1. How much will the project cost?
One of the first questions that we’ll often have from stakeholders is, “How much will this project cost?” Well, before we can answer that question, we really have to get into planning. Our approach to cost management is to create a cost management plan. And this is a subset of the overall project management strategy. And it addresses three things. How will you calculate the price? How will you manage the project budget? And how will you control costs? This is a project management process. We have several inputs, tools, and techniques, but just one output from the inputs. Here we have the project management plan, the project charter, enterprise environmental factors, and organizational process assets. Our tools and techniques include expert judgment, analytical techniques, and meetings. And then we create the cost management plan.
The cost management plan answers a lot of questions for us. Now, most of these topics are going to be controlled by enterprise-environmental factors for most project managers. the So when it comes to cost or budgeting, enterprise environmental factors are probably going to guide us through cost management planning. But in this plan, we’ll define what our cost-estimating approach will be, the budgeting approach, how we do spend the money, and how we reconcile the money that we’ve spent. cost control measures What’s the level of precision? What’s the unit of measure? So, what are our organizational procedure links in dollars and euros? So how do we communicate with the procurement office or centralized contracting or whatnot? What are our control threshold rules for performance measurement reporting formats? And what are the processes and their descriptions that we’ll use throughout the project when it comes to managing costs?
2. Estimating the project costs
One of the first questions you’ll have when a new project begins is, “How much will this project cost?” So this lecture is about estimating the project cost based on the scope and the resources that you’ll use in the project. Estimating the project cost is an activity that you’ll do to predict the future based on the information you have now. So you’re going to look at the work you have to do and then make the assumption that that work is correct, and then you can predict the project’s cost.
There are some trade-offs that you have to consider, and we’ll take a look at these costs versus buy-or-buy versus lease versus sharing resources. You also have to consider the level of accuracy that you have available. If it’s very early in the project at the project charter level, you may only be able to provide a rough order of magnitude estimate. And this is an estimate that’s really high Level. It could be up to plus or minus 50%, and then we have a budget estimate. A budget estimate is created when the project scope has been defined and the range of variance has been reduced. So maybe plus or minus 20%, the definitive estimate is the most accurate estimate type. The definitive estimate is based on the work breakdown structure. It takes the longest to create because you have to have a WBS, but it provides the highest level of accuracy. You’ll also need to consider all categories of estimated costs, not just labor but also materials, facilities, any type of rental, and any type of licence or permit. All of that has to be calculated into the cost estimate.
Now, this process has several inputs, tools, and techniques, and it outputs the inputs you’ll need to do this process. The cost management plan, the HR management plan, the scope baseline, the project schedule, the risk register, and, of course, enterprise environmental factors and organisational process assets Several tools you’ll use here expert Judgment, analogous estimation, and parametric Estimating, bottom-up estimation, and three-point estimation—we’re going to look at all of those in just a moment. You’ll also do reserve analysis, examine the cost of quality, and probably use some project management software.
If you’re dealing with vendors, you may do vendor bid analysis, and then you and the team and your subject-matter experts may go through some group decision-making techniques to predict the cost of the project. Now, the results of these tools and techniques create three types of activities: cost estimates, some information about the basis of estimates, and project document updates. As I mentioned before, the rough order of magnitude is a pretty wild swing, and I have some more precise numbers to share with you on these three types of estimates. So Rough The order of magnitude could be as conservative as -25% to +75%, so it’s pretty broad. The budget estimate is a little tighter. It is based on the scope statement, which can range from -10% to +25%, with the definitive estimate being the most accurate. It could be from -5% to plus 10%. Let’s look at what these percentages mean. It’s like saying the cost of this project.
If we’re doing a budget estimate, we could say the cost of this project is $100,000. Plus or minus 25%, so it could be as little as $90,000 or as much as $125,000. That’s what that variable means here on these different types of estimates for your exam. I really doubt you’ll see these percentages; they are going to vary depending on what source you look at. However, it’s important to understand that you go from rough order of magnitude, also known as the rom, to budget to definitive, or from least accurate to most accurate. For your exam, you must be familiar with four cost categories. You have a direct cost. A direct cost is where you have an expense in your project that is only for your project. Like in this example, this project manager is hiring a consultant. The consultant will only be working on this project, and the costs associated with the consultant are just assigned to this project.
