Project Management Institute

Cost Management

P.G. Georgas & G.V. Vallance

Stelco Inc.

Introduction and Background

Cost Management is one of the primary functions of Project Managers. When integrated with the scope/quality of the project and time management, these three functions form the core of Project Management. The cost management function maintains its important focus at every stage throughout the life cycle of a project. In listing the reasons for the success of a project, the management of cost is the most important as all project aspects affect this function. What counts for the owner is the “bottom line.”

The initial Cost Management Task Group was chaired by Mr. D.W. Haeney, Stelco Inc., (a member of the PMI Southern Ontario Chapter) in 1983. Mr. P.G. Georgas, Stelco Inc., (also a member of the PMI Southern Ontario Chapter) is now chairing the Cost Management function of Project 121, Body of Knowledge assisted by G.V. Vallance, Stelco Inc. The preliminary report of the Cost Management Function Committee was completed for presentation at the PMI October 1985 Denver Workshop. The workshop reviewed and critiqued this preliminary report and instituted several modifications. The time phase or the chronological progression of process and activities throughout the project life cycle was eliminated from the function chart. The result was that some processes were combined. The resulting two dimensional modified workshop chart still did not meet the requirements of being fully integrated with other Project management functions. A matrix system was suggested and this final report incorporates the matrix approach and the interface with other Project Management functions.

This report is the final submission of the 1985 Cost Management Function Committee. The report includes all of the ideas and work from the initial report (August 1985), the modifications recommended at the workshop, the matrix chart, technical references and all of Mr. Wideman's suggestions.

It is understood that the matrix and function charts, technical reference and glossary of terms will be used to establish a data library for education purposes (accreditation and certification) for all PMI members and students. There still remains a great deal of thinking, discussion and writing before the Cost Management function of the PMI Body of Knowledge is complete. This report is only a beginning and future groups will enlarge and refine the existing information.

Cost Management Function

The Cost Management function (WBS-1) includes the processes that are required to maintain financial control of projects (economic evaluation which initiates the project, estimating, organizing, controlling, analyzing, reporting, forecasting and taking the necessary corrective action. The Function chart (Figure 1), the Function Impact Matrix chart (Figure 2) and glossary of terms are attached to this report. The initial Function chart was developed using the guidelines of March, 1985 for presentation at the Denver workshop. The resulting Function chart (Figure 1) incorporated the workshop data and subsequent suggestions by Mr. Wideman. One major conclusion of the workshop was the addition of the matrix format to the Body of Knowledge. The Function Impact Matrix chart (Figure 2) for Cost Management illustrates the complexities of interfacing with other project management functions. Both charts encompass the total project cost management concepts from initiation to completion during the total project life cycle.

Cost Function Chart

The process levels used in the Cost Function chart (Figure 1) are as follows:

  1. Cost Estimating
  2. Cost Budgeting
  3. Cost Control
  4. Cost Applications

Each of the process levels (WBS-2) were expanded into activity levels (WBS-3). An additional level (WBS-4) lists the techniques that are associated with some of of the activities.

Cost Estimating

Cost estimating is the process of assembling and predicting costs of a project over its life cycle. It encompasses the three phases included in the initial function chart; namely, economic evaluation, project investment cost and cost forecasting.

The economic evaluation is the initial planning phase to determine whether a project is economically and technically feasible and whether sufficient funding can be obtained to implement the project. It involves the assessment of “order of magnitude” estimates, project profitability, financing and acceptance.

The project investment cost is the prediction of future cost even though all the parameters are not fully defined at times during the project's life. It is during this process that order of magnitude, budget and definitive estimates are produced.

Cost forecasting is the process of developing the future trends along with the assessment of probabilities, uncertainties and inflation that could occur during the project.

The combination of these three processes assist in predicting the future financial outcome for a successful project.

Cost Budgeting

The cost budgeting process is one of establishing budgets, standards and a monitoring system by which the investment cost of the project can be measured and managed. This process is the planning phase once project approval is obtained. It includes all the accounting functions required to establish procedures and systems to monitor the project.

Cost Controls

Although the control functions appears in all of the Project Management function charts, the activities associated with each are not universal and hence the term Cost Control is used to differentiate from the other functions. The process of cost control is the gathering, accumulating, analyzing, monitoring, reporting and managing the costs on an ongoing basis.

Cost Applications

This is the process level associated with special applications of cost techniques that are not included in the other cost processes. It also includes associated topics that affect cost management such as computer applications, value analysis, etc.

