Project Cost Management in Practice from POME by Gautam Koppala
Project Cost Management in Practice
Project Cost Management in Practice
To complete a project within budgeted cost, we must understand how to effectively estimate, allocate, and manage project cost factors. Cost management is normally preceded by activities to define and assign resources to scheduled project activities. This process is known as resource estimating.
RESOURCE ESTIMATING
A resource can be people, money, supplies equipment, material, spaceanything that is required to accomplish the project work activities.Resource requirements are identified by analyzing each activity, and determining the types and quantity of each resource necessary to complete that work. The sum of the resources identified for a given activity can be further specified as the total quantity for that activity. Activities can also be combined to define resource requirements for specified segments of the project, such as life cycle phases or discrete milestones or deliverables.
As we have said, project resource requirements are equal to the sum of the resource requirements of all the scheduled activities. Therefore, before finalizing the resource requirements estimate, it is important to consider the impact of the schedule and availability. In most cases, project estimators assume that resources will be available when required. This may not be the case and it may be necessary to make adjustments to the resource loading in order to arrive at a practical solution. There are many heuristic approaches used to load resources; two of the more popular approaches are considered below:
Assume that all project activities start and complete at their early dates. This alternative is a front loaded orearly resource aggregation, which uses resources as soon as the logic of activities allows.
Assume that all project activities start and complete at their late dates. This alternative is a back loaded orlate resource aggregation, which delays use of resources as much as the float of activities allows.
Since resources are usually limited, rarely flexible, and never unlimited, a performing organization has to achieve project duration within a level ofavailable resources. In this procedure, an activity is moved within end limits until it comes into a position where resources are available to schedule the activity. When an activity has resources and schedule dates assigned, it decreases the level of available resources. This procedure continues until the project team finds the best way to perform project activities with available resources, while meeting the project completion date. In practice, we should start by establishing some plans and then simulate different alternatives until we come to an acceptable project schedule. If no alternative can come close to the histogram of available resources, then the project completion date must be delayed.
When project objectives are not flexible regarding the project dates and have to be achieved under atime-limited schedule, we approach the problem of resource allocation by:Allocating available resources to critical activities and then determining schedule dates for those activitiesAllocating resources to other activities, which are not on the critical path, and determining schedule dates for those activities.When project objectives have no flexibility regarding resource availability and have to be achieved under a resource-limited schedule, then we approach the problem of resource allocation by:Understanding when and under what conditions the project completion date, or completion of certain milestones, can be overrunFinding out if and under what conditions some resources can be overrun.Once all resources are loaded, scheduled, and obligated, we can proceed to accomplish the remaining activities in cost management.COST ESTIMATINGProject managers and project stakeholders need accurate information to help them to lead their projects to a successful result. A key foundational control concept is the target estimate because on all projects, the estimate should serve as a guide to shape management actions. Developing detailed, consistent, and reliable cost estimates is the foundation of successful cost management.From the conceptual project phase (when everything is in an undefined condition) to the completion phase (when all contracts must be signed off and all bills paid), it is always a challenge to estimate contractors' indirect cost and value of their work. Therefore, it is important to prepare, as soon as possible, a preliminary cost estimate structured by bid packages. Aside from that, a resource requirements chart of key resources for each bid package will help avoid qualitative interpretation during thebidding process. The quality of the cost estimate determines later ability to manage contracts included in the project. In general, reliability of cost estimates plays out as follows:Those who can make cost estimating reliable and fast will be able to participate successfully in many bidding events.If the cost estimate becomes more reliable, we can expect a bigger positive difference between the contractor's bid price and the client's allowed price for a particular job.If, in addition to permanent improvement of cost estimate reliability, we want to keep the same level of revenue, we must perform more projects.A positive difference between the contractor's bid price and the client's allowed price for a particular job will be bigger even when all participants in the bidding process increase the reliability of their estimate.The cost estimating process correlates with the engineering process and evolves over time as well. Therefore, the cost estimate is developed in a certain sequence as knowledge about a project is obtained. An accurate cost estimate is one that falls within an acceptable 5% to 10% range. However, the difference between cost estimate when compared to actual cost can be substantial in the early project phases, usually ranging above 100%. This