duration estimates Tools and Techniques Expert judgment Alternatives identification Project management software
Resource Requirements
Cost Estimating
Cost estimating is the process of calculating the costs of the identified resources needed to complete the project work. The person or group doing the estimating must consider the possible fluctuations, conditions, and other causes of variances that could affect the total cost of the estimate. There is a distinct difference between cost estimating and pricing. A cost estimate is the cost of the resources required to complete the project work. Pricing, however, includes a profit margin. In other words, a company performing projects for other organizations may do a cost estimate to see how much the project is going to cost to complete. Then, with this cost information, they’ll factor a profit into the project work, as shown here:
Ill 7-3
Project cost
Profit margin Actual
Project duration
More and more companies are requiring the project manager to calculate the project costs and then factor the ROI, and other benefit models, into the project product. The goal is to see the value of the project once its deliverables are in operations.
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Chapter 7: Introducing Project Cost Management
Considering the Cost Estimating Inputs
Cost estimating relies on several project components from the Initiation and Planning process groups. This process also relies on historical information and policies from the performing organization.
Using the Work Breakdown Structure
Of course the WBS is included—it’s an input to five major planning processes: cost estimating, cost budgeting, resource planning, risk management planning, and activity definition.
Relying on the Resource Requirements
The only output of resource planning serves as a key input to cost estimating. The project will have some requirement for resources—the skills of the labor, the ability of materials, or the function of equipment must all be accounted for.
Calculating Resource Rates
The estimator has to know how much each resource costs. The cost should be in some unit of time or measure—such as cost per hour, cost per metric ton, or cost per use. If the rates of the resources are not known, the rates themselves may also have to be estimated. Of course, skewed rates on the estimates will result in a skewed estimate for the project. There are four categories of cost:
? Direct costs
These costs are attributed directly to the project work and cannot be shared among projects (airfare, hotels, and long distance phone charges, and so on). These costs vary depending on the conditions applied in the project (number of meeting participants, supply and demand of materials, and so on). These costs remain constant throughout the project (the cost of a piece of rented equipment for the project, the cost of a consultant brought onto the project, and so on). These costs are representative of more than one project (utilities for the performing organization, access to a training room, project management software license, and so on).
? Variable costs
? Fixed costs
? Indirect costs
Cost Estimating
9
Estimating Activity Durations
Estimate of the duration of the activities, which predict the length of the project, are needed for decisions on financing the project. The length of the activities will help the performing organization calculate what the total cost of the project will be, including n the finance charges. Recall the formula for present value? It’s PV= FV/(1+R) ; PV is the present value, FV is the future value, R is the interest rate, and n is the number of time periods. The future value of the monies the project will earn may need to be measured against the present value to determine if the project is worth financing, as shown here:
Ill 7-4
Finance Charges Future Value = $450,000 Present Value = $317,000
Calculations of the duration of activities are needed in order to extrapolate the total cost of the work packages. For example, if an activity is estimated to last 14 hours and Suzanne’s cost per hour is $80, then the cost of the work package is $1,120. The duration shows management how long the project is expected to last and which activities will cost the most and provides the opportunity to re-sequence activities to shorten the project duration—which consequently shortens the finance period for the project. Another aspect the project manager and management may have to determine is the long-term worth of a product in regard to tax deductions. There are three approaches to deduct the product’s cost:
? Straight-line depreciation allows the organization to write off the same
amount each year. The formula for straight-line depreciation is Purchase Value minus Salvage Value divided by Number of Years in Use. For example, if the purchase price of a photocopier is $7,000 and the salvage value of the photocopier in five years is $2,000, the formula would read: 7,000–2,000/5= $1,000.
? Double-declining balance is considered accelerated depreciation. This
method allows the organization to double the percentage written off in the first year. In our above example, a single deduction was $1000 per year, which is twenty percent of the total deduction across the five years. With double-declining, the customer would subtract 40 percent the first year, and then 40 percent of the remaining value each subsequent year. In our example, the deducted amount for year one would be $2000. For year two it’d be $1200, and year three it would be $720. This is a great method for equipment that you don’t anticipate to have around for a very long time—such as computer equipment.
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Chapter 7: Introducing Project Cost Management
? Sum of the years depreciation is like a magic trick. It works by writing
out the number of years the equipment is in production and adding each year to the year before. In our example it was five years, so we’d do this: 5+4+3+2+1=15 (note the largest to smallest). The sum of the years, 15, becomes our denominator; the five, for the first year, is our numerator. So for the first year, we’d deduct 5/15ths (or one third) of the photocopier cost after the salvage amount, which would be $1650. The second year the four would be the numerator and we’d deduct $1250, and so on. Each year we’d deduct a slightly smaller percentage than the year before.
Using Estimating Publications
You may encounter a general question on straight-line versus double-declining depreciation on the PMP Exam. You should be familiar with the concept, but don’t invest too much time memorizing these formulas for the exam. There are, for different industries, commercial estimating publications. These references can help the project estimator confirm and predict the accuracy of estimates. If a project manager elects to use one of these commercial databases, the estimate should include a pointer to this document for future reference and verification.
Using Historical Information
Historical information is proven information and can come from several places:
? Project files
Past projects within the performing organization can be used as a reference to predict costs and time. Caution must be taken that the records referenced are accurate, somewhat current, and reflective of what was actually experienced in the historical project. These databases provide estimates of what the project should cost based on the variables of the project, resources, and other conditions.
? Team members
? Commercial cost-estimating databases
The project team members’ recollections of what things cost should not be trusted as fact. It’s advice and input, but documented information is always better.
Team members may have specific experience with the project costs or estimates. Recollections may be useful, but are highly unreliable when compared to documented results.
Cost Estimating
11
Referencing the Chart of Accounts
This is a coding system used by the performing organization’s accounting system to account for the project work. Estimates within the project must be mapped to the correct code of accounts so that the organization’s ledger reflects the actual work performed, the cost of the work performed, and any billing (internal or external) that was charged to the customer for the completed work.
Acknowledging the Cost of Risk
The impact of risks, for positive or negative effect, must be evaluated and considered in the cost estimates. Risks, which we’ll cover in Chapter 11, can impact the cost of the project. For example, should a risk come into play, the mitigation of the risk may require adding several activities to squelch the risk. The expense of the activities would add cost to the project.