Now, indirect costs describe things like lights, equipment, and overhead, where yes, your project may have a portion of that expense, but it’s also like the cost of doing business. Then we have variable costs. Variable costs vary based on conditions. A great example of a variable cost in your project is travel. You know there’s going to be lots of travel over the next year. Well, depending on what happens in the project, it will depend on when people travel, and that, of course, will affect the cost of that travel. And then you have fixed costs, sometimes called uniform costs. It’s where you have an expense that is fixed or uniform throughout the project. So, as part of your project, you must rent this piece of equipment for ten months. So you have to pay $800 per month to use this piece of equipment. It’s a fixed cost throughout the whole project.
Now, project scheduling and cost estimating are where we’re getting into the specifics of how you’ll estimate the expenses. You need to consider resource availability, the timing of the procurement of resources, and the cost of project financing. If you’re working on a long-term project, you might consider financing a purchase. So you have to consider the interest rate and maybe some time-sensitive costs. You must learn to forecast cash flow and predict when large expenditures will be incurred in the project. And then you may have seasonal cost variations. A good example of that is that, just like with travel, if you travel close to a holiday, it’s probably going to be expensive. Seasonal costs, such as construction, may exist, as not much construction occurs during the winter months. And if you do, it’s probably going to cost more because it takes longer to do the work than if you did it in the summer. Now, the first estimation type is analogous.
Analogous is an analogy between two projects. So, for example, project A cost 100,000, and this new project, project B, is slightly larger in scope. So you make a quick but unreliable estimate, and you say, “Well, it’s slightly larger; it’s $130,000.” This is also known as a top-down approach. It’s quick but not reliable. The only way you can do an analogous estimate is if you have historical information that you can rely on because you have to create an analogy to this older project. Parametric estimating is when you have a parameter that you can estimate. So it’s based on a cost parameter. So, for example, $329 per software licence or $4,500 per metric ton. Now, one thing we have to look at with parametric estimation is the idea of the learning curve. The learning curve means that if I have a new type of work or a new type of software, it takes me time to ascertain my current level of efficiency. So here’s an example: We have a project where we will paint 1,000 hotel rooms on this big resort. Well, we have four people on this project team, and they go into the first room and begin painting that room. They can get it done in six hours. The next day, they come in and work a little bit faster, a little bit faster, and a little bit faster. The reason why is that they have a learning curve.
They’re becoming more and more proficient at getting that work done. They kind of develop a system. Just like if you were doing the same task over and over, you would eventually develop a system to become more and more efficient. Well, that is the learning curve: at some point, you surpass your current level of efficiency to realise a new level of efficiency. So the dip you see where we dip down that dip is you going backwards to go forward. The study of that dip is called regression analysis. I have to go backwards in order to become more efficient. And so what this means for a project is that early on, if we just say it’s 6 hours for all those hotel rooms, that’s not really accurate because our team is going to become more and more efficient. So we periodically check in to see how long it really takes to do one hotel room.
Bottom-up estimating is also known as the definitive estimate. Remember that based on the work breakdown structure, it examines the cost of each work package, and then the cost of each work package is rolled up into a sum for the entire budget. So the definitive estimate is very reliable, but it takes a long time to do. It’s called “bottom-up” because you’re starting at the bottom of the WBS, where the work packages are a three-point cost estimate. That’s all it is: an average. A three-point cost estimate takes the optimistic plus the most likely plus the pessimistic, divided by three. So what a three-point cost estimate does is add those up, find the average, and then that’s what your prediction would be for the cost.