Cost Function Impact Matrix Chart

The Function Impact Matrix chart (Figure 2) illustrates the interaction and integration of the processes of the Cost Management function with the other project management functions. The traditional core project management functions (Scope, Quality, Time and Cost) are dynamically linked with the other “softer” components (Human Resources, Communications and Contracts/Procurement) and the operational functions (Planning & Controlling, Integration & Coordination, Systems/Processes, Probability/Risk and Applications). The resulting matrix chart provides a mosaic of the interfaces and demonstrates the complexities of the Cost Management Function.

Summary

The four processes and their associated activities as shown on the Function chart (Figure 1) cover all aspects of the total Cost Management function. The Function chart, the Function Impact Matrix chart (Figure 2), glossary of terms and technical references attached provide a subject outline for an educational program. A truly successful project depends on the successful interaction and integration of all Project Management functions. The Function charts will provide the educational background required, for the accreditation and certification programs in Project Management.

Glossary of Terms

Cost Management is a function which includes the processes that are required to maintain effective financial control of projects (evaluating, estimating, budgeting, monitoring, analyzing, forecasting and reporting the cost information).

Cost is the cash value of project activity.

1. Cost Estimating is the process of assembling and predicting the costs of a project. It encompasses the economic evaluation, project investments cost and predicting or forecasting of future trends and costs.
1.a Economic Evaluation is the process of establishing the value of a project in relation to other corporate standards/benchmarks, project profitability, financing, interest rates and acceptance.
1.a.1 Feasibility Studies are the methods and techniques used to examine technical and cost data to determine the economic potential and the practicality of project applications. It involves the use of techniques such as the time value of money so that projects may be evaluated and compared on an equivalent basis. Interest rates, present worth factors, capitalization costs, operating costs, depreciation, etc., are all considered.
1.b Profitability is a measure of the total income of a project compared to the total monies expended at any period of time. The techniques that are utilized are Payout Time, Return on Original Investment (ROI), Net Present Value (NPV), Discounted Cash Row (DCF), Sensitivity and Risk Analysis.
1.c Financing involves the techniques and methods related to providing the sources of monies and methods to raise funds (stock, mortgages, bonds, innovative financing agreements, leases, etc.) required for the project.
1.d Prospectus is the assembly of the evaluation profitability studies and all the pertinent technical data in an overall report for presentation and acceptance by the owner and funders of a project.
1.d.1 Project Budget is the amount and distribution of money allocated to a project.
1.d.2 Budget when unqualified, usually refers to an estimate of funds planned to cover a fiscal period. (See Project Budget.) Also: a planned allocation of resources.
1.e Project Investment Cost is the activity of establishing and assembling all the cost elements (capital and operating) of a project as defined by an agreed scope of work. The estimate attempts to predict the final financial outcome of a future investment program even though all the parameters of the project are not yet fully defined.
1.e.1 Order of Magnitude (−25, +75 percent). This is an approximate estimate made without detailed data, that is usually produced from cost capacity curves, scale up or down factors that are appropriately escalated and approximate cost capacity ratios. This type of estimate is used during the formative stages of an expenditure program for initial evaluation of the project. Other terms commonly used to identify an Order of Magnitude estimate are preliminary, conceptual, factored, quickie, feasibility and SWAG.
1.e - Parametric Cost Estimating is an estimating methodology using statistical relationships between historical costs and other project variables such as system physical or performance characteristics, contractor output measures, or manpower loading, etc. Also referred to as “top down” estimating.
1.e.3 Budget Estimate (−10, +25 percent). A budget estimate is prepared from flowsheets, layouts and equipment details. This is often required for the owner's budget system. These estimates are established on quantitative information and are a mixture of firm and unit prices for labour, material and equipment. These estimates are used to establish the funds required and for obtaining approval for the project. Other terms used to identify a Budget estimate include Appropriation, Control, Design, etc.
1.e - Definitive Estimate (−5, +10 percent). A definitive estimate is prepared from well defined data, specifications, drawings, etc. This category covers all estimate ranges from a minimum to maximum definitive type. These estimates are used for bid proposals, bid evaluations, contract changes, extra work, legal claims, permit and government approvals. Other terms used for a Definitive Estimate include check, lump sum, tender, post contract changes, etc.
1.e.6 Project Close Out and Start Up Costs are the estimated extra costs (both capital and operating) that are incurred during the period from the completion of project implementation to the beginning of normal revenue earnings on operations.
1.f Contingencies. Specific provision for unforeseeable elements of cost within the defined project scope; particularly important where previous experience relating estimates and actual costs has shown that unforeseeable events which will increase costs are likely to occur. If an allowance for escalation is included in the contingency it should be as a separate item, determined to fit expected escalation conditions of the project.