Estimating Project Costs
Management, customers, and other interested stakeholders are all going to be interested in what the project is going to cost to complete. There are several approaches to cost estimating, which we’ll discuss in one moment. First, however, understand that cost estimates have a way of following the project manager around—especially the lowest initial cost estimate. The estimates you’ll want to know for the PMP exam, and for your career, are reflective of the accuracy of the information the estimate is based upon. The more accurate the information, the better the cost estimate will be.
Using Analogous Estimating
Analogous estimating relies on historical information to predict the cost of the current project. It is also known as top-down estimating. The process of analogous estimating takes the actual cost of a historical project as a basis for the current project. The cost of the historical project is applied to the cost of the current project, taking into account the scope and size of the current project as well as other known variables. Analogous estimating is a form of expert judgment. This estimating approach takes less time to complete than other estimating models, but is also less accurate. This top-down approach is good for fast estimates to get a general idea of what the project may cost.
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Chapter 7: Introducing Project Cost Management
Here’s an example of analogous estimating: the Carlton Park Project was to grade and pave a sidewalk around a pond in the community park. The sidewalk of Carlton Park was 1048 feet by 6 feet, used a textured surface, had some curves around trees, and cost $25,287 to complete. The current project, King Park, will have a similar surface and will cover 4,500 feet by 6 feet. The analogous estimate for this project, based on the work in Carlton Park, is $$108,500. This is based on the price per foot of material at $4.021 – note that $4.021 is not the same as $4.21.
Using Parametric Modeling
Parametric modeling uses a mathematical model based on known parameters to predict the cost of a project. The parameters in the model can vary based on the type of work being completed. A parameter can be cost per cubic yard, cost per unit, and so on. A complex parameter can be cost per unit with adjustment factors based on the conditions of the project. In addition, the adjustment factors may have additional modifying factors depending on additional conditions. To use parametric modeling, the factors the model is based on must be accurate. The factors within the model are quantifiable and don’t vary much based on the effort applied to the activity. And finally, the model must be scalable between project sizes. The parametric model using a scalable cost-per-unit approach is depicted here:.
Ill 7-5
Cost per unit = $78
Project A
Project B
There are two types of parametric estimating:
? Regression analysis
This is a statistical approach to predict what future values may be, based on historical values. Regression analysis creates quantitative predictions based on variables within one value to predict variables in another. This form of estimating relies solely on pure statistical math to reveal relationships between variables and predict future values.
Analyzing Cost Estimating Results
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? Learning curve
This approach is simple: the cost per unit decreases the more units workers complete; this is because workers learn as they complete the required work. The more an individual completes an activity, the easier it is to complete. The estimate is considered parametric, as the formula is based on repetitive activities, such as wiring telephone jacks, painting hotel rooms, or other activities that are completed over and over within a project. The cost per unit decreases as the experience increases because the time to complete the work is shortened.
Using Bottom-Up Estimating
Don’t worry too much about regression analysis for the exam. Learning curve is a topic you’ll more likely have questions on. Bottom-up estimating starts from zero, accounts for each component of the WBS, and arrives at a sum for the project. It is completed with the project team and can be one of the most timeconsuming methods to predict project costs. While this method is more expensive, because of the time invested to create the estimate, it is also one of the most accurate. A fringe benefit of completing a bottomup estimate is the project team may buy-into the project work as they see they cost and value of each cost within the project.
Using Computer Software
While the PMP examination is vendor-neutral, a general knowledge of how computer software can assist the project manageris needed. There are several different computer programs that can streamline and make accurate estimates for the project work. These tools can include project management software, spreadsheet programs, and simulations.
Analyzing Cost Estimating Results
The output of cost estimating is the actual cost estimates of the resources required to the complete the project work. The estimate is typically quantitative and can be presented in detail against the WBS components or summarized in terms of a grand total, by phases of the project, or by major deliverables. Each resource in the project must be accounted for and assigned to a cost category. Categories include the following:
? Labor costs ? Material costs
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Chapter 7: Introducing Project Cost Management
? Travel costs ? Supplies ? Hardware costs ? Software costs ? Special categories (inflation, cost reserve, and so on)
The cost of the project is expressed in monetary terms, such as dollars, euros, or yen, so management can compare projects based on costs. It may be acceptable, depending on the demands of the performing organization, to provide estimates in staffing hours or days of work to complete the project along with the estimated costs. As projects have risks, the cost of the risks should be identified along with the cost of the risk responses. The project manager should list the risks, their expected risk event value, and the response to the risk should it come into play. We’ll cover risk management in detail in Chapter 11.
Refining the Cost Estimates
Cost estimates can also pass through progress elaboration. As more details are acquired as the project progresses, the estimates are refined. Industry guidelines and organizational policies may define how the estimates are refined, but there are three generally accepted categories of estimating accuracy:
? Rough order of magnitude
This estimate is “rough” and is used during the Initiating processes and in top-down estimates. The range of variance for the estimate can be –25 percent to +75 percent. This estimate is also somewhat broad and is used early in the Planning processes and also in top-down estimates. The range of variance for the estimate can be –10 percent to +25 percent. This estimate type is one of the most accurate. It is used late in the Planning processes and is associated with bottom-up estimating. The range of variance for the estimate can be –5 percent to +10 percent.
? Budget estimate
? Definitive estimates
Considering the Supporting Detail
Once the estimates have been completed, supporting detail must be organized and documented to show how the estimates were created. This material, even the notes
Completing Cost Budgeting
15
that contributed to the estimates, may provide valuable information later in the project. Specifically, the supporting detail includes the following:
? Information on the project scope work
This may be provided by
referencing the WBS.
? Information on the approach used in developing the cost estimates
This can include how the estimate was accomplished and the parties involved with the estimate.
? Information on the range of variance in the estimate
For example, based on the estimating method used, the project cost may be $220,000 ± $15,000. This project cost may be as low as $205,000 or as high as $235,000.