Now, you may be familiar with another example called pert. Pert is optimistic plus four times the most likely plus pessimistic divided by six. And the reason it’s by six is because you have six factors instead of three. In the example, we now have 30, 45, and 80. If we add those up and divide by three, we’re going to find our estimate to be 52. A three-point estimate is also known as an atrial gauge estimate, and pert is known as beta. So be familiar with them for your exam. You will likely see a three-point estimate in point form on your exam. Now, vendor bid analysis Vendor bid analysis is the study of the bids that vendors give us when we ask them to bid on a project. You might also have a budget estimate, sometimes called a third-party estimate. Here’s the idea. We want to hire a vendor to create a new network on our campus here.And so we would hire one vendor to study it and give us their best estimate of what it should cost in order to do the project. And then we use that estimate as a benchmark for all the other vendors that bid on the project. So it’s a reasonable cost estimate.
Sometimes the vendors will get paid for that, whether they are knowingly participating in it or not. Other times we pick a vendor that we like, and then we use their estimate to gauge everyone else. In order to do vendor bid analysis, you need a statement of work. And a statement of work details all of the work that will be part of the project that the vendor is bidding on. You may have a bidders’ conference. A bidder’s conference is when you issue a statement of work and, like a request for quote or an RFP request for proposal, that’s all. The bidders come to one meeting and ask questions about the statement of work. And so everyone’s in this one meeting, they get clarity, everyone has the same information, and then they leave, and then they’ll prepare the bid or quote for you. Vendor Selection Now, based on the bids that you get, you’re going to study All right, who are we going to choose? One approach is a screening system. If you have a whole lot of bids, you can say, “We are not going to hire anybody that bids over $120,000.” So that’s a screening system. We’re not going to hire anyone who doesn’t have references from our state.
A scoring model is where you have five or six categories of interest, or key performance interests, for your project. And you would say, for example, price, delivery date, guarantee or warranty references, years of experience, and so on. And then each category would have a score associated with it. So you would go through the bids and assign scores based on these different categories, and the person with the best score gets the project. Sometimes this is called a “weighted scoring model.” Instead of having five categories worth 20 points each, you might say that price is worth 40 points and the due date or schedule is worth 25 points. And so it’s weighted toward price and schedule. And then, of course, you could just do vendor bid analysis based simply on price. This is from Chapter 12 of the Pinbox Guide, Fifth Edition. If you want to read more about this, it’s all on procurement.
In a future session, we’ll dive into procurement in great detail. So if you want to move forward to that, after this, you can go to the Pinbox and check out that information and the cost estimating results. You have your activity cost estimates, so you know how much it’s going to cost, and then you have the basis of the estimate. How did you create that estimate? What’s your supporting detail? Do you have assumptions and constraints about this estimate? Do you have any type of range of variance, like plus or minus 10%, and then what’s your confidence level in the estimate? The better your supporting detail is, the better your confidence will be and you will be able to vouch for the reliability of the estimate key points.
3. Consider the cost of quality
Everyone talks about quality, that I want a quality project or a quality deliverable, or that this project has to be delivered with quality. But what exactly is quality? So that’s one of the first things that we have to nail down before we can achieve quality and before we can talk about the cost of quality. So, what exactly is quality? Quality is the totality of an entity that satisfies its ability to conform to requirements and be fit for use. Basically, it’s everything about the project that will affect the end result.
So conformance to requirements is key here—we have clear requirements, and this allows us to achieve those requirements. We will have poor quality or quality issues if our requirements are poorly written, fuzzy, or poorly defined. So, for example, words like “good,” “fast,” and “reliable” are really subjective. What you consider to be good, fast, or dependable may not be to Bob, Susan, or the people you meet. So we need conformance to requirements, but we also need accurate requirements, and then the end result has to be fit for use. And this means that if we’re creating a piece of software, we might have all the items and all the requirements met in the software, but if the software crashes all the time, it’s not fit for use. So basically, quality means delivering exactly what was promised in the project scope. Now, in order to achieve quality, we have to spend some money, so we have a cost of conformance to quality. Sometimes this is just called the cost of quality.
So you think about some projects where you might have safety measures like training or tools or a learning curve, where if I’ve never done this type of activity before, it’s going to take me some time to get the hang of it and understand how to do the activity. So the cost of conformance to quality is the money that you have to spend to ascertain the expected level of quality in the project. Now the cost of poor quality, also called the cost of non-conformance to quality, is when we have waste, have to do rework, or don’t do training or have safety issues. So the project team is in jeopardy; perhaps you’ve lost business or your reputation has been harmed. These are all things that are the cost of nonconformance to quality.
