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The efficient cost and budget management throughout the project life cycle contribute convincingly in the success of project as well as in the overall profitability of an organization and maximization of positive cash flows. The proper administration of all direct and indirect costs related to the project can be performed effectively when these costs are appropriately integrated with all the other project management major areas, i.e. scope management, time management, resource management and quality management. The focal point of this academic paper is cost management including the prevailing techniques of cost estimating and cost control along with the different types of cost estimates and overall strategy for the cost management and cost controlling processes in conjunction with other project management domains.
The cost overruns in project directly affect the cash flows which result in minimized value and profit as an outcome of work efforts. The project manager is responsible to control, monitor and manage all the direct and indirect costs related to the project and also track the project performance with respect to cost, finance, time and available resources throughout the project life cycle.
This academic paper supplements the information pertaining to cost management provided in the Project Management Plan (PMP) for the project R012 which will be presented as part of the group assignment for the same project. The techniques and approaches presented herein for the cost control and estimating of costs will be adopted and monitored by the project manager throughout the project life cycle for the project R012.
Trustworthy cost estimates are vital for efficient project control and the management of project finance especially cash flows within the project and at the organizational level.
Correlation of Stages of Project Progress to Types of Cost Estimates:
The project cost estimate is a quantitative assessment of all resources required to execute a project's complete scope of work as per signed contract. Cost estimates are developed and further refined at each stage during the life cycle of project. In the following section, development of project at several stages is presented along with the relevant estimates prepared at the coexistent stage.
At the concept stage, a ballpark estimate or rough order of magnitude (ROM) estimates are prepared based on the available information at concept stage such as survey results, findings of feasibility report, geotechnical investigation reports and other pertinent data to the project. These estimates mainly include the scope of the project, general cost categories, basis for quantities, and basis for pricing, assumptions, inclusions, exclusions, potential risks and associated costs. Preliminary budget of a project is prepared on the basis of concept stage estimate.
A detailed cost estimate essentially expands a conceptual cost estimate to more accurately reflect the cost needs of a refined and developed project. This method adds more defined costs and cost basis within the individual cost categories. Risks associated with the project should be better understood and more focused at this point of time.
The implementation stage consists of the execution of planned activities to be performed in the construction field. For the sake of adequate cost control, these cost estimates are desired from inception to the completion of project. These cost estimates are prepared based on production rates that can be measured in terms of man-hours of labor or equipment time required to achieve a unit amount of work.
Types of Cost Estimates: The type of cost estimates mainly depend on the quality of available information and degree of confidence of estimators in the accuracy. Main types of cost estimates include the following (Lock 2007):
Ballpark estimates or Rough Order of Magnitude (ROM) estimates
Ballpark estimates or Rough Order of Magnitude (ROM) estimates: Ballpark estimates are developed with the help of vague outline information exist at the time of conceptual stage.
Comparative estimates: This type of cost estimates are prepared by comparing the work to be done for a new project with a comparison of work that has already been done for other similar projects in the past.
Feasibility estimates: These types of estimates can be prepared after getting a sufficient amount of information about preliminary design including specifications and outline drawings.
Definitive estimates: Definitive estimates are prepared after the completion of detailed design based on project specifications and final working drawings. The comparative estimates or feasibility estimates can be further refined to get the definitive estimates after incorporating all the findings of detailed design efforts.
Development of project budget:
When the cost estimate has been completed, the project control budget is prepared.
The project budget is a detailed schedule of expenses that the project manager uses for cost control purposes during the project life cycle. At the inception of project, a baseline budget for the project is established based upon the scope of work stated in the signed contract. The work progress and performance are continuously monitored and controlled against the same baseline budget. As the project progresses, the baseline budget gets refined based on the modification in scope of work due to changes resulting in a detailed budget with the aggregation of estimated costs of individual activities or work packages.
Integration of Project Costs with the Work Breakdown Structure (WBS):
All the project related costs and controls are basically originated from the work breakdown structure (WBS). The WBS is a hierarchical and logically oriented grouping of project elements (typically deliverable or phase based) that defines the total scope of the project and organizes it in a manner that is consistent with the execution plan. The top level of the WBS consists of a single element that reflects the entire project scope. Each subsequent level represents an increased level of detail until the desired control levels are established. As work progresses, the WBS provides the framework on which costs, time, and schedule/performance can be compared against the budget for each level of the WBS.
