PMI PMP Project Management Professional – Project Cost Management

1. Section Overview: Project Cost Management

Welcome to this section on project cost management. A lot of important things to talk about in cost management, there’s a lot of formulas and some math. So you want to pay attention to that business. In this section, we’re going to begin by looking at what is cost management, some trends and emerging practices and cost management. How do we plan the cost in your environment? So really important to create a cost management plan. We’ll look at estimating, the project cost and how does that relate to determining the project budget. So we estimate and we budget. So we’ll talk about that. There’s some things there that we need to know.

The good news is some of this estimating business, you’ve already learned from the previous section, on schedule management. So it’s analogous. Analogous. Estimating is creating an analogy between projects, between activities. It’s a way of taking similar project work and saying, okay, that project took six months. Ours is very similar, maybe just a little larger. So I’m going to say it takes nine months. So it creates an analogy between similar project work to what we’re going to talk about here. So estimating, project cost, developing the budget, very important. We need to create a cost baseline that will measure our cost performance against.

So we’ll talk about the idea of a cost baseline and how does that help us implementing cost control? And then probably the most important topic from this section is to calculate earned value management. So we’re going to walk through all of the earned value management formulas that you must know for your PMP. But I have confidence that you can do it. And then I have an assignment for you where you’re going to practice some earned value management and then we’ll talk about cost control. So important to control cost in our project. All right, let’s going. I’ll see you in the next lecture.

2. Trends and Emerging Practices in Project Cost Management

When it comes to some trends and emerging practices in cost management, there are a few things that you may have to account for in your role as the project manager and you should be familiar with for your PMI exam. The first is the cost of the resource. We have to consider the full cost of the resource. So a resource, resource being not just materials but also people. But think about if you have to ship things or insurance or people are traveling, that that all contributes to the cost of your project. So the whole cost of the resources needed to complete activities. You might also have a recurring cost. So you think about anything that you use on a regular basis or a monthly service fee you pay, or a subscription to a website. So any of the things that you have that are supporting your project, that happens through the duration of the project that has to be accounted for. This is not the same thing as lifecycle costing, but you may be asked to predict lifecycle costing.

Lifecycle costing is how much will it cost to maintain the thing that your project creates. You’ve seen lifecycle costing. If you ever buy an appliance, there’s a big yellow sticker on it like a water heater will tell you how much you can expect to pay to have this water heater per year in your home. That’s lifecycle costing. So you create a piece of software, what’s the TCO, the total cost of ownership for this thing that you’re creating for your customer? Some considerations in cost management, first off, is when is the cost incurred? So when does it count actually in your project? So, for some people, as soon as the decision is made that we’re going to procure these resources, it’s as if that money is depleted from their budget. Others, it only counts once the order is placed. And then you might have it happens when the item is delivered, or what I prefer is when it’s actually paid out of the budget. But your organization may have different approaches to how you count for costs being incurred.

So you need to know that because that can affect your budget if you have a very big capital expense. And as soon as the decisions made those funds are depleted from your budget, it might look like there’s a cost variance, but in reality it’s the decision made to purchase those items. You might also, in a longer project, have to calculate and consider things like interest, the return on investment, the discounted cash flow, like the time value of money, and then the payback analysis, the payback period. Cost management will also allow you to do some tailoring. The tailoring, though, is going to be subject to what are your governance, what’s the rules for tailoring in your organization.

So, knowledge management, I need some formal knowledge management about our financial approach, our financial database estimating and budgeting when it comes to tailoring. There are lots of different approaches for cost estimating and budgeting. So what are the policies I’d have to hear to in my organization, earned Value Management? We’ll look at EVM in this section. So EVM, you don’t have to do all the formulas. Maybe you just want to do a few of the formulas for your exam, though you’ll need to know all of the formulas in an agile approach.

There’s different approaches for cost estimating and the agile methodologies. You might have a few questions on agile and cost. I don’t think you’re going to see an overwhelming amount of questions on agile cost estimating for this exam. And then, of course, the governance, what’s the rules, the enterprise, environmental factors. Do you have to participate in auditing of where the monies were actually spent? So that’s something that happens with tailoring cost management that will be unique to your organization, your discipline. All right, great job. Keep moving forward.