Developing the Cost Management Plan
The cost management plan details how variances from the project costs will be managed. The performing organization may have policies and procedures on the expected reactions to cost variances within the project. For example, variances over a set dollar amount may prompt the project manager to create a Variance Report, meet with management, or even initiate an audit.
Completing Cost Budgeting
Cost budgeting is the process of assigning a cost to an individual work package. The goal of this process is to assign costs to the work in the project so that the work may be measured for performance. This is the creation of the cost baseline, as shown here:
Ill 7-6
Project cost
Cost to date BAC=$400,000
Cost baseline Variance Project schedule
Cost budgeting and cost estimates may go hand-in-hand, but estimating should be completed before a budget is requested—or assigned. Cost budgeting applies the cost estimates over time. This results in a time-phased estimate for cost, allowing an organization to predict cash flow needs. The difference between cost estimates and cost budgeting is that cost estimates show costs by category, whereas a cost budget shows costs across time.
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Chapter 7: Introducing Project Cost Management
Consider the Inputs to Cost Budgeting
Because cost budgeting and cost estimating are so closely related, you can expect many of the same inputs for both. Here are the inputs to cost budgeting:
? Cost estimates
These serve as key inputs; they’re the predicted cost for the
project work.
? Work breakdown structure ? Project schedule
It’s a key input to this process, as it is the deliverables of the project—it’s what the project is buying. The project schedule is needed to determine when the monies in the budget will be spent. The schedule should reflect the sequenced activities against a projected timeline. This allows management not only to plan financially, but also to compare expected cash inflows against the cash outflows the project will demand. The risk management plan is considered because of information it provides of the probability of identified risks and their associated costs. In addition, the risks may have an expected risk value that contributes to the contingency reserve for the project.
? Risk management plan
Developing the Project Budget
The tools and techniques used to create the project cost estimates are also used to create the project budget. Here’s a quick reminder of the four components:
? Analogous budgeting.
This is a form of expert judgment that uses a topdown approach to predict costs. It is generally less accurate than other budgeting techniques. This approach uses a parametric model to extrapolate what costs will be for a project (for example, cost per hour and cost per unit). It can include variables and points based on conditions. This approach is the most reliable, though it also takes the longest to create. It starts at zero and requires each work package to be accounted for. The same software programs used in estimating can help predict the project budget with some accuracy.
? Parametric modeling.
? Bottom-up budgeting
? Computerized tools
Implementing Cost Control
17
Creating the Cost Baseline
A project’s cost baseline shows what is expected to be spent on the project. It’s usually shown in an S-curve, as in Figure 7-3. The idea of the cost baseline allows the project manager and management to predict when the project will be spending monies and over what time period. The purpose of the cost baseline is to measure and predict project performance. Large projects that have multiple deliverables may have multiple cost baselines to illustrate the costs within each phase. Additionally, larger projects may have cost baselines to predict spending plans, cash flows of the project, and overall project performance. The purpose of a cost baseline is to measure performance, and a baseline will predict the expenses over the life of the project. Any discrepancies early on in the predicted baseline and the actual costs serve as a signal that the project is slipping.
Implementing Cost Control
Cost control focuses on the ability of costs to change and on the ways of allowing or preventing cost change from happening. When a change does occur, the project manager must document the change and the reason why the change has occurred and, if necessary, create a variance report. Cost control is concerned with understanding why the cost variances, both good and bad, have occurred. The “why” behind the variances allows the project manager to make appropriate decisions on future project actions. Ignoring the project cost variances may cause the project to suffer from budget shortages, additional risks, or scheduling problems. When cost variances happen they must be examined, recorded, and investigated. Cost control allows the project manager to confront the problem, find a solution, and then act accordingly. Specifically, cost control focuses on these activities:
? Controlling causes of change to ensure the changes are actually needed ? Controlling and documenting changes to the cost baseline as they happen
FIGURE 7-3
Project cost
Cost baselines show predicted project and phase performance.
Project cost
BAC=$400,000
BAC=$220,000
Project cost baseline Project schedule
Project cost baseline Project schedule
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Chapter 7: Introducing Project Cost Management
? Controlling changes in the project and their influence on cost ? Performing cost monitoring to recognize and understand cost variances ? Recording appropriate cost changes in the cost baseline ? Preventing unauthorized changes to the cost baseline ? Communicating the cost changes to the proper stakeholders ? Working to bring and maintain costs within an acceptable range
Considering Cost Control Inputs
To implement cost control, the project manager must rely on several documents and processes:
? Cost baseline
The cost baseline is the expected cost the project will incur. This time-phased budget reflects the amount that will be spent throughout the project. Recall that the cost baseline is a tool used to measure project performance. These reports focus on project cost performance, project scope, and planned performance versus actual performance. The reports may vary according to stakeholder needs. We’ll discuss performance reporting in detail in Chapter 10. When changes to the project scope are requested, an analysis of the associated costs to complete the proposed change is required. In some instances, such as removing a portion of the project deliverable, a change request may reduce the project cost. The cost management plan dictates how cost variances will be managed.
? Performance reports
? Change requests
? Cost management plan
Creating a Cost Change Control System
Sometimes a project manager must add, or remove, costs from a project. The Cost Change Control System is part of the Integrated Change Control System and documents the procedures to request, approve, and incorporate changes to project costs. When a cost change enters the system, there is appropriate paperwork, a tracking system, and procedures the project manager must follow to obtain approval on the proposed change. Figure 7-4 demonstrates a typical workflow for cost change approval. If a change gets approved, the cost baseline is updated to reflect the approved changes. If a request gets denied, the denial must be documented for future potential reference.
Implementing Cost Control
19
FIGURE 7-4
A Cost Change Control System tracks and documents cost change issues.
Cost charge
Cost change request
Has cost changed already occurred?
Tracking system
Yes
No
Documentation: Cause Cost Parties involved Decision
Cost change approved?
