PMI PMP Project Management Professional – Project Cost Management Part 2

8. Creating a Three-Point Cost Estimate

A three-point estimate is an average of the cost. Now, we did the same estimate back in scheduling where we had optimistic most likely and pessimistic, also known as triangular distribution. You could do the same thing for cost. So if you remember we had that 25 plus 45 plus 75 and it was an average 48. 33 hours. So instead of time, just imagine that that were money exactly the same. Pert can also be used when it comes to predicting cost. So pert would take an optimistic most likely and pessimistic with dollars instead of hours. And then remember it’s weighted towards most likely. So the formula is optimistic plus four times the most likely plus pessimistic and then that’s divided by six. So earlier we said it was 46. 66 hours.

If those were dollars, it would be the exact same $46. 66 instead of hours. So when it comes to three point estimates, a triangular and beta, you might see them with a C in front of the most likely, the optimistic or pessimistic. And that signals to you that this is time. So time and a three-point estimate, whether it’s beta or if it is triangular is the same approach. Let’s do an example here. Optimistic $4,000 most likely is $18,000 and the pessimistic is $15,000. So if we use a three-point estimate where we’re going to do the average, the average would be $9,000.

If we go over to pert and we do the weighted average that weighted most likely, it would be 4000 plus 32,000 plus 15,000 divided by six 8500. So it’s trending a little closer to our most likely. Because we are weighted, we’re skewing things towards the most likely estimate. So that’s just a quick compare and contrast of three point. And per works the same way with time or money. Data analysis is where we have to take a look at other alternatives we could use to bring costs down or to have a cost savings. What about reserve analysis? Recall that the reserve is an amount of funds set

aside for unknown unknowns and for known risk events. So if risk events start happening or if we start experiencing lateness on our project, the amount of monies that we have set aside for lateness or risk events, that begins to diminish. The sooner that we eat into our reserves, the more danger it represents for the project because we may not have enough funds to COVID the distribution of risk in the remainder of the project. So our goal and risk analysis will be to identify risk and to combat those early risk as much as possible so we don’t dip into our reserves. If I consume all of my reserves early, I have a lot of trouble in the project.

Now you can do some real quick forecasting that I have consumed my reserves. So these risks that are later in the project, I don’t have money to pay for those risks. The cost of quality we’ve not talked about. This will be in chapter eight coming up. But the cost of quality describes the monies that you have to pay to ascertain the expected level of quality. So things like training, having the right tools and equipment, paying for the right resources, that’s all part of the cost of quality. And there’s a couple of variations you’ll see in the next section.

For now, know that the cost of quality can affect my cost estimates. All of this business, all of these cost estimating approaches are supporting detail for how do we arrive at the cost estimate? So what was the documentation? How did we create it? What assumptions did we make? What constraints are we working with, like a predetermined budget or a particular resource we have to use? What risk have you identified? What’s your range of variance? What’s your range of possible estimates here? So that plus or -10% what’s the confidence level of your estimate, how confident are you that your estimate is good? All right, that’s all of our supporting detail and our approaches for cost estimating keep moving forward. I’ll see you in the next lecture.

9. Creating a Project Budget

Our next cost management process is to determine the budget. Once we have estimated cost, then we can go into the process of determining the budget, the actual allocation of funds for our project. So determine the budget is really about aggregation of the estimated cost, the individual costs, cost of those work packages are aggregated to predict the total budget for the project. Now, sometimes your cost may be already pre approved. You already have a budget that’s given to you. So you have to do some sizing. You have x amount of dollars has to fit the amount of scope and time that fits the amount of money that you have. So the budget is creating this authorized cost baseline, or being based on the authorized cost baseline, the budget excludes management reserves, but it does include contingency reserves. So the budget includes your contingency for risk.

Let’s look at our edo’s here. For determined budget, our inputs will be the project management plan, in particular the cost management plan that we just recently created, the resource management plan, the scope baseline. So project documents, the basis of our estimates, cost estimates, project schedule and the risk register. The business documents we need to concern ourselves with here for determining the budget, the business case and the benefits. Management plan agreements like our contractual agreements, EEF and OPA tools and techniques. Expert judgment cost aggregation. That’s our estimates. Our cost aggregation, the estimates that are aggregated data analysis, reserve analysis, historical information review, funding limit reconciliation, and the actual financing outputs of determined budget.

We get the cost baseline, project funding requirements, project document updates, cost estimates, project schedule and the risk registered developing the project budget. Some things that we need to know for your exam as far as your exam it goes, cost estimating happens first that you estimate how much it will cost. The cost budget is created based on a reliable estimate. The actual commitment of funds to the project work is what we’re talking about here. With budget, this amount of money specifically is set aside to do these activities to create this project scope, to deliver the product scope. Now, you may have a preassigned budget.