3. Planning the Project Costs

Our first process in the cost management knowledge area is to plan cost management. We need to create a cost management plan. So this is a subsidiary plan of the overall project management plan and it addresses three other cost management processes. It will define how you estimate costs cost, how will the budget be managed and then how will you control cost. Let’s check out the EDOs for plan cost management it’s pretty straightforward I’ll need the project charter the PM plan in particular the schedule management plan and the risk management plan. And then EEF and OPA three tools and techniques expert judgment data analysis and meetings and then the only output of planning cost management is to create the cost management plan. Some considerations for planning cost management I need the schedule management plan because I need to understand the processes and the controls that will affect my cost estimating approach.

I need the risk management plan because risk will affect my cost estimate and my cost management. Because, remember, risk, as we’ll see in chapter eleven, risk can have a factor on time and it can have a factor. Now in this section on cost and then enterprise environmental factors just all of the rules and the structure and how I interact and how I get things done. The market condition if you’re on an international project you might have to worry about the currency exchange rates. If you have a commercial database for doing cost estimating, that’s something that’s unique to your organization like x amount of dollars per square foot and then what’s the productivity like in different locales. So you think about geographical concerns. There may be some productivity differences based on the different parts of the world where your project is going to take place.

Let’s check out the cost management plan. The cost management plan basically defines how you estimate, how you budget and how you control. But there are some other things that are established in the cost management plan that you should be aware of what’s the unit of measure are you in US dollars? Are you in Euro? Are you in yen? What’s the measure for your finances that you’ll be spending in this budget? What’s the level of precision? So how precise do you have to be when it comes to predicting and controlling? Like you might have that range of variance or plus or -5%, the level of accuracy? Organizational procedure, links? So how do you procure? How do you tie this back to the scope and requirements?

What are your control thresholds? If you have a variance greater than $5,000 you have to do a variance report. For example, what’s the cost estimating approach? So analogous parametric three point how did you create these estimates? What are the rules for performance measurements? So how do you measure how do you know if you’re doing well on cost? The ones that we’ve going to look at in this section will be earn value management and then reporting formats. Do you have a status report? Do you do a variance report or an exceptions report? So how do you communicate performance when it comes to cost? These are all questions that are answered in the cost management plan. Great job. I’ll see you in the next lecture.

4. Estimating the Project Costs

Now let’s talk about estimating how much the project is going to cost. That’s always one of the first questions we hear right from stakeholders. How much is this thing going to cost? The second question is when can you have it done? Well, estimating the project cost is where we take and make a prediction based on the information that we have right now. The more reliable the information is that we have, the more accurate our cost estimate will be. We also want to consider some cost trade offs. So cost trade offs and what risk may be introduced.

 So things like cost out of pocket to build it versus buy it, what’s the cost of owning it versus leasing it? And then can I share resources with other projects, the level of accuracy? What about the rough order of magnitude? So my raw estimate, that is a very wild estimate. A budget estimate is typically based on the scope. It’s a little bit more precise. And the definitive estimate, this is a bottom up estimate like we saw in time that I account for the cost of every deliverable and add that up, it’s the aggregate of my cost. I also defined all categories of cost. So do I have to account for labor or not? In some projects you have to account for the labor as the PM.

 In other organizations, the labor is just considered an indirect cost. It’s part of the cost of doing business and it doesn’t affect the project budget. So we need to know upfront though, when it comes to estimating, what am I expected to estimate as the PM? Our edo’s here for estimating costs, we have our inputs, the project management plan, the cost management plan, the quality management plan, and the scope baseline. Some documents you’ll need lessons learned register, your schedule, your resource requirements and the risk register. And of course you have EEF and OPA tools and techniques for estimating costs. Expert judgment. And then you’ve seen these already analogous parametric bottomup and threepoint estimates. We did those in time for a schedule. Now we can do the same approach for cost. So we’ll look at these again, but it’s exactly the same approach. Data analysis. So doing some alternative analysis and how alternatives may affect cost.

Reserve analysis and the cost of quality project management information system, doing some decision making and voting our outputs of estimating costs well, you get the cost estimate and the basis for how are these estimates created. You have project document updates, so you might be updating your assumption, log your lessons learned register and the risk register. There are four types of costs you need to know. When we think about resources in our project, we have a direct cost, which means this is an expense that’s only for your project. So you need to purchase some drywall material, drywall project, you’re working on, a house that you’re building or whatever, that’s only for that project, right? You can’t use that drywall anywhere else. It’s only for your project. An indirect cost is it’s shared to more than one project. So you have to purchase a piece of equipment. So this piece of equipment can be used on multiple projects. So it’s not just yours, but there’s other projects that can share it and use that piece of equipment as well. So that’s an indirect cost.