4. Working with the project budget
In most projects, it’s easier to get more time than to get more money. And that’s why it’s so important to manage changes to the project’s cost. This introduces a new project management process for controlling costs. It involves monitoring the status of the project expenses and managing any changes to the cost baseline.
And we do that through variance management. Remember, the difference between what we actually spend and what we said it was going to be is a variance. So we have to take corrective action. How can we correct or recoup those costs? And then, how can we prevent that mistake from happening again? We must sometimes balance project risk and reward. For example, we may be able to take a shortcut in the project work and save time, but this may introduce a risk and cost us money in the project. Or maybe we can crash the project, add a bunch of labour, get it done early, and then only increase our cost a little bit. So risk and reward is something that we have to do with controlling cost. Now, this process has several inputs, tools, techniques, and outputs. The inputs you’ll need will be the project management plan, project funding requirements, work performance data, and organisational process assets. The tools and techniques you’ll use have been earned. Value Management: We’re going to look at that in detail in just a moment.
Forecasting and there’s a special formula called the “Complete Performance Index” that shows the probability of being able to finish the project on time based on current conditions, performance reviews, project management software, and reserve analysis of your outputs. Work performance data, cost forecasting, change requests, and updates to your project management plan, project documents, and, of course, organisational process assets to control costs are all available here. We’re talking about influencing change factors because we don’t want errors in the project and we don’t want changes to come in. We don’t want gold plating or scope creep; we want the project to go as planned. Now, change requests are almost inevitable in a project. A change request in a project, though, usually means that we’re changing something in the scope usually.
And if that’s the case, the price should reflect it. However, you might have a change in cost without changing your scope. If you’re using a particular type of material and that material suddenly goes up in price, then you have a cost problem for which you’ll need a change request. You’ll also need to manage those changes. How would you incorporate those changes into the project? Sometimes a change can come to your project that causes you to undo work that you’ve already paid for. The labour has already been spent in order to incorporate the change. So you have to manage those changes. Notice I mean approved and unapproved changes. We do flesh things out pretty easily.
Unapproved changes, like when a customer asks for new additions to this piece of software Well, we can’t approve it. Right now we’re too far along, so that’ll have to go into the next release. But we record it. So when we get to the end of the project, the customer doesn’t say, “Hey, where’s that great feature that I asked for?” Throughout the project, we have to track costs. And then, when there are variances, we have to isolate those, study them, and really understand why that variance came into the project. Cost control is really setting us up for earned value management, and we’re going to be looking at that in just a moment. As a project manager, one of your key activities is to communicate the cost status. Normally, you just include the total cost of the project to date in your weekly status report. Now again, your enterprise’s environmental factors may control what information you share with regard to cost and who you share it with.
So know that before just blasting out the cost of the project to everyone, if there are cost variances, you have to look at those variances. Do they fit or exceed the allowed variances? Remember, in our project estimate, we could say plus or minus a certain percentage or a certain dollar amount. So does that cost overrun fit into that variance? Now, in cost control, when we talk about influencing factors that affect cost variances, we’re looking at labour doing the work right the first time and materials understanding and tracking the cost of materials. And if there’s waste, then we have to buy new materials. If there’s waste, that means we probably have to do rework. So we’re paying for the work twice, and then you may have to deal with vendors. And then sometimes what happens is that we rush into estimating and have a really aggressive estimate that turns out to be wrong. So poor cost estimating is probably going to cause you to make a change request for more money to complete the project.
5. Controlling project costs
In most projects, it’s easier to get more time than to get more money. And that’s why it’s so important to manage changes to the project’s cost. This introduces a new project management process for controlling costs. It involves monitoring the status of the project expenses and managing any changes to the cost baseline. And we do that through variance management. Remember, the difference between what we actually spend and what we said it was going to be is a variance. So we have to take corrective action. How can we correct or recoup those costs? And then, how can we prevent that mistake from happening again? We must sometimes balance project risk and reward. For example, we may be able to take a shortcut in the project work and save time, but this may introduce a risk and cost us money in the project. Or maybe we can crash the project, add a bunch of labour, get it done early, and then only increase our cost a little bit. So risk and reward is something that has to do with cost control. Now, this process has several inputs, tools, techniques, and outputs.