Yes
No
Measuring Project Performance
Earned Value Management (EVM) is the process of measuring performance of project work against a plan to identify variances. It can also be useful in predicting future variances and the final costs at completion. It is a system of mathematical formulas that compares work performed against work planned and measures the actual cost of the work performed. EVM is an important part of cost control as it allows a project manager to predict future variances from the expenses to date within the project. EVM, in regard to cost management, is concerned with the relationships between three formulas that reflect project performance. Figure 7-5 demonstrates the relation between these EVM values:
? Planned Value (PV)
Planned Value is the work scheduled and the authorized budget to accomplish that work. For example, if a project has a budget of $100,000 and month six represents 50 percent of the project work,
BAC = $100,000 Total project 25% Complete
FIGURE 7-5
Earned value management measures project performance.
Month 6 = 50%
Earned Value %COMP X BAC $25,000
Actual Costs How much was actually spent? $27,000
Planned Value What the project should be worth at this point in the schedule. $50,000
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Chapter 7: Introducing Project Cost Management
the PV for month six is $50,000. Planned Value used to be known as the Budget Cost of Work Schedule (BCWS), and you may see this term on the PMP Exam.
? Earned Value (EV)
Earned Value is the physical work completed to date and the authorized budget for that work. For example, if a project has a budget of $100,000 and the work completed to date represents 25 percent of the entire project work, its EV is $25,000. Earned Value used to be known as the Budgeted Cost of Work Performed (BCWP). Actual Cost is the actual amount of monies the project has required to date. For example, if a project has a budget of $100,000 and $35,000 has been spent on the project to date, the AC of the project would be $35,000. Actual Cost used to be known as Actual Cost of Work Performed (ACWP).
? Actual Cost (AC)
These three values are key information about the worth of the project to date (EV), the cost of the project work to date (AC), and the planned value of the work to date (PV). These values will be revisited later in this chapter and in Chapter 10.
Additional Planning
Planning is an iterative process. Throughout the project there will be demands for additional planning—and an output of cost control is one of those demands. Consider a project that must complete by a given date and that also has a set budget. The balance between the schedule and the cost must be kept. The project manager can’t assign a large crew to complete the project work if the budget won’t allow it. The project manager must, through planning, get as creative as possible to figure out an approach to accomplish the project without exceeding the budget. The balance between cost and schedule is an ongoing battle. While it’s usually easier to get more time than money, this isn’t always the case. Consider deadlines that can’t move, or the company may face fines and penalties, or a deadline that centers on a tradeshow, an expo, or the start of the school year.
Using Computers
It’s hard to imagine a project, especially larger projects, moving forward without the use of computers. project managers can rely on project management software
Considering the Cost Control Results
21
and spreadsheet programs to assist them in calculating actual costs, earned value, and planned value. It’s not hard to create a spreadsheet with the appropriate earned value formulas. Once the spreadsheet has been created, you can save it as a template and use on multiple projects. If you want, and your software allows it, you can tie in multiple earned value spreadsheets to a master file to track all of your projects at a glance.
Considering the Cost Control Results
Cost control is an ongoing process throughout the project. The project manager must actively monitor the project for variances to costs. Specifically, the project manager always does the following:
? Monitor cost variances and then understand why variances have occurred ? Update the cost baseline as needed based on approved changes ? Work with the conditions and stakeholders to prevent unnecessary changes
to the cost baseline
? Communicate to the appropriate stakeholders cost changes as they occur ? Maintain costs within an acceptable and agreed range
Revising the Cost Estimates
As the project progresses and more detail comes available, there may be a need to update the cost estimates. A revision to the cost estimates requires communication with the key stakeholders to share why the costs were revised. A revision to the cost estimates may have a ripple effect: other parts of the project may need to be adjusted to account for the changes in cost, the sequence of events may be reordered, and resources may have to be changed. In some instances, the revision of the estimates may be expected, as with phased-gate estimating in a long project.
Updating the Budget
Updating the budget is slightly different than revising a cost estimate. Budget updates allow the cost baseline to be changed. The cost baseline is the “before project snapshot”
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Chapter 7: Introducing Project Cost Management
of what the total project scope and the individual WBS components should cost. Should the project scope grow, as shown here, the cost will also likely change to be able to fulfill the new scope.
Added Time
Ill 7-7
de Ad t os dC
Time Original Project
Cost
Scope
Added Scope
If a project undergoes drastic changes—due to large changes to the project scope, false assumptions, or new demands from the customer—it may be necessary to rebaseline the project cost. Rebaselining is done only in drastic changes, as it essentially resets the project. All historical information up to the rebaseline is cleared, and the project starts fresh.
Applying Corrective Actions
Throughout a project, the project manager will apply corrective actions. Corrective actions are any actions applied to project performance to bring the project back into alignment with the project plan. Corrective actions can be scheduling changes, a shift in resources, a different approach to completing the project work—any action, even nudges or shoves, to bring the project back to its expected level of performance.
Preparing for the Estimate at Completion
The Estimate at Completion (EAC) is a hypothesis of what the total cost of the project will be. Before the project begins, the project manager completes an estimate for the project deliverables based on the WBS. As the project progresses, there will be in most projects some variances between what the cost estimate was and what the actual cost is. The difference between these estimates is the variance for the deliverable.
Considering the Cost Control Results
23
EAC is part of the Earned Value Management approach. We’ve talked about Earned Value, Planned Value, and Actual Costs earlier in this chapter. To complete this discussion on EAC, we’ll need another formula from the EVM family. We’ll discuss the entire EVM process in Chapter 10; for now, the one we’re after is the Cost Performance Index (CPI).
Calculating the CPI
CPI is a value that demonstrates how the project costs are performing. CPI is a value that reveals how much money the project is losing. Or, if you’re an optimist, how much money the project is making. For example, a project with a CPI of .93 is losing seven cents on the dollar, assuming US dollars. Or, for the optimist, it’s making .93 cents on the dollar. The fact of the matter is, a project with this CPI value is likely to be over budget because for every dollar spent seven cents evaporates. This shows the CPI in action:
Ill 7-8
BAC = $100,000 Total project 25% Complete CPI=EV/AC CPI=25,000/27,000 CPI=.93
Earned Value %COMP X BAC $25,000
Actual Costs How much was actually spent? $27,000
CPI is a value that shows how the project costs are performing to plan. It relates the work you have accomplished to the amount you have spent to accomplish it. A project with a CPI of .93 means you are spending 1.00 for every .93 worth of work accomplished. Therefore, a CPI under 1.00 means the project is performing poorly against the plan. However, a CPI over 1.00 does not necessarily mean that the project is performing well. It could mean that estimates were inflated or that an expenditure for equipment is late or sitting in accounts payable and has not yet been entered into the project accounting cycle. If you don’t want to think of the CPI value as making or losing money, that’s fine too. Just know the CPI value should be as close to 1.00 as possible. Oh, and don’t celebrate too loudly if the CPI is greater than 1.00. A CPI greater than 1.00 may just reflect poor, bloated estimates, rather than an over-performing project.