A variable cost is where the price varies based on how much you order and when you order it. So a variable cost could be you’re going to have a workshop and you need to have it catered. The more people that attend the workshop and the price goes up. Another variable cost is like travel. Every time you book a flight, even if it’s the same flight over and over. The cost of that varies based on the marketplace conditions. A fixed cost is any cost that’s uniform through the project. So you’re going to rent a large piece of equipment and it’s $1,500 a month and you’re going to have it for six months. So it’s uniform $1,500 for six months.

Or you have a consultant. And that consultant is x amount of dollars per month, so it’s uniform through the project. There are times where you can mix and match these costs. So for example, you could have a direct cost like the consultant. It’s your project only, but it’s also a fixed cost that it’s uniform through the project. But these are just different attributes of costs that we want to think about when we go into cost estimating. When we create a cost estimate, there are three types of estimates. We have a Rom or a rough order of magnitude, a budget and a definitive. These percentages that we see here are approximate ranges of variances. So you can make these tighter or bigger, whatever your enterprise environmental factors allow. So a Ram is very unreliable.

It’s kind of your first understanding of what the project may be. So it’s a hallway estimate or an elevator estimate where a stakeholder they stop you and they say, how much did it do? XYZ. Well, that’s the Rom. So it’s negative 25 to plus 75. Pretty big swing there on its reliability. Not very reliable. A budget estimate is typically based on the scope, so we have a lot more information. So now we could give a price, but our range of variance or tolerance level would be negative 10% all the way up to plus 25%. So still a pretty big swing there on cost. The definitive estimate is based on our work breakdown structure and that’s the most reliable and the most accurate.

But it takes the longest to create, so a definitive could be from negative 5% to plus 10%. Now, again, those ranges are just a standard. Your organization may say, no, it’s negative three to plus three. All right? So they could have a very tight cost estimate and often it’s based on how much information do you have? So if you’re doing the same types of project over and over and over, you can take a similar project, you’ve got a good idea of what it’s going to cost based on this past historical information and then you could apply the estimate based on that historical information. So your estimates may vary, but these are just some standard ranges of variance. The risk register is considered because risk can have a financial impact. I also want to think about opportunities versus threats. An opportunity, an opportunity is a positive risk. It can bring an income, it can save time. A threat is a negative event that can cost money, that can cost time. So often we think about risk, we only think about negative. But maybe there’s a cost savings or a time savings.

So that’s a positive risk event. Now management reserves and contingency reserves, we talked about these a little bit. Management reserves, these are for unknown unknowns. Like a task goes over, you couldn’t predict that was going to happen or some risk came out of nowhere. So an unknown unknown is a risk event that you could not identify. It’s used for time and risk, a contingency reserve. This is money set aside for known risk events. So we’ve done risk identification, we’ve done quantitative analysis and we have found our risk exposure. We will look at contingency reserves in chapter eleven in the Pin box. So just a few sections from now, for right now, just know contingency reserves are for known risk events. We need our scope baseline in order to create a cost estimate. The scope baseline is needed because it is the scope statement, the WBS and the WBS dictionary. If I have that information, then I can make a very accurate cost estimate.

The scope statement is needed because it first has a high level estimate of what the project funding requirements are. The WBS shows the relationship among deliverables and the WBS dictionary identifies each of those deliverables and provides a description of the work. So those two documents will give me some really clear insight into what we have to create and deliver and that will help me create a much more accurate cost estimate. As far as the project schedule goes, we want to think about cost estimating, what’s the availability of resources? And if I use a resource as a later time or an earlier time, will that affect the price for that resource? What about the timing of procurement? So we’ve already seen this idea of lead time for procurement.

So how does that affect my resources and how will that affect cost estimating? What about the cost of project financing? Do you have to consider the time value of money or interest rates or inflation? Probably just topically aware of that for your exam. You won’t have to calculate interest rates or inflation. You might have to calculate future value and present value, but maybe just one or two questions there. What about the cost of financing? So the interest rate, time sensitive cost that if you purchased after this particular date, costs are going to go up. So there’s an urgency associated with when you purchase. And then there might also be seasonal. Think about travel. If you’re traveling over some holidays, the cost of travel goes up because of supply and demand. So seasonal cost variations can come into play as well. So these are all things I’ll factors that we have to consider for cost estimating. And there’s definitely some differences here than what we saw in schedule and activity duration estimating. So it’s a lot more often, a lot more sensitivity with cost than time. Okay, good job. Keep moving forward. You’re doing great.