That preassigned budget, remember, is a constraint, but it could also be a risk if the budget is not realistic. If your scope is this big and your project budget is this big, you’ve got a problem, it’s not going to fit. So that’s a risk. Historical Relationships just like we saw with time, we can use historical information to predict cost. So parametric and analogous are both examples of historic base estimates. Parametric because we have a parameter that we’re basing it on, but where did that parameter come from? But we have proven data of how much it costs per unit, where someone has told us x amount of dollars per unit if you want to buy from us.

The historical information is really kind of a dangerous remember that this one’s quick and it’s fast, it’s subjective. Well, if that accuracy of the historical information, if it’s not accurate, then that’s going to create a flawed estimate. In your current project, do you really have quantifiable parameters? So you have to have repeatable processes, repeatable units. If there’s fluctuations in these units, you really can’t do a parametric estimating. Parametric has to be uniform. The parameter has to be the same. These little fluctuations, that makes it too complicated and not very reliable. To create a parametric estimate, models have to be scalable.

So a parametric model is like a cost per square foot. Or for this type of package, the more you purchase, this is the price so it doesn’t fluctuate. It’s a known model and it remains the same price whether you have ten licenses, $99 each, or 10,000 licenses, $99 each. The concept of funding limit reconciliation means we have to reconcile what we planned it was going to cost and what we actually spent. So this is funding limit reconciliation. The two have to match. If they don’t match, we have a cost variance. If we have a cost variance, we probably need a corrective action. We have to go back and reestimate or we have to trim scope or we’re going to have to ask for more money. So why was there a cost variance within the project budget? There’s a couple of concerns that we have as we map out the budget. What we’re trying to find out will be what is the actual cost of the project? You never know how much a project actually cost until the project is done.

So in this example, what we’re seeing here on the X axis is the project schedule. That’s our timeline. On the Y axis will be our cost. As those two arrows, one goes up and one goes future. As we move further and farther in the future, that little curve that you see should represent the cumulative cost that we spend more and more and more and we run out of time. Ideally, we run out of time and money at the same point, and that equals the completion of the project. In this example, you can see that little dashed square represents our cost to date, and it also represents how far we’ve gone in the schedule. The cost baseline is what we thought it was going to cost to get these things, these deliverables. At this point in the schedule, at this point in our project, we are already trending away from that cost baseline. We have spent more than what we planned and we have done it sooner than what was anticipated.

So this is a cost variance. So early on, I’m trying to predict, will there be a trending of cost? Is this going to continue to have a variance? Will my cost variance trend away and away and away from the cost baseline? In this example? It doesn’t look very healthy, right? We have to do a lot of work a lot of corrective action to try to get this back in alignment with our cost baseline. So we’re looking at the actual cost of the project. All right, good job. I’ll see you in the next lecture.

10. Creating the Cost Baseline

A cost baseline shows the predicted cost and when we have those costs throughout the project. The cost baseline we use to measure performance. It predicts the total cost, the total expenses for our project in its lifeline. Typically, we, we see a cost baseline as an S curve. So we see this nice S that’s stretched out with the closer we get to the top of the S, that means we’re out of time and we’re out of money. And that represents the end of the project.

This will also predict when you can expect to spend money in the project. Discrepancies early are a pretty good sign that you’re going to be off on your budget, that your cost baseline isn’t very accurate. So you had some big problems early on. Now, really big projects may have multiple cost baselines, so you could have a cost baseline for each phase of your project. These also help predict spending plans. So when will you have capital expenses or very large expenses that will show the cash flow of the project? So you may have some deliverables that also will bring cash back into the project. So when will those happen? And a cost baseline or multiple cost baselines can show overall project performance. This is a cost baseline, or a pretty typical insight into a cost baseline.

Again, on the Y axis we have our cumulative cost, and on the X axis we have our time. The solid blue line represents our cost baseline. That’s our prediction. The red line represents our actual cost. And then if you notice, there’s a very thin black line. That’s our expenditures when we expect to spend money at different points in the project. So we can look at this one. Notice our red line at the beginning is not hitting our cost baseline. It’s below things aren’t costing as much as what we planned. And then you can notice it begins to trend up, up as we move later in the project.

So probably I’m just guessing what happened here is we had a slow start spending or we had a slow start to getting the work done. So maybe we have crashed the project to hit our timeline, but that’s caused our cost to increase, or we had a pretty big expenditure. You can see it begins to trend up our expenditures and it costs more than we thought, or we had waste, or who knows? But just looking at this, you can see early on there’s some reason why our costs were so far away from what we predicted that at the end of the project they’re so much greater. So there’s definitely a problem here in this project. But this is an S curve of when we expect to spend money, our cost baseline and the overall actual cost.

