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Project Cost Management – The Essential Things to Know and Do

Project Cost Management

Project Cost Management often puts people off. It feels complicated and has the mystical air of mathematical magic and wizardry. But there’s little your project sponsor, your client, or their Finance Director care about more than your budget and how closely you can stick to it.

Project cost over-runs are common. But this is not a cause for a defeatist attitude.

No. Instead, you must act with determination to understand project cost management and implement all the tools at your disposal to control costs and bring in your expenditure on budget.

PMI Talent Triangle - Technical Project Management

We know that projects have different priorities – best understood through the Iron Triangle of time, cost and quality. Some projects are all about delivering your scope to an absolute set of quality standards. And others have an absolutely firm deadline that makes schedule their essential priority.

But, for some projects, quality can flex a little, and timescales can slip if they must. What is not negotiable is the budget. Once set, you must respect it, and deliver to it.

So, in this feature article, we’ll look at:

So, get set. We have a lot to cover.

What is Project Cost Management?

Project Cost Management

Project Cost Management

Project Cost Management is a process that has two principle components:

  1. Estimating costs and creating a project budget from them
  2. Monitoring and controlling project expenditure to adhere to your budget

The Project Management Institute’s (PMI’s) Project management Body of Knowledge (the PMBoK) has Project Cost Management as one of its ten Knowledge Areas (or KAs).

PMBoK divides Project Cost Management into four processes:

  1. Plan Cost Management – which we’ll look at next
  2. Estimate Costs – which we’ll look at together with…
  3. Determine Budget
  4. Control Costs – which actually covers monitoring, controlling, reporting, and responding to cost variances and the issues that link to them

I view project cost management as a master process, which you would document in your Project Cost Management Plan. This sets out the ‘rules of the road’ for how you are going to establish and manage your project costs. It is one of two primary control documents for the financial aspects of your project – alongside your Business Case. We also have a large guide to the Project Business Case.

Your Project Cost Management Plan

If your project will spend significant amounts of someone else’s money, you need to demonstrate that you can:

  • give them a clear idea of how much they need to commit
  • control how much of their money you spend
  • account for that expenditure

Your Project Cost Management Plan sets all that out. You can consider it either as a part of  your project management plan, or as an associated document. Either way, you must ensure that all aspects integrate well and are entirely consistent.

What to Include in Your Project Cost Management Plan

Here are some of the things to include:

Budgeting and Estimating

  1. The basic measurable quantities that you will use to budget and then track costs (like cash, time for people, weights, lengths, areas, and volumes for materials)
  2. The basis for how you will estimate different aspects of cost. This needs to include:
    1. how accurate you need to be (see the section on tailoring your project cost management process, below),
    2. the size of your ranges of estimates (single point estimates are poor practice on large projects)
    3. the confidence levels – these will link to how wide your ranges are
    4. and maybe even the levels of precision with which you will express your estimates.
  3. Banking, borrowing, and foreign exchange (forex) policies and processes
  4. How the project is funded and the mechanism for requesting and drawing down funding

Monitoring and Controlling

  1. How you will monitor your expenditure
  2. The level of variance (or deviation from baseline budget – PMBoK refers to these as ‘Control Thresholds’ or ‘Variance Thresholds’) you will allow before:
    1. reporting the variance
    2. taking corrective action
  3. How you plan to measure project performance levels
  4. Your reporting process – when, how often, to whom, and what format

Anything else…

You’ll also want to add in whatever else your Project Management Office(PMO), your Project Board, or your Project Sponsor asks you to include

Establishing Your Costs: Estimating and Budgeting

The PMBOK has two processes:

  1. Estimate Costs
  2. Determine Budget

But these are so deeply intertwined, that I prefer to think of them together. It is not always clear how to allocate a tool or method to one or other of these processes.

Happily, we have already published another of our big guides on Estimating: it’s a big and important topic. Do take a look at it: Project Estimation: Master the Tools and Techniques. No doubt, we’ll do another on Budgeting soon, so watch this space, and there will be a link here too!

Why you Need a Budget

The outcome of estimating and budgeting will be a Budget that sets out your baseline costs. You will use this as the basis for:

  • Completing your Business Case and Investment appraisal
  • Determining your funding requirement
  • Winning approval
  • Framing any contract negotiations
  • Controlling costs
  • Reporting on cost management
  • Determining success measures for your project, upon completion

Estimating and budgeting is best done task-by-task. For each task, create an estimate and then a budget figure, for each class of cost.