difference decreases in later project phases; after contracts have been awarded, it should be in the 5% to 10% range. The following sequence illustrates cost estimating stages:TheOrder of Magnitude stage is based on rough technical requirements and related materials and services for the project. It usually estimates total project cost by using the actual cost of similar projects. In this stage, estimators often use the analogous estimating approach to determine their result.TheConceptual stage is normally based on more information, such as a preliminary design, feasibility studies, defined specifications for major equipment, and long-lead items. It usually estimates total project cost by estimating quantifiable and scalable parameters for project deliverables and suggesting the alternative with the best balance between cost, duration, and performance for deliverables and project. In this stage, it is normal that 20% of the work (typically the most difficult pieces or the most comprehensively specified) represents approximately 80% of total cost estimate. In this estimating stage, the parametric modeling technique is normally used.ThePreliminary stage is based on procurement documents, including detail design and specifications for structured components of the project. It usually estimates total project cost by estimating budgets against which invitations for bids can be made. In this estimating stage the bottom-up estimating technique (discussed later) is frequently used.TheDefinitive stage is based on development submittals and cost estimates from selected contractors, and suppliers of materials and equipment. It usually estimates total project cost by estimating structured budget against which contracts can be signed. This stage must include specific contractual conditions that are oriented towards different contractors and regulate their cost estimating submittals. In this estimating stage the client typically asks the bidders to apply the bottom-up estimating technique.TheControl stage is based on bid, quotation, or proposal from those contractors andsuppliers of materials and equipment that have been awarded the contract. In addition to awarded contracts and other external agreements, this cost estimating stage must include detailed estimates for all internal commitments, risks, money costs, overhead, profit, and management reserve. Also, this stage must have a system for collection and cost estimation of change orders.There is no other decision-making process wrapped in so many unknowns, and at the same time so important, as cost estimating. This process, which has a short duration for completion coupled with an unlimited period during which it can be challenged and criticized, can be divided into three subsystems:Developing and maintaining cost estimating databases or using commercial databases.Identifying the description of the work and specifying quantity and price of work to complete the project. This process could be simplified by using templates developed from previous projects.Calculating and defining the bidding price.The subsystem of developing and maintaining cost estimating databases, or using commercial databases, relates to all projects within an organization. This is central to an organized and efficient way of cost estimating. Use of cost estimating databases improves the quality of decisions, because both those who prepare cost estimates and those who make the decisions about price often use the same elements for their judgment. This can eliminate most of subjective opinions. The most important data of the subsystems are:Description of work to be performedUnit of measure for the workClassification code of the workQuantities of each resource used to perform unit of measure of the workUnit price for each resource used to perform the work.The subsystem of developing a description of work and specifying quantity and price of that work in relation to a specific project enables detailed and reliable work descriptions of individual activities by using a cost estimating database. When all work has been identified in the database, then estimating professionals use project documentation to calculate quantity and price for each line item that describes the work of an activity. This estimating technique is known as activity-based costing or bottom-up cost estimating. If this approach is not feasible, we can apply analogous estimating or parametric modeling techniques. In each case, the cost estimate must be detailed enough that each line item can be assigned by a single work breakdown structure code or specific work breakdown structure components (activities, work packages, or deliverables) and one or more cost accounts for each component. Otherwise, a line item has to be broken down into more components.The subsystem of calculating and defining bidding price includes expert judgment, which allows fine-tuning of calculated prices. Such a package contains prices, estimating documentation, assumptions made, and range of possible results of cost, including market conditions, all indirect cost, money costs, overhead, and profit. This material, whichcontains total cost of all resources, except management reserve, is sent to management for the final definition of bidding price. When the project is awarded to the performing company, then the same line items used for bidding purposes will become a part of the database for project progress tracking and the payment application process.COST BUDGETINGCost budgeting is the process of aggregating the cost of individual activities to produce a time-phased project cost estimate. A time-phased presentation of a project cost estimate shows total cost at each period during project development and establishes a structure of spending for each particular period. When accepted, this structure will become a guideline for project financial plan and policy, which must be aligned with other projects within the organization.Time-phased cost estimate is a synonym forPlanned Value (PV), Budget (B), Original Budget (OB), Target Budget (TB), Baseline Cost (BC), Schedule Value, orBudgeted Cost of Work Scheduled (BCWS) and represents the value of the work that should have been accomplished by a specific date. For example, if activity costs are distributed linearly, then planned value by a specific date for an activity is the product of the total planned value and the percent complete of activity duration that the plan should be on the specific date, or:Planned Value (PV)(by specific date) = (OD-RD)/OD) *Planned Value (PV) (total)(OD is Original Duration;RD is Remaining Duration. Planned value here is an initial planned value, which has been set as the target budget rather than the current planned value.)It is important to note that the sum of all of the planned values, or the sum of all the budgeted work for the project, is known as Budget at Completion (BAC). Budget at completion does not change with the ebb and flow of the project; it remains constant unless there is an approved change that formally modifies the baseline. In developing a project cost budgeting system and establishing the BAC, it is necessary to consider all direct and indirect costs.Direct cost belongs to a specific project task or activity, and will be tracked exclusively to that work product or service. Direct costs are the sum of all resources necessary to accomplish this activity.Indirect cost belongs to a group of activities because the cost factor is not trackable or exclusive to one task activity. Indirect costs are defined through the cost of all resources necessary to accomplish the group or hammock activity, which encompasses two or more task activities. The keys for specification of indirect cost might be:Time oriented, when cost cannot be defined periodically, but its value is shown over a defined period of time; e.g., contingency, overhead, and profit.Proportionally oriented, when cost is in direct proportion to some other direct cost; e.g., freight cost to equipment deliveries cost.Also, regardless of activity type, it is necessary that the following points are defined for each activity:Cost amount, or resource quantity and unit price for each resource.Relative start point for activation of cost or resources for the activity. In most cases this start point is between activity start and finish. There are cases when the start point for cost or resources can be outside the activity they are related to; e.g., advance payment for an activity that has to be made one week before the activity can start.A relative end point for activation of cost or resources for the activity. In most cases this end point is between activity start and finish. There are cases when the end for cost or resources can be outside the activity they are related to, such as a retainage payment that is collected for an activity that has to be held for one month after the activity has been finished.A distribution pattern for cost amount or resource quantity over the duration of an activity. This can be specified as a certain cumulative function for total quantity for an activity or as a discrete quantity for each time unit of activity duration.Cost accounts, which show where there is a responsibility for cost amount, or resource quantity for each resource. Each cost account should have cost account categories, which show labor, material, expenses and subcontracts for that account. Cost accounts are used to show resources or cost specifications and establish a budget for different project structures; e.g., work breakdown structure components. Each component within the structures can have many cost accounts, and each cost account can appear in many components.Cost budgeting is a simulation process that has to be performed until we get satisfactory results across the project scope structure and project organizational structure. As a result of this approach, we come to an initial and fully integrated plan of project cost and schedule. This brings up the question of how detailed a project cost plan should be. The general consensus among practitioners is that this job should be performed as follows:If budget cost has been assigned to each detailed project activity, we can get a precise project plan of project cost and schedule. As this process requires skills across several knowledge areas it, is recommended for experienced users.For projects that have developed a detailed scope structure, it is acceptable to assign resources or cost to a hammock activity, which spans the work package(s) (from start to finish). In that case, cost budgeting is greatly simplified. However, this alternative does not include the planned cost for individual activities; therefore, grouping activities can hide a reason for cost deviation within a work package. Even if we apply this simplified procedure, it is necessary to make a detailed assessment of all work packages that show a negative cost trend.If we apply a system for cost budgeting based on project management knowledge, then we must develop a procedure that maintains integrity of project cost and schedule. We must assure that:The work breakdown structure is a backbone for other project structures, such as cost estimating structure, organizational structure, and contracting structure.Each activity that has a cost must have one or more cost accounts, which show the responsibility for the cost; e.g., engineering, fabrication, installation, etc.Each cost account should contain one or more cost categories (labor, material, expenses, subcontracts).The first alternative for cost estimating uses the parameters of normal work conditions.The total cost estimate for a project must be distributed to project activities.Costs from particular cost accounts can be summarized only in a single element of the particular project structure; e.g., work breakdown structure.Each project activity must have other codes, which define activity location and summarization of activity information within different project structures; e.g., organizational breakdown structure. belowshows