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Chapter 7: Introducing Project Cost Management
Calculating Estimate at Completion
Now that the CPI is known, the project manager can calculate the Estimate at Completion. There are actually a few different ways to calculate the EAC. The project manager should choose the approach that best matches what has been experienced in the project. . 7-6 shows all of the EAC formulas in action. The next sections describe the different formulas and the conditions in which to use them.
Experiencing Expected Conditions
If the project is going as planned with little variances, the project manager can use the most basic EAC formula to predict the EAC. Here’s the formula for this condition: EAC=Budget at Completion (BAC)/Cost Performance Index (CPI); you can also write this formula as EAC=BAC/CPI. For example, if the project’s BAC is $575,000 and the CPI is .91, the EAC for this project is $631,868. Those nine cents on every dollar sure do add up!
Accounting for Flawed Estimates
Know this formula for calculating the EAC. It’s the most common of the formulas presented. Imagine a project to install a new operating system on 1000 workstations. One of the assumptions the project team made was that each workstation had the correct hardware to install the operating system automatically. As it turns out, this assumption was wrong, and now the project team must change their approach to installing the operating system. Because the assumption to install the operating system was flawed, a new estimate to complete the project is needed. This new estimate to complete the work is known as the “Estimate to Complete (ETC).” The ETC represents how much more money is needed to complete the project work, and its formula is ETC=EAC-AC.
EAC= BAC CPI EAC=AC+ETC EAC= $575,000 .91 EAC=$20,000+175,000 EAC= $631,868 EAC=$195,000
FIGURE 7-6
There are many approaches to calculating the EAC
EAC=AC+BAC-EV EAC= AC+(BAC-EV) CPI
EAC=$7,000+24,000-$2,450 EAC= $45,000+($250,000-37,500) .83
EAC=$29,050 EAC+$301,024
Considering the Cost Control Results
25
In this scenario of a flawed assumption, the project manager will use a slightly different formula to predict the EAC: EAC = AC +ETC. For example, if the project’s original BAC was $100,000 and the project team had spent $20,000 before realizing the project assumption was flawed, they’d have to create a new estimate to complete the remaining work. Let’s pretend the ETC the project team arrived at was $175,000. The formula EAC=AC+ETC would result in $20,000+$175,000=$195,000. This is because the project had spent $20,000, and $175,000 more is needed to complete the work.
Accounting for Anomalies
Monies that have been spent on a project are called sunk costs. In evaluating whether a project should continue or not, the sunk costs should not be considered—they are gone forever. Sometimes in a project weird stuff happens. These anomalies, or weird stuff, can cause project costs to skew. For example, consider a project to construct a wooden fence around a property line. One of the project team members makes a mistake while installing the wooden fence and reverses the face of the fencing material. In other words, the material for the outside of the fence faces the wrong direction. The project now has to invest additional time to remove the fence material, correct the problem, and replace any wood that may have been damaged in the incorrect installation. This anomaly likely won’t happen again, but it will add costs to the project. For these instances, when events happen but the project manager doesn’t expect similar events to happen again, this EAC formula should be used: EAC=AC+BACEV. Let’s try this out with our fencing project. The project’s AC so far was $7,000; the BAC was $24,500; the EV is only $2,450, as the project has barely started. The formula would read: EAC=$7,000+$24,500-$2,450 and result in an EAC of $29,050— a costly mistake.
Accounting for Permanent Variances
This last EAC formula is used when existing variances in the project are expected to be typical of the remaining variances in the project. For example, a project manager has overestimated the competence of the workers to complete the project work. Because the project team is not performing at the level the project manager had expected, work is completed late and in a faulty manner. Rework has been a common theme for this project.
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Chapter 7: Introducing Project Cost Management
The EAC formula for these instances is: EAC=AC+((BAC-EV)/CPI). In our example, let’s say the AC is $45,000; the BAC is $250,000; the EV is $37,5000; and our CPI is calculated to be .83. The EAC formula for this project is EAC= $45,000+(($250,000-$37,500)/.83). The result of the formula (following the order of operations) is $301,024.
Closing out the Project
Cost control requires accountability for the funds spent. As part of project closeout, phase closeout, or even project cancellation, there must be identified processes and procedures on how to shut down the project. A formal audit may be called for to review the time, costs, materials, and budget of the project. In some instances, a review may happen with management or the Project Sponsor to account for the project budget and how well cost control was managed within the project.
Updating Lessons Learned
As part of Cost Control, the project manager should update the Lessons Learned document to reflect the decisions behind the actions taken. For example, the project manager should identify:
? Changes to cost baseline and why they were approved ? Corrective actions and why they were implemented ? Cost control challenges and issues and how they were resolved ? Other cost control information that may be beneficial for other projects
CERTIFICATION SUMMARY
There are several contributing factors to cost on any project: the expense of the labor to complete the project, the expense of materials needed to complete the project, and the expense of the equipment needed to complete a project. These expenses must be estimated, planned for, and monitored for a project to finish on budget. Management and customers will want to know how much a project is going to cost so they can determine if the project is worth doing, if the project deliverable will be worth the cost, and if the project will be profitable. The estimates for project costs can come in several forms:
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27
? Analogous estimating: uses similar historical information to predict the cost
of the current project.
? Parametric modeling: uses a parameter, such as cost per metric ton, to predict
project costs.
