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The Importance of Project Cost Management
• Projects have a poor track record for meeting cost goals • Average cost overrun from 1995 CHAOS study was 189% of the
original estimates; improved to 145% in the 2001 study • The 2003 CHAOS studies showed the average cost overrun (the
additional percentage or dollar amount by which actual costs exceed estimates) was 43 percent.
• In 1995, cancelled projects cost i.e IT in the U.S. over $81 billion • U.S. lost $55 billion in projects i.e IT in 2002 from cancelled projects
and overruns compared to $140 billion in 1994.*
*The Standish Group, “Latest Standish Group CHAOS Report Shows
Project Success Rates Have Improved by 50%,” A Standish Group Research Note (3/25/03).
What is Cost and Project Cost Management?
Project Cost Management Processes
1. Resource planning: determining what resources and quantities of them should be used
2. Cost estimating: developing an estimate of the costs and resources needed to complete a project
3. Cost budgeting: allocating the overall cost estimate to individual work items to establish a baseline for measuring performance
4. Cost control: controlling changes to the project budget
Basic Principles of Cost Management
• Most CEOs and boards know a lot more about finance than technical/engineering, so technical project managers must speak their language
– Profits are revenues minus expenses
– Life cycle costing is estimating the cost of a project plus the maintenance costs of the products it produces
– Cash flow analysis is determining the estimated annual costs and benefits for a project
– Benefits and costs can be tangible or intangible, direct or indirect
– Sunk cost should not be a criteria in project selection
Example : Cost of Defects
When Defect is Detected Typical Cost of Correction
User Requirements $100-$1,000
Coding/Unit Testing $1,000 or more
System Testing $7,000 - $8,000
Acceptance Testing $1,000 - $100,000
After Implementation Up to millions of dollars
It is important to spend money up-front on projects to
avoid spending a lot more later.
Basic Principles of Cost Management
1. Tangible costs – can easily measured.
2. Intangible costs – difficult to measure.
3. Direct costs - directly related to producing products and services.
4. Indirect costs - not directly related to the products or services of the project
5. Sunk cost - money that has been spent in the past
Basic Principles of Cost Management
Quantity Produced
Un
it C
ost
When many items are produced repetitively, the unit cost of those items decreases in a regular pattern as more units are produced
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Reserves are dollars included in a cost estimate to mitigate cost risk by allowing for future situations that are difficult to predict.
Contingency reserves allow for future situations that may be partially planned for (sometimes called known unknowns) and are included in the project cost baseline.
Management reserves allow for future situations that are unpredictable (sometimes called unknown unknowns).
Resource Planning
The nature of the project and the organization will affect resource planning
Some questions to consider: How difficult will it be to do specific tasks on the project?
Is there anything unique in this project’s scope statement that will affect resources?
What is the organization’s history in doing similar tasks?
Does the organization have or can they acquire the people, equipment, and materials that are capable and available for performing the work?
Cost Management Plan
• A cost management plan is a document that describes how the organization will manage cost variances on the project.
• A large percentage of total project costs are often labor costs, so project managers must develop and track estimates for labor.
Figure 7-1. Surveyor Pro Project Cost Estimate
Figure 7-2. Surveyor Pro Software Development Estimate
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Common Sources of Project Cost
Labor
Materials
Subcontractors
Equipment & facilities
Travelling, Mileage, Allowances, Refreshments
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Name Hours Needed
Overhead Charge
Personal Time Rate
Hourly Rate
Total Direct Labor Cost
John 40 1.80 1.12 $21/hr. $1,693.44
Bill 40 1.80 1.12 $40/hr. 3,225.60
J.P. 60 1.35 1.05 $10/hr. 850.50
Sonny 25 1.80 1.12 $32/hr. 1,612.80
Total Direct Labor Cost =
$7,382.34
Eg: Labour Costs
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Cost Classifications
Direct Labor X X X X
Building Lease X X X X
Expedite X X X X
Material X X X X
No
n-r
ecu
rrin
g
Dir
ect
Ind
irec
t
Fixe
d
Rec
urr
ing
Var
iab
le
No
rmal
Exp
edit
ed
Costs
Cost Estimating
• An important output of project cost management is a cost estimate
• Several types of cost estimates and tools and techniques to help create them
• It is also important to develop a cost management plan that describes how cost variances will be managed on the project
VO = Variances Order
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Cost Estimation
Ballpark \ Yellow Pad \ Guesstimate 30%
Comparative 15%
Feasibility 10%
Definitive 5%
Types of Cost Estimates
Type of Estimate When Done Why Done How Accurate
Rough Order of
Magnitude (ROM)
Very early in the
project life cycle,
often 3–5 years
before project
completion
Provides rough
ballpark of cost for
selection decisions
–25%, +75%
Budgetary Early, 1–2 years out Puts dollars in the
budget plans
–10%, +25%
Definitive Later in the project, <
1 year out
Provides details for
purchases, estimate
actual costs
–5%, +10%
Cost Estimation Tools and Techniques
• 3 basic tools and techniques for cost estimates:
–analogous or top-down: use the actual cost of a previous, similar project as the basis for the new estimate
–bottom-up: estimate individual work items and sum them to get a total estimate
–parametric: use project characteristics in a mathematical model to estimate costs
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Problems with Cost Estimation
Low initial estimates
Unexpected technical difficulties
Lack of definition
Specification changes
External factors
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Creating a Project Budget
• Top-down
• Bottom-up
• Activity-based costing (ABC)
Project Plan
WBS
Scheduling Budgeting
The budget is a plan that identifies the resources, goals and schedule that allows a firm to achieve those goals
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Activity-Based Costing
Projects use activities & activities use resources
1. Assign costs to activities that use resources
2. Identify cost drivers associated with this activity
3. Compute a cost rate per cost driver unit or transaction
4. Multiply the cost driver rate times the volume of cost driver units used by the project
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Months
Activity January February March April May Total by Activity
Survey 4,000 4,000
Design 5,000 3,000 8,000
Clear Site 4,000 4,000
Foundation 7,500 7,500
Framing 8,000 2,000 10,000
Plumb & Wire
1,000 4,000 5,000
Monthly Planned
4,000 9,000 10,500 9,000 6,000
Cumulative 4,000 13,000 23,500 32,500 38,500 38,500
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Budget Contingencies The allocation of extra funds to cover
uncertainties and improve the chance of finishing on time.
Contingencies are needed because
• Project scope may change
• Murphy’s Law is present
• Cost estimation must anticipate interaction costs
• Normal conditions are rarely encountered
ABC VIDEO
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• Project Management Institute – home of the Project Management Body of Knowledge (PMBOK)
http://www.pmi.org/Pages/default.aspx
• NYS Project Management Guidebook Release 2 http://www.oft.state.ny.us/pmmp/guidebook2/index.htm
• FNS Handbook 901, Chapter 5 http://www.fns.usda.gov/apd/Handbook_901/V_1-2/Chapter_5.pdf
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