Project Cost ManagementProject Cost ManagementTime is MoneyTime is Money

PM-BOK Chapter 7PM-BOK Chapter 7

Manuel Guzman Manuel Guzman ■ Carlos Hurtado ■ Matthew Lyberg■ Carlos Hurtado ■ Matthew Lyberg

Professor KanabarProfessor Kanabar May 20, 2005May 20, 2005

PROCESS GROUPSPROCESS GROUPS

Resource Planning

Cost Estimating

Cost Budgeting

Cost Control

I

Planning

E

Controlling

C

Resource PlanningResource Planning

Determine physical resources, what quantities of Determine physical resources, what quantities of each and when they would be needed to each and when they would be needed to perform project activities.perform project activities.

1. WBS2. Historical

information3. Scope statement4. Resource pool

description5. Organizational

policies6. Activity duration

estimates

1. Alternatives identification

2. Project management software

1. Resource requirements

Inputs Tools Outputs

Cost EstimatingCost Estimating

Approximation of the resources needed to Approximation of the resources needed to complete project activities.complete project activities.

Cost estimating and Pricing:Cost estimating and Pricing:– Cost estimating: how much will it cost the performing Cost estimating: how much will it cost the performing

organization to provide the product or service organization to provide the product or service involved?involved?

– Pricing: how much will the performing organization Pricing: how much will the performing organization charge for the product or service? charge for the product or service? Business decisionBusiness decision..

Estimating should be done by the person doing Estimating should be done by the person doing the work.the work.

Cost EstimatingCost Estimating

Based on the WBS to increase the accuracy.Based on the WBS to increase the accuracy.

Project managers should analyze the needs of Project managers should analyze the needs of the project, to compare and reconcile any the project, to compare and reconcile any differences with cost requirements from differences with cost requirements from management.management.

1. WBS2. Resource

requirements3. Resource rates.4. Act. duration est.5. Historical info.6. Chart of accounts7. Risks

1. Analogous est.2. Parametric

modeling3. Bottom-up est.

1. Cost estimates2. Supporting details3. Cost

management plan

Inputs Tools Outputs

Cost EstimatingCost EstimatingCost estimates for all resources that will be Cost estimates for all resources that will be charged to the project.charged to the project.– Generally expressed in units of currency to facilitate Generally expressed in units of currency to facilitate

comparisons both within and across projects.comparisons both within and across projects.– Generally includes appropriate risk response planning.Generally includes appropriate risk response planning.

Supporting detail must include:Supporting detail must include:– Reference to WBS.Reference to WBS.– How it was developed?How it was developed?– Assumptions made.Assumptions made.– Range of possible results.Range of possible results.

Cost management plan how cost variances will Cost management plan how cost variances will be managed.be managed.

Cost BudgetingCost Budgeting

Allocate the overall cost estimates to individual Allocate the overall cost estimates to individual activities or work packages to establish a cost activities or work packages to establish a cost baseline for measuring project performance.baseline for measuring project performance.

1. Cost estimates2. WBS3. Project schedule4. Risk management

plan

1. Cost budgeting tools and techniques

1. Cost baseline

Inputs Tools Outputs

Cost BudgetingCost Budgeting

The cost baseline will be used to measure and The cost baseline will be used to measure and monitor cost performance of the project.monitor cost performance of the project.

Expected Cash Flow

Cost Baseline

Cumulative Values

Time

Estimates vs. AccuracyEstimates vs. Accuracy

Most difficult to estimate as very Most difficult to estimate as very little project info is availablelittle project info is available

EstimateEstimate AccuracyAccuracy

Order of Order of Magnitude Magnitude (Early)(Early)

-25%-25%

+75%+75%

Budget Budget EstimateEstimate

-10%-10%

+25+25

Definitive Definitive EstimateEstimate

-5%-5%

10%10%

Used to finalize the Request for Used to finalize the Request for Authorization (RFA), and establish Authorization (RFA), and establish commitmentcommitment

Development stage estimate. Development stage estimate. Needed to predict revised project Needed to predict revised project completion datecompletion date

Tools for Estimating (and Tools for Estimating (and Budgeting)Budgeting)

Top Down Top Down EstimatingEstimating

Accuracy depends on experienceAccuracy depends on experience

Fast, but estimates are roughFast, but estimates are rough

Bottom Up Bottom Up EstimatingEstimating

Slow, but reliableSlow, but reliable

High cost (time) / WBS neededHigh cost (time) / WBS needed

Buy-in from the teamBuy-in from the team

Parametric Parametric ModelingModeling

Mathematical models to predict costsMathematical models to predict costs

Two types: REGRESSION ANALYSIS, Two types: REGRESSION ANALYSIS, and LEARNING CURVEand LEARNING CURVE