The inputs you’ll need will be the project management plan, project funding requirements, work performance data, and organisational process assets. The tools and techniques you’ll use have been earned. Value Management: We’re going to look at that in detail in just a moment. Forecasting is used, and there’s a special formula called the “Complete Performance Index” that shows the probability of being able to finish the project on time based on current conditions, performance reviews, project management software, and reserve analysis of your outputs. Work performance data, cost forecasting, change requests, and updates to your project management plan, project documents, and, of course, organisational process assets to control costs are all available here. We’re talking about influencing change factors because we don’t want errors in the project and we don’t want changes to come in.
We don’t want gold plating or scope creep; we want the project to go as planned. Now, change requests are almost inevitable in a project. A change request in a project, though, usually means that we’re changing something in the scope usually. And if that’s the case, the price should reflect it. However, you might have a change in cost without changing your scope. If you’re using a particular type of material and that material suddenly goes up in price, then you have a cost problem for which you’ll need a change request. You’ll also need to manage those changes. How would you incorporate those changes into the project? Sometimes a change can come to your project that causes you to undo work that you’ve already paid for. The labour has already been spent in order to incorporate the change. So you have to manage those changes. Notice I mean approved and unapproved changes. We do flesh things out pretty easily. Unapproved changes, like when a customer asks for new additions to this piece of software Well, we can’t approve it. Right now we’re too far along, so that’ll have to go into the next release.
But we record it. So when we get to the end of the project, the customer doesn’t say, “Hey, where’s that great feature that I asked for?” Throughout the project, we have to track costs. And then, when there are variances, we have to isolate those, study them, and really understand why that variance came into the project. Cost control is really setting us up for earned value management, and we’re going to be looking at that in just a moment. As a project manager, one of your key activities is to communicate the cost status. Normally, you just include the total cost of the project to date in your weekly status report. Now again, your enterprise’s environmental factors may control what information you share with regard to cost and who you share it with. So know that before just blasting out the cost of the project to everyone, if there are cost variances, you have to look at those variances. Do they fit or exceed the allowed variances?
Remember, in our project estimate, we could say plus or minus a certain percentage or a certain dollar amount. So does that cost overrun fit into that variance? Now, in cost control, when we talk about influencing factors that affect cost variances, we’re looking at labour doing the work right the first time and materials understanding and tracking the cost of materials. And if there’s waste, then we have to buy new materials. If there’s waste, that means we probably have to do rework. So we’re paying for the work twice, and then you may have to deal with vendors. And then sometimes what happens is that we rush into estimating and have a really aggressive estimate that turns out to be wrong. So poor cost estimating is probably going to cause you to make a change request for more money to complete the project.
6. What is earned value management?
Earn Value Management is a suite of formulas to show project performance. I’m going to walk you through all of the Earn Value Management formulas. But first, let’s talk about what EVM does for you. Earn Value Management allows you to create some forecasts on project costs. It allows you to measure performance based on the work you’ve already done. EVM is a suite of formulas, and if you go over and click the Resources tab, you’ll see there’s an Excel spreadsheet that has all of the formulas in it that you can use to create some examples and study from. You will have a few exam questions on the EVM. Don’t expect a tonne of questions on this.
Let’s start with the foundation of earned value management. Let’s say this is your project, this grey box here, and your budget at completion is $100,000. You are 25% of the way through the project. Well, the first formula is called “earned value.” It’s your percent completed times your budget at completion. The budget for the project is $100,000. So if you’re 25% done, your earned value is 25,000. However, to reach this point, you actually spent $27,000. So that’s your actual cost. The project is really having some issues. The project is supposed to be 50% done today, but you’re only 25% done. Well, the project’s planned value, or what the project should be worth at this point in the schedule, is $50,000. Now that I’ve made this really extreme here just to show an example, the variances, as you may have already guessed, are earned value minus the actual cost, which will reveal the cost variance. So in this example, we have $25,000 as our earned value, and the actual cost was $27,000. So we have a variance of $2,000, Now our planned value is $50,000.