? Bottom-up estimating: starts from zero and adds the expenses from bottom-up. ? Top-down estimating: uses a similar project as a cost baseline and factors in
current project conditions to predict costs. The resources needed to complete a project may be one of the biggest expenses in the project’s budget. The activities the resources complete must be worthy of the resource’s time. In other words, the project manager does not want to assign a $125 per hour engineer to filing activity that a $15 per hour administrative assistant is qualified to do. Accurate assignment of project resources to project activities helps prevent waste. Projects also have four different kinds of cost:
? Direct costs: these are costs that attributed directly to the project and cannot
be shared with operations or other projects.
? Variable costs: costs that vary depending on the conditions within the project. ? Fixed costs: costs that remain the same throughout the project. ? Indirect costs: these costs can be shared across multiple projects that use the
same resources – such as training room or piece of equipment. There is one last cost, called opportunity costs. This is a special cost because it really doesn’t cost the organization anything out of pocket, but rather the cost of a lost opportunity. Opportunity costs are an expense companies that complete projects for other organizations realize. When an organization that completes projects for others must forgo one project in order to complete the other, the value of the forgone project is the opportunity cost. For example, a company has two projects it can complete but it must choose only one of them. Project A is worth $75,000 and Project B is worth $50,000. If the company chooses Project A the opportunity cost is $50,000 because the company misses out on the opportunity.
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Chapter 7: Introducing Project Cost Management
KEY TERMS
If you’re serious about passing the PMP exams, memorize these terms and their definitions. For maximum value, create your own flashcards based on these definitions and review daily.
Actual costs
Analogous estimating Bottom up estimating Budget at completion Chart of accounts Cost baseline Cost budgeting Cost change control
Cost control
Cost estimating Cost management plan Cost Performance Index Earned value Earned value management Estimate at completion Estimate to complete
Estimating publications
Parametric modeling Planned value Risk Top-down estimating Variance
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TWO MINUTE DRILL
Resources and the Project Work ? The project manager must know what resources are needed to complete the
project work. How will the project ever be completed without the resources? The project manager must know the people, the equipment, materials, and other resources needed to make the vision of the project a reality.
? The resources also must be known so the project manager may predict,
monitor, and control what the project costs are expected to be. The relation between the project vision and the needed resources can help the project manager work within the predicted costs.
? Resources to complete a project also include services, leases, real estate, and
other components that contribute to the project work being completed.
Creating Project Estimates ? The identified resource requirements and the WBS are two key tools
to identify what resources are needed for what component of the project. The cost of the resources help the project manager calculate the estimated costs based on the duration of the project activities or the amount of materials applied to the project.
? Analogous estimating uses a similar project to predict what the costs of the
current project should be. It is less accurate, but easier and faster to complete than other methods.
? Bottom-up estimating starts with zero, and each component of the WBS is
accounted for to reach a grand total of the project. It is the most accurate method, but it takes longer to complete.
? Parametric estimating uses a parameter for units of goods and time to
calculate what the project will cost. For example, cost per hour, cost per metric ton, or cost per cubic yard.
Management Project Costs ? The cost management plan documents how the project manager will react
to cost variances within the project. The performing organization will likely have policies and procedures on unacceptable variances.
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Chapter 7: Introducing Project Cost Management
? Variances that cross a given threshold may require the project manager to
create a variance report to explain the variance, why it has happened, and what corrective action has been applied to prevent the variance from recurring.
? Cost control is the process of monitoring and documenting cost changes,
whether they are allowed to occur or prevented from occurring. The project manager studies the cost changes to understand why the change has happened and then makes corrective actions to the project if needed.
Applying Earned Value Management
Earned value management is a method to measure project performance. The formulas we covered in this chapter are:
? ? ? ? ? ? ?
BAC=Our predicted budget at completion EV=%Complete X BAC PV= What the project should be worth at this point in the schedule AC=The actual costs of the project work to date CPI=EV/AC EAC=BAC/CPI ETC=EAC-AC
Considering the Cost Control Results
31
INSIDE THE EXAM
The PMP examination requires the exam candidate to know how to estimate, budget, and manage costs. The WBS is an input to estimating costs, as it reflects the whole of the project. When creating the estimates, rely on documented historical information over team member’s recollections. There are three estimating approaches:
? Analogous
to +75 percent and is used in the initiation process and in top-down estimating.
? Budget estimate
The accuracy of the estimate is –10 percent to +25 percent. This is used early in the planning process and also in top-down estimating. The accuracy of the estimate is –5 percent to +10 percent. This is used late in the planning process and in bottom-up estimating.
A top-down approach that is less costly and less accurate than others and provides just an idea of what the project will cost. Starts with zero and adds up all the expenses. This is more costly and takes longer, but gains team buy-in to the project. Uses a parameter for labor and goods to calculate the cost of the project.
? Definitive estimate
? Bottom-up
? Parametric modeling
The accuracy of the estimates is based on available information. As the project manager and the project team progressively elaborate the project plan, more details become available. The more details a project has, the more accurate the estimate. Know these facts on estimating:
? Rough order of magnitude
The accuracy of the estimate is –25 percent
The resources on a project can include people, materials, and equipment. If the people on a project do not have the necessary skill set to complete the work, either hire an SME to guide the project implementation, outsource the project work, or train the current people for the needed skills. Earned value management is a tool to measure project performance. Earned value is the budget at completion multiplied by the percentage of the project work that has been completed. The Cost Performance Index shows how well the project is performing financially. It is calculated by dividing EV by the actual costs spent on the project. Use the most common formula for finding the estimate at completion, EAC=BAC/CPI.
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Chapter 7: Introducing Project Cost Management
SELF TEST
1. Which one of the following best describes analogous estimating? A. B. C. D. Regression analysis Bottom up estimating Less accurate More accurate
2. You are the project manager for GHG Project. You are about to create the cost estimates for the project. Which input to this process will help you the most? A. B. C. D. Parametric modeling WBS Project scope Requirements document
3. You are the project manager for the JKH Project. You have elected to use parametric modeling in your cost estimating for the project. Which one of the following is an example of parametric modeling? A. B. C. D. $750 per ton Historical information from a similar project Estimates built from bottom-up based on the WBS Estimates based on top-down budgeting
4. You are the project manager for a new technology implementation project. Management has requested that your estimates be as exact as possible. Which one of the following methods of estimating will provide the most accurate estimate? A. B. C. D. Top-down estimating Top-down budgeting Bottom-up estimating Parametric modeling
5. Your company has been hired to install the tile in 1000 hotel rooms. All rooms will be identical in nature and will require the same amount of materials. You calculate the time to install the tile in each hotel room as six hours. The cost for labor for each room is calculated at $700. Your Project Sponsor disagrees with your labor estimate. Why?