Integration of Project Cost with Quality:
All quality related issues have an associated cost, i.e. cost of conformance or cost of non conformance, therefore avoidance, prevention, and resolution of quality problems equates to the reduction of total cost to the project. An effective corrective and preventive action program avoid project nonconformance. If nonconformance occurs, the project manager must ensure that it is identified and corrected and that quality is re-verified before the product is delivered.
Corrective action eliminates the cause of a known nonconformance to prevent its recurrence.
Preventive action is taken to eliminate the causes of potential non-conformances or other undesirable situations.
Cost of Conformance
Cost of Nonconformance
Internal Failure Costs
(Build a quality product)
(Failures found by the project)
â€¢ Document processes
â€¢ Time to do it right
External Failure Costs
(Failures found by the customer)
(Assess the quality)
â€¢ Warranty work
â€¢ Lost business
â€¢ Destructive testing loss
Money spent during and after
the project because of failures
Money spent during the project
to avoid failures
Figure 1 - Cost of Quality
(A Guide to the Project Management Body of Knowledge, 2008, p. 195)
Integration of Project Cost with Resource Management:
Project completion with maximum time and cost efficiency requires proper resource management including human resources, material and equipment. The project manager shall plan all the required resources within the allocated budget by keeping all the unforeseen circumstances in consideration such as extreme weather conditions, fluctuating socio-economic factors and cost variations due to high demand or shortage of materials. In addition, an effective resource management also entails competent staffing levels and optimized labor mix, i.e. at some stages of the project progress, highly skilled and technical human resources are required than other project stages. The required staffing level and associated costs vary with respect to time as shown below in the figure.
Figure 2 - Typical Cost and Staffing Levels across the Project Life Cycle
(A Guide to the Project Management Body of Knowledge, 2008, p. 16)
Techniques of Cost Estimating: A Guide to the Project Management Body of Knowledge, 2008 states the following methods for the estimating of costs depending upon the available information and project requirement:
Expert Judgment: Expert judgment, i.e. opinions of subject matter experts guided by historical information, provides valuable approach about the information from similar past projects.
Analogous Estimating: Analogous cost estimating uses a similar past project as a starting point for the current project.
Parametric Estimating: This technique uses a statistical analysis and relationship between available historical information and other governing variables to prepare an estimate for the project.
Bottom-up Estimating: The bottom-up estimating technique follows the hierarchy of work breakdown structure from bottom to top.
Three-Point Estimating: This concept is originated from the probability based theories as per Program Evaluation and Review Technique (PERT). It uses three estimates to define an approximate range of an activity cost:
Most Likely (CM): The cost of activity based on realistic effort.
Optimistic (CO): The cost of activity based on analysis of the best-case scenario with minimal difficulties.
Pessimistic (CP): The cost of activity based on analysis of the worst-case scenario with maximum difficulties.
PERT analysis calculates an expected (CE) activity cost by considering a level of uncertainty and using a weighted average of these three estimates:
CE = (CO + 4CM + CP) / 6
Project Cost Accounting:
Project cost accounting is the key constituent in the project cost system. It provides the fundamental data required for both cost control and estimating processes. Cost accounting relates exclusively to determining the detailed makeup of productivity and costs associated with the production of a product in the field, including the necessary overhead expense (Sears, K, Sears, A & Clough, H 2008).
Project Cost Coding:
All project related activities are described by a name or descriptive title augmented by a specific cost code with respect to their positions in the hierarchy of project work breakdown structure. A brief representation of project cost codes with respect to the work breakdown structure activities is presented below:
Description as per WBS
Execution of Works
Administration and Project Control
Project Cost Categories:
The project costs can be broadly classified into following main categories:
Variable costs or Direct costs: All costs that benefit a particular project, including salaries, fringe benefits, subcontracts, equipment, material, and other direct costs.
Fixed costs or Indirect costs: These are the costs that do not directly attribute to a particular project, such as overhead costs (bid and proposal work, general and administrative costs).