Our earned value is only $25,000. So our schedule variance is EV minus PV, or earned value minus plan value. As you can see, we have a $25,000 schedule variance. An index is always something divided by something. And there are two different indices: cost and schedule. Your cost performance index is earned value divided by actual cost. So in this example, it’s 25,000. Your earned value divided by 27,000 is your actual cost of zero 93. The goal is for your CPI to be as close to 1 as possible. One way of talking about the CPI is to say that for every dollar you spend on the project, you lose $0.07. So the goal is to have a CPI. Now the SPI is very similar. It’s your earned value divided by your planned value. So in this example, it’s pretty easy. 25,000 is your earned value. Your planned value is $50,000. So you’re 50% off schedule at 00:50. And again, your goal is to be as close to one as possible.
Now the next formula we’re going to look at deals with predicting the future. So this is our current project; we have a 25,000 EV. We spent $27,000, and we’re supposed to be worth $50,000. Well, based on conditions right now, I wonder what our estimate at completion would be. So the EAC takes your budget at completion, divided by the CPI. In this case, your EAC is the total budget divided by zero. 93. So our estimate at completion is $107,526. Excuse me. You can see we’re losing about seven cents on every dollar. So that makes sense. We’re going to be about $7,000 off our budget. Now we have another way to look at this, and that’s our estimate for completion. How much more will you need to get to the end of the project? So if our estimate at completion was $107,000 and you’ve already spent $27,000, we still have to put $80,526 into this project. So how much more will you need to get to the end of the project? Now, the last one as far as predicting the future is a variance. The variance simply says, “What was your original budget?” 100,000 minus your EAC of 107,526. As a result, your V AC variance at completion is approximately $7500. That’s making the assumption that our costs are not going to increase. Then we have a two-part performance index. The two complete performance indices basically ask: can you meet the budget at completion based on what’s happening today? C
an you meet the estimate at completion? So there are two different flavours of the two complete performance indices. The first is the budget at completion minus the earn value divided by the budget at completion minus the actual cost. And then the second one is budget at completion minus earned value divided by EAC minus actual cost. Let’s take a look at this. So, here’s the formula in action. Remember, it’s budget at completion minus earned value. So 100,000-25,000 divided by budgeted completion minus actual cost 100,000. -27,000, we would divide 75,000 by 73,000, and we would have a CPI of 1.0273. So we have a very small variance. So chances are we’ll be able to hit our existing budget at completion. It’s a very tiny variance here. Now, if we look at our EAC, it’s much more positive. The lower this number, the better. So, using our EAC and the second part of the equation, our number is 107,000.-27,000, or zero point 93. So we have a lot of room. The chances are we will pass the EAC because it makes sense. We have 7526 more dollars than what was in the original budget. Now, there are five EVM rules for you. First off, EV is always first in the formulas. Variance means something less than something. An index means something divided by something, and then less than one is bad in an index, usually other than TCPI, and negative is bad in a variance.
7. Section wrap
We talked about planning, so we had to plan our costs. And then we talked about estimating our costs, which allowed us to determine our budget. And then we control costs. Those were the four processes we talked about in this knowledge area. Now, the really important things from this chapter for your exam are that we talked about cost estimating. Remember from cost estimating that we have three different levels here based on where we are in the project.
We had Rom really early on; he was not very reliable. Then we had a budget estimate, usually based on our scope. And then, once we have our work breakdown structure, we have the definitive estimate. Now, these estimates give us some idea of where we’re going to end up with the project. Earned Value Management shows the performance of how we’re tracking against what we believe the project should be worth at these points in time. Earn Value Management is a suite of formulas to show project performance. Then, of course, we work to keep costs under control because we don’t want them to spiral out of control. We want our costs to track as closely as possible to our cost baseline. So that’s it. Way to go here on cost management. Keep going. I know you can do this.