5. Using Analogous Estimating

You’ve already seen analogous estimating. We saw this in schedule. Analogous estimating is an estimating approach where we take historical information and then from that we predict how long or how much the project is going to cost. I have to have really good historical information. If the historical information is flawed or hasn’t been updated to reflect what actually happened, then I’m going to have a poor cost estimate.

This is a form of expert judgment because it’s based on what past experiences and they’ve been updated. It’s less time to complete an analogous estimate and it’s also less accurate than our other estimating approaches. Let’s look at an example of an analogous estimate. So here’s this park project. And in this park project they created a sidewalk around this pond and then they calculated it out that it was $25,287 to complete. Well, there’s a new project here, this King project, very similar.

It’s 4500ft by 6ft. So they used an analogous estimate based on this difference in the square footage. And then they predicted that the Carlton Park is 100 and the Carlton Park was 25,287. And this King Park is slightly larger or considerably larger. So it will be 108,500. So you can see there’s some flaws and some risk here between the two. Just because you have the same type of material and about the same square footage, it might not really always work out that way. There may be more curves, there may be more work to create the path where the paving is going, but it’s a real quick estimate. So analogous is not very reliable, but it’s fast. And so this is an analogous estimate based on historical information. I can predict the future or the current cost of this project, but not always very reliable.

6. Using Parametric Estimating

Parametric estimating is when I have a parameter to multiply a cost. So, for example, it’s $100 per square foot. And so the more square feet you have, the more it’s going to cost. So it’s a mathematical model based on parameters to forecast cost. So the parameters can vary based the type of work that you’re doing. But some good examples can be cost per cubic yard or cost per unit or cost per software license. You might also have some more complex parameters where a cost per unit and then there’s some adjustment factor where it’s a cost per unit plus the delivery. And the delivery is by how many miles you are from where our headquarters are from.

So you could also say you might have a cost of construction for this. One particular type of project is $28 per square foot. But if they change the materials, then that cost goes up. So that’s an example of a parametric. There are a couple of other factors with parametric estimating types. Just need to be topically familiar with these for your exam. The first one is regression analysis. Regression analysis. This is a statistical approach where you take variables from historical information and you look at those variables and you say, okay, which one of these variables are most important? And that will help me predict the current cost in my project.

So regression analysis, you look backwards at historical information to predict future cost. And then another parametric estimating factor is the learning curve. So if you have a cost per unit and you’re charging for time we know the learning curve tells us that over time we become more efficient. And so my cost could reduce because I can install the fixtures faster. So if have a cost per unit based on time we want to consider the learning curve. You can only do that for repetitive activities. So you’re doing the same type of work over and over and over. Okay, great. That’s the parametric estimating keep moving forward.

7. Using Bottom-Up Estimating

Back in project schedule management, we talked about using a bottom up estimate where we start at zero. We start at the leaf package and the work breakdown structure, and we account for every component in the WBS. And this creates a sum for the project that is a bottom up estimate that you start at zero and you’re worked your way up. Bottoms up.

It means we’re starting at the bottom and accounting for all the cost in our WBS. So it’s usually something that was associated with cost, just like I said. But you could do it with time. All right, so it’s used for resource estimating and used for how long these activities will take. You have to have a work breakdown structure to do a bottom up estimate. So you have to know exactly the type of resources and exactly what that work package is going to create.

So you’re accounting for the time. In this instance. Later, we’ll see that it works for cost as well. Some factors here with bottom up estimating, you do this with the project team. This typically isn’t a solo activity that you have the project team involved because they are the experts. But it’s one of the most time consuming methods because I have to identify every work package in the WBS. It’s more expensive because of all the time involved to create it, but it’s the most accurate. The benefit of creating this bottom up estimate is it helps the project team members buy in and have synergy and a sense of ownership because they see the cost. And if you use this for time, they see the cost and the time and the value of each activity that they’ll be building, each work package they’re building in the project. So that’s bottom up estimating for costs.