Delphi Delphi Method Method (analogous)(analogous)

Expert judgmentExpert judgment

Tasks need not to be identifiedTasks need not to be identified

Considerable experience neededConsiderable experience needed

Cost ControlCost Control

Monitor Cost PerformanceMonitor Cost PerformanceDetect and understand variances from Detect and understand variances from plan plan Ensure all changes are recorded and Ensure all changes are recorded and agreed uponagreed uponPrevent bogus changes from being Prevent bogus changes from being included in cost baselineincluded in cost baselineInform stakeholders of authorized changesInform stakeholders of authorized changesBring costs within acceptable limitsBring costs within acceptable limits

Cost Control Cost Control

Understand what is driving variances, good and Understand what is driving variances, good and bad, and decide what action to take.bad, and decide what action to take.

1. Cost Baseline2. Performance

Reports3. Change Requests4. Cost

Management Plan

1. Cost Change Control System

2. Performance Measurement

3. Earned Value Management

4. Additional Planning

5. Computerized Tools

1. Revised Cost Estimates

2. Budget Updates3. Corrective Action4. Estimate at

Completion5. Project Closeout6. Lessons learned

Inputs Tools Outputs

Cost ControlCost Control

Work completion methods:Work completion methods:0/100 0/100 Conservation approach. No work, no Conservation approach. No work, no money.money.

20/80 20/80 20% at start of the project, the rest when 20% at start of the project, the rest when it is completed.it is completed.

50/50 50/50 Liberal approach. Liberal approach.

Cost Control: Earned Value ManagementCost Control: Earned Value Management

Earned Value:

Integrates cost, time and scope. Used to forecast future performance and project completion dates

Key concepts:Key concepts:EV = Earned Value (BCWP)EV = Earned Value (BCWP)

Estimated value of the work actually accomplishedEstimated value of the work actually accomplished

PV = Planned Value (BCWS)PV = Planned Value (BCWS)Estimated value of the work planned to be doneEstimated value of the work planned to be done

AC = Actual Cost (ACWP)AC = Actual Cost (ACWP)Actual cost incurred for the work accomplishedActual cost incurred for the work accomplished

Earned Value ManagementEarned Value Management

BAC = Budget At Completion BAC = Budget At Completion Estimated total cost of the project when doneEstimated total cost of the project when done

EAC = Estimate At Completion EAC = Estimate At Completion Forecast of most likely total project cost based on Forecast of most likely total project cost based on

projectproject performance and risk quantificationperformance and risk quantification

CPI = Cost Performance Index CPI = Cost Performance Index Ratio of budgeted costs to actual costRatio of budgeted costs to actual cost

SPI = Scheduled Performance Index SPI = Scheduled Performance Index Estimated total cost of the project when doneEstimated total cost of the project when done

Earned Value Management Earned Value Management Key Formulas:Key Formulas: CV = Cost Variance = EV- ACCV = Cost Variance = EV- AC

NegativeNegative is over budget, Positive is under budget is over budget, Positive is under budget

SV = Schedule Variance = EV- PVSV = Schedule Variance = EV- PVNegativeNegative is behind schedule, Positive is ahead schedule is behind schedule, Positive is ahead schedule

CPI = Cost Performance Index = EV / ACCPI = Cost Performance Index = EV / AC SPI = Schedule Performance Index = EV / PVSPI = Schedule Performance Index = EV / PV EAC = Estimate At Completion =EAC = Estimate At Completion =

BAC / CPI BAC / CPI Most often used formula Most often used formula AC + ETCAC + ETC AC + BAC - EVAC + BAC - EV AC + (BAC - EV) / CPIAC + (BAC - EV) / CPI

EAC = Estimate At Completion = EAC - ACEAC = Estimate At Completion = EAC - AC VAC = Variance At Completion = BAC - EAC VAC = Variance At Completion = BAC - EAC

Big DigBig Dig

Started construction on 1991 and planned Started construction on 1991 and planned completion by 1997 (6 years), it was to cost $3 completion by 1997 (6 years), it was to cost $3 Billion, the project included 6 highways ($0.5 Billion, the project included 6 highways ($0.5 Billion per highway/year)Billion per highway/year)

At the end of the first year, 1/2 highway was At the end of the first year, 1/2 highway was completed and the cost was $2 Billion.completed and the cost was $2 Billion.