11. Establishing Project Funding Requirements

We need to be able to predict, to communicate when we expect to spend money in our project. And this is to establish our project funding requirements. The cost baseline is one of those tools we can use to help determine when we’re going to be spending money. Typically it’s tied to the phases or milestones stones or capital expenses like a big purchase for a piece of equipment. Project funding requirements, we often map that to the schedule because we want to communicate when we need these cash outlays. And then this introduces a concept called project step funding.

Let’s look at all of this business in motion here. So if you remember in the earlier lecture, we saw this, we saw the red line was our actual cost and we had our expenditures and the blue line was our predicted cost, our cost baseline. What’s changed here now is notice these stair steps. The stair steps represent the funding at different points in the project. So the very first stair step takes us to the end of phase one. And so that is a step funding. So based on what we did in the first phase, we get another infusion of funds to go to the second phase. And so on the second phase we finish it, we get more money to go to the third phase.

And the height of each step represents the amount of money we’re going to spend as part of the cumulative value or cumulative cost. So as we have large capital expenditures, we might have a bigger step, at least on our curve here, that shows we have spent more money or we anticipate to spend more money. So this is the cost performance baseline with step funding requirements at the end of a phase. Recall as a phase gate.

The phase gate is a way to examine what happened in this phase before you can go on to the next phase. So a phase gate is also an opportunity to do phase gate estimating where we estimate the cost and sometimes the time to complete the next phase of the project. A phase gate is also called a stage gate. It might also be called a kill point.

A killpoint means it’s an opportunity to kill the project. So if we go back and we look at our cost baseline, you can see that we have these opportunities to kill the project based on poor performance. So instead of a step funding to go up, we might say you’re not doing too well. We’re not going to invest any more money into this, so we’re going to kill the project, we’ll cancel the project. Not a very nice term, right? But it’s one that you want to know, hopefully not one that you ever hear in your career. All right, good job, keep moving forward.

12. Implementing Cost Control

Our last process that we need to examine when it comes to cost management is to control cost. As a project manager, we’re going to have to control costs. We can’t just be spending like crazy fun to do, but we’re not allowed to do that. So we have to control costs. We’re going to monitor the status of our cost, keep an eye on our costs, cost baseline, any changes that happen to scope, any changes that happen with errors or defects, how does that cause a change in our cost baseline? Where we begin to see we have a variant, so we need corrective actions and then we’ll be balancing risk and reward. So cost is really tied to chapter eleven when we talk about risk management. Chapter eleven in the Pinball, the ETOs for control costs are inputs.

We have our PM plan, specifically cost management plan, the cost baseline, the performance measurement baseline, our project documents, lessons learned, project funding requirements, work performance data and OPA tools and techniques, expert judgment. We have data analysis like earn value analysis, variance analysis, trend analysis, and reserve analysis. So we’ve seen most of those already, we’ve not seen EVM, so we’ll be looking at that. Coming up here we have the TCPI part of Earn value management just basically tells us how likely are you to hit your budget. And then we have the PMIs, our outputs of control cost.

We have work performance information, we have cost forecasting, change request, project management plan updates which may include the cost management plan update, updating your cost baseline, updating your performance measurement baseline. Finally, we have project document updates. We have the assumption log, the basis of estimates, the actual cost estimates, the lessons learned register, and the risk register. So these are our EDOs for control cost. When we talk about controlling costs, we first begin by influencing factors that cause changes. So vendors, the project teams, stakeholders that we want to make certain we’re doing the work correctly. The first time we’re doing work accurately, we don’t want rework.

When we have rework, we have poor quality and poor quality typically means a waste of time and money. Change Request if a change request is introduced, we have to go through integrated change control. And so that will affect our cost, that could affect our time, could affect our scope and really every area of our project. When changes are approved, we have to rebase line to accommodate the cost for those new changes. If they’re unapproved, we just don’t throw them away. We put those in the change lock. Now an unapproved change regarding cost may means that now you’re going to have a variance. Something else has to give.

We have no more money to put into this project. Tracking costs will be how will you track or trace your costs throughout the project? So you want to see when are you spending the money and what are you getting in return for that spend? You’re isolating variances. So if I have a variance, I don’t just say, well, we have a $35,000 variance. All right, well, how did you get $35,000? Is that one big variance or are there lots of little variances that you need to study and see? How is this something that was an exception? Is this something that looks like it’s going to be repeated? So what are these variances and how do they get into your project?