the OBS Code as an interface between key project structures.An activity that has assigned resources or cost cannot be modified or deleted from the plan until the resources and cost differences are transferred to other activities within the project.Specified work and budget cannot be transferred to other activities independently from one another.The budget for work breakdown structure components that are in progress or have not started yet cannot be changed without approved change orders.Once the project budget has been prepared, it provides the basis for subsequent control of costs.COST CONTROLOnce we have a project cost plan, our emphasis moves from planning processes to controlling processes. Methodologies for cost control or controlling changes to project budget differ from company to company. Most methodologies include features that help react to changes, find out causes of variances, and act to improve a project trend. They fit within one of following systems:Thestandard cost control system has, for each line item from the plan, two cost categories: planned (or standard) cost and actual cost. Having two cost categories for each line item, we can make a comparison between planned and actual cost and then determine variance. Comparing actual cost to planned cost shows the cost variance on a given date. This variance between planned and actual cost is caused by either: Resources used to accomplish the work have been paid more than was planned.Resources used to accomplish the work have been consumed in more quantity than was planned.Therefore, cost analysis based on a standard cost-control system has been focused on two elements: resources and cost of resources. Now we can formulate equations, which calculate planned cost, actual cost and variance for any line item and at any level of the project structure that aggregates a set of line items. By this system:Planned cost = Planned Quantity * Planned unit priceActual cost = Actual Quantity * Actual unit priceTotal variance = Planned cost Actual costStandard cost control works well for serial production, which creates a large number of the same products. Schedule and cost for a production program are based on aprocedure that develops standard activities for one finished unit of a production program or one time unit of a production program.Theproject cost control system assumes that each activity or group of activities become the time and cost controlling center. The system starts with an analysis of work results, i.e., outcomes of the activities performed to accomplish the project. Regarding cost control we should collect: an estimate of percent completed of activity duration, remaining duration to complete each activity, any change orders or pending change orders that impact activity time and cost, and new cost estimate for activity and actual cost for activity.Although there are many aspects of project cost control, we are concerned, at the start, with value of progress for activities. This value represents the percentage of planned costs allocated to the work that was actually accomplished. The value of the work performed is a synonym forTotal Completed and Stored To Date, Budgeted Cost of Work Performed (BCWP), orEarned Value (EV). If we can measure the quantity of work accomplished, then the Earned Value is calculated as the product of the resource percent complete and the current Planned Value for the resource. If we cannot measure the quantity of work accomplished then Earned Value is calculated as a product of the Planned Value and percent complete of the activity duration, or:Earned Value (EV)(by specific date) = (OD-RD)/OD) *Planned Value (PV) (total)OD is Original Duration,RD is Remaining Duration. As we can see, earned value is calculated with the same equation as planned value, however, planned value here is a current planned value rather than target budget, which has been used to calculate planned value. Consequently, earned value will be different from planned value if current planned value or current schedule dates are different from target budget or target schedule dates. If target budget has not been set, then earned value is equal to planned value at any point of time.Although this simplified procedure does not measure the quantity of work accomplished or resource consumption for this work, it gives instant results that are usually sufficient and reliable enough for decision makers.Collection of Actual Cost (AC) for work elements is an important project function. It is a synonym forActual Cost of Work Performed (ACWP) and represents costs actually incurred for work planned and accomplished during a specific period, usually to the data date. This is the most complicated job in controlling because of difficulties in:Obtaining actual cost related to labor hours spent, material consumed, expenses, and subcontracts of accomplished work elementAllocating actual cost of resources exactly at places where they have been plannedBringing together a structure for developing planned value and a structure for accumulating actual cost. As these structures are usually different, a base for analysis of actual cost could be inconsistent.If we face such a situation, we should look for a procedure that can operate quickly and with enough precision to be used as a routine. The collection of actual cost could be simplified if we assume that most of actual costs have been generated where they have been earned. Therefore, by use of some global calculation we can distribute actual cost proportionally to each earned value amount. This will enable performance measurementat some higher management level. However, from time to time, it is necessary to make a detailed distribution of actual costs to work elements where they have been spent. This will help to get a clear picture of current work elements and also to store the structure of cost amount for use in a future project.While earned value and actual cost specifics are relevant to task activities and associated direct cost, it