How is the performance of the project?How is the performance of the project?(Crappy is not a choice)(Crappy is not a choice)

Big Dig: The NumbersBig Dig: The Numbers

EV = Earned Value = $0.25 Billion EV = Earned Value = $0.25 Billion $0.5/2$0.5/2

PV = Planned Value = $0.5 BillionPV = Planned Value = $0.5 Billion

AC = Actual Cost = $2 BillionAC = Actual Cost = $2 Billion

BAC = Budget At Completion = $3 BillionBAC = Budget At Completion = $3 Billion

Big Dig: Performance Big Dig: Performance

CV = EV - AC = $0.25 - $2 = - $1.75 BillionCV = EV - AC = $0.25 - $2 = - $1.75 BillionOver Budget by $1.75 BillionOver Budget by $1.75 Billion

SV = EV - PV = $0.25 - $0.5 = - $0.25 BillionSV = EV - PV = $0.25 - $0.5 = - $0.25 BillionBehind of scheduleBehind of schedule

CPI = EV / AC = $0.25 / $2 = 0.12CPI = EV / AC = $0.25 / $2 = 0.12Getting 0.12 cents out of every dollar budgetedGetting 0.12 cents out of every dollar budgeted

SPI = EV / PV = $0.25 / $0.5 = 0.50SPI = EV / PV = $0.25 / $0.5 = 0.5050% of progress planned50% of progress planned

EAC = BAC / CPI = $3 / 0.50 = $ 6 BillionEAC = BAC / CPI = $3 / 0.50 = $ 6 Billion

EVM Hints EVM Hints

Rita Says:Rita Says:– EV comes first in every formulaEV comes first in every formula– If it’s variance, the formula is EV – somethingIf it’s variance, the formula is EV – something– If it’s index, EV / somethingIf it’s index, EV / something– If it relates to cost, use Actual CostIf it relates to cost, use Actual Cost– If it relates to schedule, use PVIf it relates to schedule, use PV– Negative numbers are bad, positive is goodNegative numbers are bad, positive is good

Cost Types Cost Types

Direct Costs Direct Costs Related “Directly” to the projectRelated “Directly” to the project

ex. Labor hours, material, equipment, ex. Labor hours, material, equipment, food, travel. . .food, travel. . .

Indirect Costs Indirect Costs Overhead used for more than one projectOverhead used for more than one project

ex. Building rent, taxes, janitorial ex. Building rent, taxes, janitorial servicesservices

Cost TypesCost Types

A cost by any other name, really isn’t the same!A cost by any other name, really isn’t the same!Variable Cost – Changes with volume Variable Cost – Changes with volume Fixed Cost – Stay the same, regardless of volumeFixed Cost – Stay the same, regardless of volume

COSTCOST

Volume Volume

TC = VC+FC

VC

FC

Cost Types Cost Types

Project Costs Project Costs Are incurred while the project is being Are incurred while the project is being

fulfilled.fulfilled.

Life Cycle CostsLife Cycle CostsIncludes the costs after project completion.Includes the costs after project completion.

There may be temptation to lower project costs at There may be temptation to lower project costs at the expense of long term costs. Life Cycle the expense of long term costs. Life Cycle Costing gives the PM a way to consider costs Costing gives the PM a way to consider costs outside of the scope of project fulfillmentoutside of the scope of project fulfillment

Important ConceptsImportant Concepts

Sunk CostsSunk Costs

Forget ‘em, they’re goneForget ‘em, they’re gone

Law of Diminishing ReturnsLaw of Diminishing ReturnsSituation when the more you put in, the less you Situation when the more you put in, the less you

get get outout

Working CapitalWorking Capital Current Assets (Cash, Inv, AR) – Current Current Assets (Cash, Inv, AR) – Current

Liabilities Liabilities (Notes, AP, Accr)(Notes, AP, Accr)

Cost and Project SelectionCost and Project Selection

Present Value Present Value Is $10,000 in your pocket now worth more than the Is $10,000 in your pocket now worth more than the $10,000 in your pocket one year from now? $10,000 in your pocket one year from now?Yes! You can use the money now to make more Yes! You can use the money now to make more money. The 10,000 in a year from now should be money. The 10,000 in a year from now should be “discounted” to the present, since it’s not worth as “discounted” to the present, since it’s not worth as much.much.