So, you’ll need a grid (spreadsheets like Excel, Numbers, or Google Sheets are perfect) with a list of tasks down the side, and a list of categories of cost along the top.

Indicative Project Budget Spreadsheet

Indicative Project Budget Spreadsheet

Tasks

The best source of your task list is your Work Breakdown Structure* (WBS). By adding costs to every task, you will be creating a Cost Breakdown Structure.

The benefit of this approach is that, once you move into delivery stage, you will be able to track expenditure by task, and compare it directly to budget.

* Note that I learned my project management in the UK. Here, a WBS contains ‘work’ – that is tasks, or activities. In the US, for example, a WBS breaks down the work into products. This approach will also work as the basis of your budget, but is more complex, as often many tasks contribute to the delivery of one or more products. So this approach often requires both aggregation of task costs to product level, and disaggregation of accumulated costs among multiple tasks.

Relationship of Products and Tasks

Relationship of Products and Tasks

Categories of Cost

Typical categories of cost include:

  • time costs (for contractors and consultants on hourly rates)
  • time costs for the organization’s staff, if you need to account  for that (it is wise to)
  • Materials costs (usually expressed as a unit cost multiplied by the number of units)
  • Hire and lease costs for equipment and sometimes facilities
  • Other direct costs, such as travel, printing, and equipment purchase
  • Taxes on goods and services that may not be directly reclaimable, or for which there may be a substantial delay (such as from other international trading blocks)

Indirect Costs

You may also need to include indirect costs that can only partially be attributed to a specific project. Common exampes include:

  • premises costs
  • software licences
  • office equipment
  • telecoms charges
  • insurances
  • banking costs
  • general administrative overhead

Uncertainties to consider

When preparing your estimates and budget, there will be a lot of uncertainties. Important ones to remember include:

  • Inflation and materials cost changes (particularly on internationally traded commodities like iron and steel)
  • Foreign exchange rates, if you are buying goods and
  • Significant risks (like weather, events, political)
  • Time and Materials (T&M) contracts have big uncertainties compared to fixed cost contracts

Your response to these types of uncertainty is to add contingency sums to your budget. The PMBoK calls this ‘reserves’.

Governance of Project Expenditure

The PMI’s PMBOK is weak on governance throughout. So it is little surprise that it has nothing (that I can find) to say about the governance of Project Cost Management.

Ooops!

But, as always, the UK Government’s PRINCE2 methodology has governance as a key strength, and points us in the right direction.

Financial Review

Clearly your Project Board and Sponsor have a crucial role to play in the oversight of your spending. It should be on the Project Board’s standing agenda to review budget reporting, and I favor ensuring that one member of the Project Board has sufficient financial skills to competently monitor and advise Board colleagues on the financial situation. For a substantial project (in terms of expenditure, profile, or risk), I suggest this needs to be someone with a financial qualification.

The Senior Financial Officer Role

Some UK Governmental projects appoint a Senior Finance Officer (SFO) to the biggest projects. These carry out the same level of oversight and have the same level of accountability as the Senior Responsible Officer (SRO – the Sponsor), but in the domain of the project’s finances. In other models, the SFO is an advisor to support the SRO. I recommend you give these kinds of model careful consideration. Especially if your project has a large expenditure and significant risk or profile.

Stage Gates

The other hugely valuable contribution to financial governance that PRINCE2 mandates is through the Gateway Review process. This is also used in non-PRINCE2 projects, so is well worth considering. Here, the Stage Gate process links directly to the release of funding to the project. Tranches of budgeted funding can only be released for spending on successful completion of a stage gate review, and approval by the review team or the Project Board. You’ll find we have a full-length article on the Project Stage Gate Process – and why it will make you a better project manager.

Monitoring and Controlling Expenditure

These are your activities to keep your project on budget.

Monitoring

Tracking actual expenditure against your budget. Ideally, do this as near to real-time as you can. The more your project is spending, the more frequently you need to monitor.

Control

Taking corrective actions is expenditure looks like it will exceed budget or has already done so.