Project Cost Control:
The project manager must ensure that all work is performed in a cost effective manner and that appropriate cost controls are in place on the project at all times. The project manager is also responsible to review and approve all labor charges and other project costs and to take immediate action to correct negative variances.
The cost control necessitates a proper cost management process, which primarily includes the following (Kerzner 2009):
Project cash flow
Organization cash flow
Direct labor costing
Overhead rate costing
Other tactics, such as incentives, penalties, and profit-sharing
In addition to the above, the project manager for project R012 will implement the following for an effective and efficient cost control during the progress of project:
Prompt and accurate invoices to the client for payment
Development of meaningful budget baselines at the outset of the project
Integration with the work breakdown structure and the schedule
Monthly analysis of variances and trends
Proper review and coding of costs
Trustworthy cash flow and gross profit projections
Timely incorporation of change orders into the budget baseline
Project cost control initiates with the preparation of the original cost estimate and the subsequent project budget. As the work progresses, cost accounting methods are applied to determine the actual costs of production. The costs as they actually occur are continuously compared and matched with the budget. In addition to monitoring the current operational expenses, periodic reports are prepared that forecast final project costs and compare these predicted costs with the established allocated budget (Sears, K, Sears, A & Clough, H 2008).
Techniques for the Project Cost Control: A Guide to the Project Management Body of Knowledge, 2008 describes the following techniques as effective cost control tools.
Earned Value Analysis (EVA)
To-complete performance Index (TCPI)
Project management software
Earned Value Analysis (EVA):
Earned value analysis is a proven method to measure project performance against the scope, schedule and cost baselines. In project R012, the project manager will implement the Earned Value Management (EVM) techniques to manage and control the project performance. In EVM, cost, schedule, and technical scope are all integrated and described by using a common unit of measure (i.e. currency or labor hours). The EVM technique allows the project manager to evaluate and control project risk by planning, measuring, and analyzing the financial and physical project performance. The Earned value management develops and monitors three key dimensions for each work package and control account.
Earned Value (EV): Earned value is the percentage of completed work on the project.
Planned Value (PV): The budgeted value of all activities or WBS components that were scheduled to have been performed.
Actual Cost (AC): The true cost of services and goods used in accomplishing actual works performed for all activities or WBS components.
Figure 3 - Earned Value, Planned Value and Actual Costs
(A Guide to the Project Management Body of Knowledge, 2008, p. 183)
Any deviations of schedule and cost from the baselines can be monitored with the help of schedule variance and cost variance as mentioned below:
Schedule Variance (SV): Schedule variance is a measure of schedule performance on a project. It is equal to the difference between planned value (PV) and earned value (EV), i.e. SV = EV - PV.
Cost Variance (CV): Cost variance is a measure of cost performance on a project. It is equal to the difference between actual cost (AC) and earned value (EV), i.e. CV = EV - AC.
The schedule variance and cost variance can further be converted into efficiency indicators, i.e. schedule performance index (SPI) and cost performance index (CPI) which can also be used in trend analysis or to forecast the anticipated expenses at completion and expected finish date of project.
Schedule Performance Index (SPI): A schedule efficiency factor or the value produced to the value that should have been produced according to the schedule, the SPI is equal to the ratio of the EV to the PV, i.e. SPI = EV/PV.
Cost Performance Index (CPI): A cost efficiency factor or the ratio of the value produced to the cost to produce it, the CPI is equal to the ratio of the EV to the AC, i.e. CPI = EV/AC.
Earned Value Metrics
EV - PV
Ahead of schedule
EV - AC
Ahead of schedule
Earned Value Methods: The earned value on project R012 will be determined by using one of the following methods depending upon the available data and project requirements (Booz, Allen & Hamilton n.d.).
Milestone Weights with % Complete
Level of Effort
Fixed Formula: The method is used to measure the progress by applying it to control accounts and work packages with a shorter duration. It uses a percent complete to the start and finish of an activity with the following rules:
0/100 - Nothing is earned when the activity starts but 100% of the budget will be earned when completed.
50/50 - 50% is earned when the activity starts and 50% will be earned when finished.
25/75 - 25% is earned when activity begins and 75% will be earned on completion
Milestone Weights: The Milestone Weighting method assigns budget value to each milestone.