Self Test
33
A. You haven’t completed one hotel room yet so you don’t know how long the work will actually take. B. You have not factored in all of the effort applied to the work. C. You have not considered the law of diminishing returns. D. You have not considered the learning curve. 6. You are the project manager for a construction project to build 17 cabins. All of the cabins will be identical in nature. The contract for the project is set at a fixed cost, the incentive being the faster the project work is completed, the more the profitable the job. Management has requested that you study the work method to determine a faster, less costly, and better method to complete the project. This is an example of which one of the following? A. B. C. D. Time constraint Schedule constraint Value analysis Learning curve
7. You are the project manager for a technical implementation project. The customer has requested that you factor in the after-the-project costs, such as maintenance and service. This is an example of which one of the following? A. B. C. D. A. B. C. D. Life cycle costs Scope creep Project spin off Operations Rough order of magnitude Budget estimate Definitive estimate WBS estimate
8. Which one of the following provides the least accurate in estimating?
9. Which one of the following is true? A. The cost management plan controls how change management affects the BAC. B. The cost management plan controls how cost variances will be managed. C. The cost management plan controls how the project manager may update the cost estimates. D. The cost management plan controls how the BAC may be adjusted.
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Chapter 7: Introducing Project Cost Management
10. You have just started a project for a manufacturer. Project team members report they are 30 percent done with the project. You agree with their completion status but do not change any of the progress in your report to the customer. This is an example of which one of the following? A. B. C. D. 50/50 rule 0/100 rule Percent Complete Rule Poor project management
11. You and your project team are about to enter a meeting to determine project costs. You have elected to use bottom-up estimating and will base your estimates on the WBS. Which one of the following is not an attribute of bottom-up estimating? A. B. C. D. People doing the work create the estimates Creates a more accurate estimate More expensive to do than other methods Less expensive to do than other methods
12. What is the present value if the organization expects to make $100,000 four years from now and the annual interest rate is six percent? A. B. C. D. $100,000 $58,000 $25,000 Zero
13. You are the project manager for the construction of a new hotel. Before you begin the cost budgeting process, what is needed? A. B. C. D. Costs estimates and project schedule Cost estimates and supporting detail EAC and BAC Parametric model used to arrive at the costs submitted
14. You are the project manager of the MNJ Project. Your project is falling behind schedule and you have already spent $130,000 of your $150,000 budget. What do you call the $130,000? A. B. C. D. Planned value Present value Sunk costs Capital expenditure
Self Test
35
15. You are the project manager of the JHD Project. Your project will cost your organization $250,000 to complete over the next eight months. Once the project is completed, the deliverables will begin earning the company $3500 per month. The time to recover the costs of the project is which one of the following? A. B. C. D. Not enough information to know Eight months 72 months 5 years
16. You are the project manager for the consulting company. Your company has two possible projects to manage, but they can only choose one. Project KJH is worth $17,000, while Project ADS is worth $22,000. Management elects to choose Project ADS. The opportunity cost of this choice is which one of the following? A. B. C. D. $5,000 $17,000 $22,000 Zero, as project ADS is worth more than Project KJH
17. You are the project manager for the CSR Training Project, and 21,000 customer service reps are invited to attend the training session. Attendance is optional. You have calculated the costs of the training facility, but the workbook expense depends on how many students register to the class. For every 5000 workbooks created the cost is reduced a percentage of the original printing cost. The workbook expense is an example of which one of the following? A. B. C. D. Fixed costs Parametric costs Variable costs Indirect costs
18. You are the project manager of a construction project scheduled to last 24 months. You have elected to rent a piece of equipment for the duration of a project, even though you will need the equipment only periodically throughout the project. The costs of the equipment rental per month are $890. This is an example of __________________________. A. B. C. D. Fixed costs Parametric costs Variable costs Indirect costs
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Chapter 7: Introducing Project Cost Management
19. You are the project manager for the Hardware Inventory Project. You have a piece of equipment that was purchased recently for $10,000 and is expected to last five years in production. At the end of the five years the expected worth of the equipment is $1,000. Using straight-line deprecation, what is the amount that can be written off each year? A. B. C. D. Zero $1,000 $1,800 $2,000
20. You are the project manager of the LKG Project. The project has a budget of $290,000 and is expected to last three years. The project is now ten percent complete and is on schedule. What is the BAC? A. B. C. D. $29,000 $290,000 $96,666 $9,666
21. Your project has a budget of $130,000 and is expect to last ten months, with the work and budget spread evenly across all months. The project is now in month three, the work is on schedule, but you have spent $65,000 of the project budget. What is your variance? A. B. C. D. $65,000 $39,000 $26,000 $64,999
22. You are the project manager of the Carpet Installation Project for a new building. Your BAC is $600,000. You are now 40 percent done with the project, though your plan called for you to be 45 percent done with the work at this time. What is your earned value? A. B. C. D. $240,000 $270,000 $30,000 –$30,000
23. You are the project manager of the Carpet Installation Project for a new building. Your BAC is $600,000. You have spent $270,000 of your budget. You are now 40 percent done with the project, though your plan called for you to be 45 percent done with the work at this time. What is your CPI?