““You do not have to be an You do not have to be an accountant accountant to Pass this Exam” to Pass this Exam”

Rita Rita Mulcahy, PMPMulcahy, PMP

Present Value of Your PMP Present Value of Your PMP Consulting Gig Consulting Gig

Time Time Income Income Present Value Present Value

00 10,00010,000 10,00010,000

11 10,00010,000 9,0909,090

22 10,00010,000 8,2648,264

33 10,00010,000 7,5137,513

44 10,00010,000 6,8306,830

TotalTotal 50,00050,000 41,69741,697

“You do not have to calculate the PV, just understand it.” Rita Mulcahy, PMP

Net Present ValueNet Present Value

NPV, like Present Value, discounts future NPV, like Present Value, discounts future cash flows to the presentcash flows to the present

PV of Revenue – PV of CostsPV of Revenue – PV of Costs

Net Present Value: Your PMP Gig Net Present Value: Your PMP Gig

Time Time Revenue Revenue Present Present Value Value

CostsCosts PV of PV of CostsCosts

NPV NPV

00 10,00010,000 10,00010,000 12,00012,000 12,00012,000 -2000-2000

11 10,00010,000 9,0909,090 2,0002,000 1,8181,818 7,2727,272

22 10,00010,000 8,2648,264 2,0002,000 1,6531,653 6,6116,611

33 10,00010,000 7,5137,513 2,0002,000 1,5021,502 6,0116,011

44 10,00010,000 6,8306,830 2,0002,000 1,3661,366 5,4645,464

TotalTotal 50,00050,000 41,69741,697 20,00020,000 18,33918,339 23,35823,358

Internal Rate of Return Internal Rate of Return

What is the return on the money invested?What is the return on the money invested?Expressed as percentageExpressed as percentage

Great for comparing between two projects of Great for comparing between two projects of different valuedifferent value

Project A has an IRR of 21% and Project B has an Project A has an IRR of 21% and Project B has an IRR of 14%. Which would I choose?IRR of 14%. Which would I choose?

Payback PeriodPayback Period

How long until we get the money back?How long until we get the money back?““Quick and Dirty” method for project selectionQuick and Dirty” method for project selection

Does not take into account the Time Value of Does not take into account the Time Value of MoneyMoney

Your Project costs $50,000, and the cash Your Project costs $50,000, and the cash flow it will bring is $11,000 a year.flow it will bring is $11,000 a year.

The Payback Period is. . . 5 yearsThe Payback Period is. . . 5 years

Benefit Cost Ratio Benefit Cost Ratio

Compares the revenues to the costsCompares the revenues to the costsRevenue in this is the same as “payback”Revenue in this is the same as “payback”

1 is the magic number where costs = revenue1 is the magic number where costs = revenue

Less than 1, costs are greater than benefitsLess than 1, costs are greater than benefits

Greater than 1, and the benefits are greater than Greater than 1, and the benefits are greater than costs.costs.

If Project A has a BCR of 2.2 and Project B If Project A has a BCR of 2.2 and Project B has a BCR of 1.2, pick A.has a BCR of 1.2, pick A.

PMP Exam QuestionsPMP Exam Questions

If Earned Value (EV) = 300, Actual Cost If Earned Value (EV) = 300, Actual Cost (AC) = 450, Planned Value (PV) = 275, (AC) = 450, Planned Value (PV) = 275, what is the Cost Variance (CV)?what is the Cost Variance (CV)?

a. 25a. 25

b.-150b.-150

c. 150c. 150

d. 175d. 175

PMP Exam QuestionsPMP Exam Questions

If Earned Value (EV) = 300, Actual Cost If Earned Value (EV) = 300, Actual Cost (AC) = 450, Planned Value (PV) = 275, (AC) = 450, Planned Value (PV) = 275, what is the Cost Variance (CV)?what is the Cost Variance (CV)?

a. 25a. 25

b.-150b.-150

c. 150c. 150

d. 175d. 175

CV = EV – AC

Negative is Over Budget

Positive is Under Budget

PMP Exam QuestionsPMP Exam Questions

You have 4 projects from which to chose You have 4 projects from which to chose 1. Project A is a 5 year project with an 1. Project A is a 5 year project with an NPV of $80,000. Project B is a 2 year NPV of $80,000. Project B is a 2 year project with an NPV of $40,000. Project C project with an NPV of $40,000. Project C is a 4 year period and has an NPV of is a 4 year period and has an NPV of $50,000. Project D is being done over 1 $50,000. Project D is being done over 1 year and has an NPV of $70,000. year and has an NPV of $70,000.

Which Project should you chose?Which Project should you chose?