Monitoring and Control Tools

For most small projects, if I’m honest, a spreadsheet will do! But this approach is fraught with risks. If you are leading a larger project, you need a tool built for the job.

This type of tool is called a Project Management Information System (or PMIS – careful how you say it!). There are many varieties.

  • Stand alone financial management tools, built for the project environment
  • Project Management add-ons to enterprise financial management tools (like Oracle, Sage, or SAP)
  • Comprehensive Project Planning and Monitoring tools that can handle project financial reporting

What a PMIS needs to do

It is way (way, way) beyond the scope of this article to review the options out there. But for project cost management, you need a tool that can:

  • gather
  • record
  • safely store
  • colate
  • analyse
  • present
  • prepare reports on

all of your financial data. And ideally, it will be easy to use and integrate well with other essential project management systems and process you use.

Earned Value Management (EVM)

Another topic that is outside the scope of this article is EVM – sometimes known as EVA (Earned Value Analysis). This is a powerful toolkit for analysing budget and schedule performance, and their variances against each other. It also allows you to project trends and calculate forecasts to completion.

The TCPI

One particularly widely used figure is the To-Complete Performance Index (TCPI). This is a measure of how the remaining budget compared to the work you still need to do. A number bigger than 1 will mean you have more budget than you expected to need, when you prepared your budget. If it’s smaller than one, you’ll need to create savings by working more efficiently or economically than you planned.

Trend Analysis and Forecasting to Completion

Whatever methodology you use, you may need to prepare an assessment of your expenditure through time. This will give you a trend, form which you’ll need to forecast out-turn expenditure. If your estimated cost at completion exceeds your budget, you have two choices:

  1. remedial action to redress your over-spend
  2. Seeking approval for a budget extension

What if Your Forecast Exceeds Budget but is still Within Your Contingency?

This is why you need a Project Cost Management Plan and good governance. Your plan should give you the answer to this question. At the very least, I always say that you need to notify your sponsor and Board if this is the case.

Reporting

Reporting is a key adjunct to your monitor and control process. You need to report on:

  1. Budget performance (sometimes under key headings or workstreams)
  2. Forecasts that will inform board decision-making

We have also written a feature article on Reporting that will set your budget reporting in a wider context, as well as showing why it is so important.

Shift Happens: Responding the Reality

As project managers, we never expect everything togo perfectly smoothly! So you’ll be needing to make a number of updates to project documentation and control tools throughout your project lifecycle.

Common updates that will stem from monitoring your project costs include:

  • Your budget, plan, and baselines
  • Risks, issues, and contingencies
  • Lessons learned

Change Control

The need to make changes will create a need to adjust your budget and forecasts. So your Change Control process will need to integrate fully with your project cost control. We have written another one of our giant guides about Change Control.

Tailoring Your Project Cost Management Process

Finally, as we start to run out of space (can you do that on a web page? …Ed), I wan to briefly address the need to tailor your project cost management approach to the nature of your specific project.

How big is your project?

Always scale your cost management process to match scale and risk of your project. A lot of the tools and methods are irrelevant to small projects. But likewise, for the largest projects, you’ll need sophisticated software tools to give you any chance of keeping track of your project spending. And they will need to be robust enough to provide the quality of audit trail your finance department mandates.

What approach are you taking to your project?

I’ve written much of this article to assume your project will take a Predictive, or planned approach. But what if you need to use an Adaptive (Agile) methodology?

Here, you’ll want a more light-touch estimation process. You cannot abandon estimating altogether. That would make it impossible for the sponsoring organization to make a robust decision. But you can use high-level approaches to make ‘order of magnitude estimates’ as a basis of informed decision-making.

Later, you can then make more detailed estimates at each iteration, to harness the greater levels of certainty over short-term planning horizons

What is your Experience of Project Cost Management?

Do let me know your experiences, your favorite tools, or any questions you have. I will respond to any comments below.

About the Author Mike Clayton

Dr Mike Clayton is one of the most successful and in-demand project management trainers in the UK. He is author of 13 best-selling books, including four about project management. He is also a prolific blogger and contributor to ProjectManager.com and Project, the journal of the Association for Project Management. Between 1990 and 2002, Mike was a successful project manager, leading large project teams and delivering complex projects. In 2016, Mike launched OnlinePMCourses.

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