And then we have earned value management. Earn Value Management, a suite of formulas to show project performance. We need to communicate cost status or status report. A variance report or an exceptions report. An exception is the same thing as a variance. It’s considered an exception because it’s an exception. Exception to the cost baseline, an exception to what was planned. What do you do with a cost overrun? Do you have an allowed variance or do you have to communicate that and you’re going to get in trouble for having a cost overrun? So how do you communicate that and document this cost overrun? So these are all factors for controlling costs.

13. Measuring Project Performance

Now let’s talk about project performance and how we measure it using earned value management. Earned value management is a suite of formulas that we can use to forecast project performance and to show current project performance. You will have a few questions on earned value management on your existing exam. So let’s take a look at this now on how we calculate EVM and what EVM is. So, the foundations here of earn value management, we have a project that has a budget at completion, the BAC of $250,000. Right now we are 40% done with this project, we’re supposed to be 55% done, and we have spent $112,000. And that’s called our actual cost.

Where we are right now is earned value. Earned value is 40% of our budget at completion. So EV is percent complete times the budget at completion. So 40% of $250,000 is $100,000. Our earned value is $100,000. Our planned value is where we’re supposed to be at this time. So our planned value is 55% and we’re of 250,000. So we’re supposed to be worth 137,500. So 55% of 250,000. We know we have some variances here our variances, we have a cost variance and we have a schedule variance. The cost variance is our earned value minus actual cost.

So earned value is 100,000, and we have spent $112,000. So 100,000. -112, it’s negative, 12,000. So we have spent more than what our earned value is. We spent more than what we’re worth. Our schedule variants, we’re 40% complete, we’re supposed to be 55% complete. So it’s earned value minus plan value, 100,000 -137, five negative 37,500. So that’s our schedule variance. Next, let’s look at measuring performance. So this is where we create indexes.

An index is always something divided by something. So in this example, we want to see how well are we performing on time and how well are we performing on cost. So first, let’s look at cost. Its earn value divided by actual cost will tell us our cost performance index. The closer to one we are, the better we’re performing on cost. So in this example, it’s 100,000, that’s our earn value divided by our actual cost, $112,000. So zero point 89, not doing great on cost here. So we have spent more than what we’re worth. You could say that for every dollar we spend, we lose about $0. 11. So that’s not good. The closer the one, the better we are. Our schedule is doing even worse. Our schedule performance index is our earned value divided by planned value.

So 100,000 divided by 137 five, it’s about zero point 73. So you are roughly 27% off schedule here, so we’re not doing too great. So the closer the one you are, the better you should be, the better you are doing. Based on this information, we can now do some predictions about how the project is going to end up, how well the project is going to perform as a whole. So this is where we create our estimate at completion. We take our budget at completion and divide by the CPI. So 250,000 divided by zero point 89 is 280,000. So right now we’re losing $0. 11 on the dollar.

If we continue to lose $0. 11 on the dollar, if we continue to be at zero 89, then we are going to have an end of the project at 280,000, 30,000 more than what we are right now. Now the estimate to complete, we can take our EAC of 280,000 minus how much have we spent already? 112,000. And we will need 168,000 more. So to keep these two formulas straight and what they’re telling us the EAC is how much are we going to be at the end of the project based on performance. Now the etc. is how much more do you need to get to the end of this project. So right now we need 168,000 more based on our current performance at zero zero 89.

If our CPI continues to dip, that’s going to go up and up and up. Because we continue to spend more than what we are worth. We have an estimate at completion based on our current cost performance. So this is a little variation of EAC we take our future work is what we’re considering here. So we’re trying to forecast our final project cost based on our current performance. So this formula for the EAC, we take our actual cost plus our budget at completion minus earned value. So this is predicting the future.

So our EAC based on current performance, actual cost was 112,000. Our budget at completion is 250,000 minus our earned value of 100,000. That will be 262,000. Remember, our standard formula was 250,000 divided by zero point 89 for 280. So basically what we’re saying here is we’re going to be able to improve. It’s still not going to be 250,000, but it’s not going to be 280,000. So current performance is what we’re after, that things are going to improve. Another approach with EAC is to consider the CPI and the SPI. So we make basically a guess that the same efficiency rate is going to happen for time and cost. We could, if we wanted, monkey around with the CPI and the SPI and weight those do like a weighted average, like pert for your exam.