PMP Exam QuestionsPMP Exam Questions

Project Project TimeTime NPVNPV

AA 5 yr5 yr $80,000$80,000

BB 2 yr2 yr $40,000$40,000

CC 4 yr4 yr $50,000$50,000

D D 1 yr1 yr $70,000$70,000

NPV already takes time into account, so you always pick the project with the highest NPV!

PMP Exam QuestionsPMP Exam Questions

Early in the project you and your sponsor are Early in the project you and your sponsor are discussing which estimation should be used. discussing which estimation should be used. You want expert judgment, the sponsor wants You want expert judgment, the sponsor wants analogous estimating. The best option is to analogous estimating. The best option is to

a. Agree to analogous – it’s a form of a. Agree to analogous – it’s a form of expertexpert

b. Determine why the sponsor wants b. Determine why the sponsor wants such an such an accurate estimate.accurate estimate.

c. Try to convince the sponsor to allow c. Try to convince the sponsor to allow expert expert judgment since it is usually judgment since it is usually more more accurate.accurate.

d. Suggest life cycle as a compromise. d. Suggest life cycle as a compromise.

PMP Exam QuestionsPMP Exam Questions

a. Agree to analogous – it’s a form of experta. Agree to analogous – it’s a form of expert

b. Determine why the sponsor wants b. Determine why the sponsor wants such an such an accurate estimate.accurate estimate.

c. Try to convince the sponsor to allow c. Try to convince the sponsor to allow expert expert judgment since it is usually judgment since it is usually more more accurate.accurate.

d. Suggest life cycle as a compromised. Suggest life cycle as a compromise. .

Trick Question – Analogous Estimating is a form of expert judgment. Choice B seems tempting, but if you know that analogous estimation is not accurate, you realize this is a trap. A cruel and vicious trap, set for you by the PMP.

PMP Exam QuestionsPMP Exam Questions

Cost performance measurement is BEST done Cost performance measurement is BEST done through: through:

a. Ask for a percent complete from each team member and a. Ask for a percent complete from each team member and reporting that.reporting that.

b. Calculating the earned value and using the indexes and b. Calculating the earned value and using the indexes and other calculations to report past performance and other calculations to report past performance and forecast future performance. forecast future performance.

c. Using the 50/50 rule and making sure the life cycle c. Using the 50/50 rule and making sure the life cycle cost is less than the project cost.cost is less than the project cost.

d. Focusing on the amount expended last month and d. Focusing on the amount expended last month and what will be expended the following month.what will be expended the following month.

PMP Exam QuestionsPMP Exam Questions

a.a. Ask for a percent complete from each team member and reporting that.Ask for a percent complete from each team member and reporting that.

Inaccurate because based on subjective guess.Inaccurate because based on subjective guess.

c. Using the 50/50 rule and making sure the life cycle cost c. Using the 50/50 rule and making sure the life cycle cost is less than the project is less than the project cost.cost.

50/50 rule isn’t always in the progress report, and the life cycle cost can 50/50 rule isn’t always in the progress report, and the life cycle cost can never be lower than the project cost, since the life cycle goes on well, for never be lower than the project cost, since the life cycle goes on well, for life.life.

d.d. Focusing on the amount expended last month and what will be expended the Focusing on the amount expended last month and what will be expended the following month.following month.

Rookie Answer – usually for inexperienced since the past can’t Rookie Answer – usually for inexperienced since the past can’t always always be used to tell the future.be used to tell the future.

b. Calculating the earned value and using the indexes and other b. Calculating the earned value and using the indexes and other calculations to report past performance and forecast future calculations to report past performance and forecast future performance.performance.

Objective measurements based on performance that can be applied to the future

SourcesSources

PMBOK GuidePMBOK Guide. PMI, Newton Square, PA. 2000, . PMI, Newton Square, PA. 2000, pp 83-95pp 83-95

PMP Exam Prep, Third Edition, Rita Mulcahy PMP Exam Prep, Third Edition, Rita Mulcahy PMP. RMC publications, 2002. pp. 133-161. PMP. RMC publications, 2002. pp. 133-161. Exam Questions adapted from pps. 150 #3, 153 Exam Questions adapted from pps. 150 #3, 153 #24, 151 #9, 154, #31.#24, 151 #9, 154, #31.

Preparing for PMP Exam, Vijay Kanabar. Preparing for PMP Exam, Vijay Kanabar. Boston, MA, Boston University. 2004, pp 98-110Boston, MA, Boston University. 2004, pp 98-110