Self Test
37
A. B. C. D.
100 89 .89 .79
24. You are the project manager for the Facility Installation Project. The project calls for 1500 units to be installed into a new baseball stadium. Your team wants to know why you have not assigned the same amount of time for the last 800 units as you had for the first five hundred units. You tell them it is because of the learning curve. Which one of the following best describes this theory? A. B. C. D. Production increases as workers become more efficient with the installation procedure. Efficiency increases as workers become more familiar with the installation procedure. Costs decreases as workers complete more of the installation procedure. Time decreases as workers complete more of the installation procedure in the final phases of a project. Historical information from a recently completed project An SME’s opinion Recollections of team members that have worked on similar projects Vendor’s white papers
25. Of the following, which one is the most reliable source of information for estimating project costs? A. B. C. D.
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Chapter 7: Introducing Project Cost Management
SELF TEST ANSWERS
1. þ C. Analogous estimating is less accurate than other estimating methods. ý A is incorrect, as regression analysis is a type of parametric modeling. B is incorrect, as bottom-up estimating starts with zero and adds up the project costs. D is incorrect, as analogous estimating is not more accurate. 2. þ B. The WBS is the input that can help you the most with the cost estimates. ý A is incorrect, as parametric modeling is a form of estimating, not an input. C is incorrect, as the project scope is not an input to the estimating process. D is incorrect, as the requirements document is also not an input to the estimating process. 3. þ A is correct; $750 per ton is an example of parametric modeling. ý B is incorrect, as historical information is analogous, not parametric. C and D are incorrect, as these do not describe parametric modeling. 4. þ C. Bottom up estimating provides the most accurate estimates. The project manager starts at zero, the bottom, and accounts for each cost within the project. ý A, B, and D are all incorrect as they do not reflect the most accurate method to create an estimate. 5. þ D is the best choice. As the project team completes more and more units, the time to complete a hotel room should take less and less time. ý Choices A, B, and C are incorrect as they do not answer the question as fully as answer A. 6. þ C. Value analysis is a systematic approach to find less costly ways to complete the same work. ý A and B are not correct, as this situation does not describe a specific time or cost constraint. D is incorrect, as the learning curve happens as the project team completes the work. Value analysis is a study of a process to complete the work faster and more affordably. 7. þ A. The after-project costs are known as the life cycle costs. ý Choices B and C are incorrect, though tempting, because the do not describe the process of calculating the ongoing expenses of the product the project is creating. D is incorrect; operations do not fully describe the expenses unique to the product. 8. þ A. The rough order of magnitude is the least accurate approach, as it may vary from –25 percent to +75 percent. ý Choices B and C are more accurate estimates than the rough order of magnitude. Choice D is not a valid answer for this question. 9. þ B. The cost management plan controls how cost variances will be managed. ý Choices A, C, and D are incorrect descriptions of the cost management plan.
Self Test Answers
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10. þ B. This is an example of the 0/100 rule. This completion method allows for zero percent credit on an activity until it is 100 percent complete. ý Choice A allows for 50 percent completion when the work begins and 50 percent when the work is completed. Choices C and D are incorrect responses, as they do not describe the scenario. 11. þ D. Using bottom-up estimating is not less expensive to do. ý A, B, and C are not correct choices, as these are attributes of a bottom-up estimating process. 12. þ B. The present value of $100,000 four years from now can be calculated through this formula: Present Value = FV/(1+R)n. FV is the future value, R is the interest rate, and n is the number of time periods. ý Choices A, C, and D are all incorrect answers, as they do not reflect the present value. 13. þ A. Cost estimates and the project schedule are inputs to the cost budgeting process. ý Choices B, C, and D are all incorrect as they are not inputs to cost budgeting. 14. þ C. Sunk costs are monies that have been spent. ý A is incorrect, as planned value is the amount the project should be worth at this point in the schedule. B is incorrect; present value is the current value of future monies. D is incorrect; a capital expenditure is money spent to purchase a long-term asset, such as a building. 15. þ C. The time to recoup the monies from the project is 72 months. This is calculated by dividing the ROI of $3500 per month into the project cost. ý A is an incorrect answer. B is incorrect; eight months is the amount of time left in the project schedule. D, five years, is also incorrect. 16. þ B. The opportunity cost is the amount of the project that was not chosen. ý A is incorrect; $5000 is the difference between the two projects, it is not the opportunity cost. C is incorrect, as $22,000 is the amount of the project that was selected. D is an incorrect answer. 17. þ C. This is an example of variable costs. The more students that register to take the class the more the cost of the books will be. ý A is incorrect, as the cost of the book varies depending on the number of students that register for the class. B is incorrect, as the cost of each book diminishes as more books are created. A parametric cost would remain the same regardless of how many books were created. D is not correct, as this is not an example of an indirect cost.
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Chapter 7: Introducing Project Cost Management
18. þ A. This is a fixed cost expense of $890 per month—regardless of how often the piece of equipment is used. ý B is incorrect, as a parametric cost is a value used to calculate cost per use, cost per metric ton, or cost per unit. While it may appear B is a correct choice, there is no historical information mentioned to base the parametric model on. C is incorrect, as the cost does not vary within the project. D is also incorrect; this is a cost attributed directly to the project work. 19. þ C. The straight-line depreciation takes the purchase value of the item, minus the salvage price of the item, divided by the number of time periods. In this instance, it’d be $10,000 minus $1000, or $9000. The $9000 is divided by five years and equates to $1800 per year. ý A, C, and D are all incorrect, as they do not reflect the correct calculation. 20. þ B. The BAC is the budget at completion, which is $290,000. ý A is incorrect, as it describes the earned value for the project. C and D are both incorrect values. 21. þ C. $26,000 is the variance. This is calculated by subtracting the actual costs of $65,000 from the earned value of $39,000. EV is calculated by taking the 30 percent completion of the project against the BAC. The project is considered to be 30 percent complete because it’s slated for ten months, is currently in month three, and is on schedule. ý A, B, and D are all incorrect calculations for the problem. 22. þ A. The earned value is calculated by multiplying the percentage of completion, 40 percent, by the BAC, which is $600,000, for a value of $240,000. ý B, C, and D are incorrect calculations of the earned value formula. 23. þ C is the correct answer. The EV of $240,000 is divided by the AC of $270,000 for a value of .89. ý A and D are incorrect calculations. B is incorrect, as the value needs a decimal. 24. þ B. The learning curve allows the cost to decrease as a result of decreased installation time as workers complete more of the installation procedure. ý Choices A, C, and D are all incorrect choices, as the do not correctly describe the learning curve in relation to time and cost. 25. þ A. Of the choices presented, historical information from a recently completed project is the most reliable source of information. ý B, while valuable, is not as proven as historical information. C is incorrect, as recollections are the least reliable source of information. D is also incorrect, though it may prove valuable in the planning process.
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