Milestone Weights with Percent Complete: The Milestone Weighting with Percent Complete method assigns budget value to each milestone, and it is earned based on the percent of work Completed against each individual milestone.
Percent Complete: The Percent Complete method applies a percent complete to a budget value to determine what is earned.
Level of Effort: The Level of Effort (LOE) method is based on the passage of time. A monthly budget value is earned with the passage of time and is always equal to the monthly planned amount.
Units Complete: The Unit Complete method uses a physical count to determine what is earned.
Forecasting: As the project progresses, the project manager shall develop a forecast for the estimate at completion (EAC) and budget at completion (BAC) based on the project performance indicators. EACs are typically based on the actual costs incurred for the work completed, plus an estimate to complete (ETC) the remaining work. One of the common techniques to EAC forecasting approach is a manual, bottom-up summation by the project manager. EAC = AC + bottom-up ETC. The following techniques for EAC forecast are presented as per A Guide to the Project Management Body of Knowledge, 2008.
EAC forecast for ETC work performed at the budgeted rate: This method recognizes the actual project performance to date and predicts that all future ETC work will be accomplished at the budgeted rate. EAC = AC + BAC - EV.
EAC forecast for ETC work performed at the present CPI: This method presumes what the project has practiced to date can be predicted to continue in future. EAC = BAC/cumulative CPI.
EAC forecast for ETC work considering both SPI and CPI factors: To calculate a trended EAC, the ETC work will be performed at an efficiency rate that considers both the cost and schedule performance indices. EAC = AC + [(BAC-EV) / (cumulative SPI x cumulative CPI)].
To-Complete Performance Index (TCPI): It gives awareness to the project manager about the rates which should be met for the remaining work in order to stay within the allocated budget. It can be based on BAC or EAC. The TCPI based on the BAC = (BAC-EV)/(BAC-AC). The TCPI based on EAC = (BAC-EV)/(EAC-AC).
Figure 4 - To-Complete Performance Index (TCPI)
(A Guide to the Project Management Body of Knowledge, 2008, p. 186)
Performance reviews compare cost performance over time, schedule activities or work packages overrunning and under running the budget, and estimated funds needed to complete work in progress. For the performance reviews based on EVM, the following information is determined (A Guide to the Project Management Body of Knowledge, 2008):
Variance analysis: Variance analysis compares the actual project performance to planned or expected performance.
Trend analysis: Trend analysis monitors the project performance with respect to time. The project manager shall review schedule status and identify trends regularly. Critical and near critical activities must be monitored very closely, and any delays to these activities must be scrutinized to understand the cause, predict further slippage, and implement corrective actions.
Earned Value Performance: Earned value management compares the baseline plan to actual schedule and cost performance.
Cost Performance measurements (CV, CPI) are used to measure the magnitude of variation to the original cost baseline (A Guide to the Project Management Body of Knowledge, 2008).
Project Management Software:
Project management software is also used to monitor the three essential EVM dimensions (i.e. PV, EV and AC), to display graphical trends and forecast a range of possible final project results (A Guide to the Project Management Body of Knowledge, 2008).
As an indicator of the financial performance of the project, the project manager will submit the financial reports to the senior management every month for review pertaining to project R012. These financial reports present the overall picture of financial health of a project. These financial reports provide critical input to support business planning and monthly Gross Profit (GP) and cash flow forecasts used by all levels of management. This paper includes numerous financial metrics that collectively provide a strong indication of the financial performance of a project. The process required to complete the report demands rigor in the project manager's review of project performance so that they can identify, understand, and explain any anomalies to management. This process can provide an early warning of performance problems, including gross profit erosion.
The financial reports for project R012 will contain several key financial metrics, including gross profit sold (GPS), gross profit produced (GPP), actual costs (AC), estimate to complete (ETC), estimate at completion (EAC), earned value (EV), cash flow, anticipated change orders, and accounts receivable.
CONCLUSION AND RECOMMENDATION:
To ensure the success for project R012, the Earned Value Management System will be implemented to monitor the performance of project since this method contains a logical integration and correlation between project scope, schedule and cost. In addition to the earned value management system, the project manager will be responsible to utilize the available resources efficiently as per the project requirement with the optimized and effective configuration and change control.