And for right now it’s just all the same. We don’t have to get crazy with this. So our SPI and CPI factors, this is a pretty convoluted formula, but it would be our actual cost plus our budget at completion minus earn value divided by CPI times SPI. And remember your order of operations, we start with the parentheses first and then we would do the division and then we would add the actual cost. So let’s see what that would look like in this example. So we would take 112,000 as our actual cost plus 250,000 -100,000 divided by zero 89 times zero point 73. So that would be 112 plus 150 divided by zero point 65. So 112 plus 230,000, our EAC would be 342,000. So really, really big. It’s saying that your SPI, which is really bad and your CPI is not great, that that’s really going to add up a lot more than you think. So you’re going to be spending a lot more than just the standard formula of budget at completion divided by CPI. So there are three different formulas here for EAC. All right, do you need to know all these if you have time, sure. But most likely will be budget at completion divided by CPI. Another formula you need to know is the two complete performance index.

We’re basically asking based on performance. Now can you hit the original budget at completion or is it more likely that you’ll hit the new estimate at completion, the new EAC? So the formulas are very simple, but there’s a subtle difference. We have the TCPI equals budget at completion minus earn value divided by budget at completion minus actual cost. But notice the one below, it the second part of the equation. Instead of using the BAC, we use the EAC, the estimate at completion. All right, let’s see what this looks like here. So we have TCPI budget at completion minus earn value divided by budget at completion minus actual cost. So this would be 250,000 -100,000, divided by 250,000 -112,000, so right? Now that would come out to 1. 9.

So in this example, we are above one. So the closer you are or below, the more likely you are to hit that value. So right now we are 0. 9. So it’s not very likely we’re above one. Not very likely that we’re going to be able to hit our budget at completion because we know that our EAC is 280,000 and our budget at completion is 250,000. So we’re spending more based on earned value than what we’re really worth because we have an actual cost here and we’re supposed to be further along in the project. So this early on, not likely.

So 1. 9, if it’s above one, you’re not likely to hit that value. So we’re not likely to hit our BAC. Now do you think we’re going to be able to hit our estimate at completion? Our estimate at completion was 280,000. So we do the same formula, but instead of the BAC for the second half, we drop in 280. So our formula then would be 150 divided by 168 comes out to zero 89.

So this is well below the factor of one. And the farther below you are, the more likely it is you’ll be able to achieve that factor. So, yeah, it looks pretty good that we would hit the EAC, but not very good that we would hit the BAC. All right, so there’s of your earn value management formulas, you want to practice those and work on those. And in the next lecture, I’m going to show you a little spreadsheet that you can follow along with and exercise these and learn these different formulas for your exam. All right, let’s take a look at that now.

14. Section Wrap: Project Cost Management

Great job finishing this section on cost management. I know there’s a lot of terms and a lot of formulas, just a lot of work to do here in this section. But you’re making great progress. You’re sticking with it. You’re working towards the goal that you set out to do. And that is fantastic. Remember, the big picture here is to pass the exam. Not to memorize formulas, not to get bogged down in the minutiae, but to know enough to apply on the exam and to pass the test. Well, how much is enough? I think this is part of your comfort level, your threshold here, your tolerance level.

Enough is when you’re comfortable with it and you have a clear understanding of the material. When you go into pass your exam, you’re going to have butterflies in your stomach. You’re going to be a little nervous. You’re going to have some anxiety to combat that, to think about in the future. How we can combat that nervousness and that anxiety is doing the work here. By really understanding all of this information, that will mean when we go in and take the test, there’s no reason to feel that anxiety or that nervousness. So by doing the work now, which you are doing and stick to it, you’re helping yourself in the future. Just by knowing it, it’s going to help you put you at ease because your confidence level is going to go up. So stick with it. Don’t get discouraged. This is a lot of information. I have confidence that you can do this. I have confidence that you can earn the PMP. Great job. You did it. You finished this section on cost management.

Cost management is a really important topic that we need to know as project managers because people are always interested in number one, how much is this going to cost? And then number two, when can it be done? So cost management is always important. We started our conversation by talking about creating the cost management plan. Recall that this is a subsidiary plan and the overall project management plan. Then we looked at estimating the project cost, estimating the activity cost, talking about labor, materials and other things that we may need to purchase vendor services, things like that. So estimating the cost and then creating the project budget.

Once we have the project budget developed, then we can create this cost baseline. Remember, the cost baseline shows what was planned and then what was actual. And the difference between the two is a variance. We also looked at measuring project performance. One of the most interesting parts of this section is earned value management, where we looked at earn value management and cost variances, schedule variances, the different indexes, they’re doing some forecasting. We need to know all of that in order to pass the exam. You’re going to have questions on that for your exam, of course.

So I hope you do that assignment and I hope that you create some scenarios to practice. This is something that you can do on your own, just to create some different scenarios to practice. Earn value management. Okay, good job finishing this section on project cost management. Keep moving forward.