should be noted that indirect planned costs are assigned to hammock activities; therefore, they are usually earned as percent of time progress on activities within the group, and their actual costs are usually set equal to earned value.If, for unpredictable reasons, a change is made to the project work, it is necessary to estimate the cost for that change. This base equation relates actual cost and cost to complete an activity, and forecasts most likely total activity cost:Estimate at Completion (EAC) = Actual Cost (AC) + Estimate to Complete (ETC), where:EACis an estimate of total cost that will be used to complete an activity.ETCis an estimate of the remaining cost to complete an activity.This equations works well if assessment of an activity has justified a need to make new ETC for remaining work.However, in most cases this is not necessary and ETC is calculated from existing data, usually as remaining budget to complete the activity, where:ETC = Planned Value (PV)(total, current) Earned Value (EV)This equation works well if assessment of an activity shows that current performance is unique and cannot be used to predict future ETC and EAC.The concepts we have applied to a singular task can also be applied to the project as a whole. If the organization consistently develops a record of past project performance, then a Cost Performance Index (CPI) can be used to predict future Estimate to Complete (ETC) and Estimate at Completion (EAC). (Note: CPI is defined later ) In this situation:EAC = BAC/Cost Performance Index (CPI)ETC = EAC ACWPThere are also forecasting techniques, which add the cost of changes directly. Cost of changes can be added to Estimate to Complete (ETC), where:ETC = Planned Value (PV)(remaining, current) + currentChange Orders (CO)ETC = Planned Value (PV) Earned Value (EV)+ currentChange Orders (CO)The cost of changes can be added to Estimate at Completion (EAC) or to PV, where:EAC = Planned Value (PV)+ currentChange Orders (CO)When we have figured Planned Value (PV), Earned Value (EV), Actual Cost (AC), and Estimate to Complete (ETC), which are the essence of project cost control, we can know:Project status, or the value and meaning of project cost categories and indexes as of the data dateProject progress or accomplishments as of the data dateProject forecast, or what is projected to happen regarding project progress and result based upon results up to this data date.Variances and Indexes Used in Cost ManagementBased on derived cost categories, we can calculate different variances and indexes to get more comprehensive picture of project development. The variances and indexes have the following meaning:Budget Variance (BV) shows the difference between Estimate at Completion (EAC) and Budget at Completion (BAC).Budget Variance (BV) = Estimate At Completion (EAC) BACIn real-life projects, Estimate at Completion (EAC) can be used as a projection of the impact of Change Orders (CO). Budget Variance (BV) will show the magnitude of these changes with respect to the target plan. When changes are eventually approved, the baseline will be updated, and the BAC will increase or decrease accordingly.Cost Variance (CV), shows the difference between Actual Cost (AC) and Earned Value (EV), or how much paid differs from earned. If variance is negative, then payment should be stopped until a detailed assessment of project cost has been done.Cost Variance (CV) = Earned Value (EV) Actual Cost (AC)Schedule Variance (SV), shows the difference between Planned Value (PV) (target) and Earned Value (EV), or how much planned value differs from earned value. We should not use Schedule Variance (SV) to discuss a specific schedule position, but if it is negative, we may want to speed up work. However, a negative Schedule Variance (SV) does not necessarily mean that project completion has been delayed, because negative Schedule Variance (SV) could arise from a delay in activities with positive float. Similarly, a positive Schedule Variance (SV) does not mean that the project completion will be earlier, because a positive Schedule Variance (SV) could result from the acceleration of activities with positive float.Schedule Variance (SV) = Earned Value (EV) Planned Value (PV)(target)Itshows the key cost control categories and cost variances.Besides the cost categories described above, the reader should understand the meaning of cost indexes, which are derived from the cost categories.Cost Performance Index (CPI), known as cost efficiency indicator, shows Earned Value (EV) against Actual Cost (AC), or the dollar value achieved for each dollar paid. It is favorable if the result is greater than 1.Cost Performance Index (CPI) = Earned Value (EV) / Actual Cost (AC)Schedule Performance Index (SPI), known as schedule efficiency indicator, shows Earned Value (EV) against Planned Value (PV), or how much progress (value) accomplished against progress planned. It is favorable if the result is greater than 1.Schedule Performance Index (SPI) = Earned Value (EV)/Planned Value (PV)The way in which the cost indexes vary can indicate the need for more extensive use of project management system knowledge in order to determine the adequacy of project progress.Concluded Note:Project Cost Management is one area of project management that has the potential to create great discord among project teams, project managers, sponsors, and clients. Or, if it is well done, the reverse is also true: Good cost management can be the foundation of a harmonious relationship among all stakeholders to a project. In addition, well-founded cost management provides a basis for realistic planning and controls of project objectives. When performing the cost management processes described in this chapter, the project manager and team should always be aware that they are laying the knowledge-based groundwork for project success.Gautam Koppala,POME Author Project Cost Management in Practice from POME by Gautam KoppalaBy: GAUTAM KOPPALA
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