1.g Inflation/Escalation is a factor in cost evaluation and cost comparison that must be predicted as an allowance to account for the price changes with time that can occur and over which the Project Manager has no control (such items as cost of living index, interest rates, other cost indices, etc.).
1.i Cost Forecasting is the activity used to predict future trends and costs within the project duration. These activities are normally marketing oriented. However, such items as sales volume, price and operating cost can affect the project profitability analysis. Items that affect the cost management function are: predicted time/cost, salvage value, etc.
1.i. - Trend Analyses are mathematical methods for establishing trends based on past project history and allowing for adjustment, refinement or revision to predict future cost. Regression analysis techniques can be used for predicting cost/schedule trends using data from historical projects.
1.j Statistics are the mathematical methods used to determine the best range of probable values for a project and to assess the degree of accuracy or allowance for unpredictable future events such as accidents, technological innovations, strikes, etc., that can occur during the project life. The techniques that can be used are risk analysis with Monte Carlo simulation, confidence levels, range analysis, etc.
2. Cost Budgeting is the process of establishing budgets, standards and a monitoring system by which the investment costs of the project can be measured and managed, that is, the establishment of the control estimate. It is vital to be aware of the problems “before the fact” so that timely corrective action can be taken.
2.a Work Breakdown Structure (WBS). A task-oriented “family tree” of activities which organizes, defines and graphically displays the total work to be accomplished in order to achieve the final objectives of a project. Each descending level represents an increasingly detailed definition of the project objective. It is a system for subdividing a project into manageable work packages, components or elements to provide a common framework for Scope/Cost/Schedule communications, allocation of responsibility, monitoring and management.
2.b Code of Accounts. Once the project has been divided into the WBS work packages, a code or numbering system is assigned to the cost data for cost monitoring, control, reports, tax class separations and forecasting purposes.
2.c Budget Costs are the translation of the estimate into manhour rates, quantity units of production, etc. so that these budget costs can be compared to actual costs and variances developed to highlight performance and alert those responsible to implement corrective action if necessary.
2.d Cash Flow Analysis is the activity of establishing cash flow (dollars in and out of the project) by month and the accumulated total cash flow for the project for the measurement of actual versus the budget costs. This is necessary to allow for funding of the project at the lowest carrying charges and is a method of measuring project progress.
2.e Managerial Reserves are the reserve accounts to allocate and maintain funds for contingency purposes on over-or under-spending on project activities. These accounts will normally accrue from the contingency and other allowances in the project budget estimate.
2.f Cost Performance Measurement Baseline is the task of formulating the budget costs measurable goals (particularly time and quantities) for the purpose of comparisons, analyzing and forecasting the future costs.
2.g Project Cost Systems is the establishment of a project cost accounting system, ledgers, asset records, liabilities, write offs, taxes, depreciation expenses, raw materials, pre-paid expenses, salaries, etc.
2.g.1 Project Accounting is the process of identifying, measuring, recording and communicating actual project cost data.
2.h Funding (PMI, 1986). The status of internal fund allocation or allocation by an external agency, if applicable, to perform the SOW tasks.
3. Cost Controls are the processes of gathering, accumulating, analyzing, reporting and managing the costs on an on-going basis and includes all of the following activities.
3.c Project Procedures are the methods, practices and policies (both written and verbal communications) that will be used during the project life.
3.e. - Project Cost Changes are the changes to a project and the initiating of the preparation of detail estimates to determine the impact on project costs and schedule. These changes must then be communicated clearly (both written and verbally) to all participants that approval/rejection of the project changes have been obtained (especially those which change the original project intent).
3.f Monitoring Actual versus Budget is one of the main responsibilities of cost management for continually measuring and monitoring the actual cost versus the budget in order to identify problems, establish the variance, analyze the reasons for variance and take the necessary corrective action. Changes in the Forecast Final Cost are constantly monitored, managed and controlled.
3.g Variance Analysis is the analysis of the following:
3.g.1 Cost Variance = BCWP - ACWP
3.g.2 img
3.g.3 Unit Variance Analysis
  • - Labour Rate
  • - Labour Hours/Units of Work Accomplished
  • - Material Rate
  • - Material Usage
3.g.5 Schedule/Performance = BCWP - BCWS
3.h Integrated Cost/Schedule Reporting is the development of reports that measure budget versus actual, S curves, BCWS, BCWP, ACWP.
3.h 2 BCWP - is the Budget Cost of Work Performed
3.h.1 BCWS - is the Budget Cost of Work Scheduled
3.h.3 ACWP - is the Actual Cost of Work Performed
3.h.4 S Curves - are the graphical display of the accumulated costs and labour hours against time for both budgeted and actual amounts.
3.i Progress Analysis is the development of performance indices such as:
3.i.1 Cost Performance Index = img
3.i.2 Schedule Performance Index = img
3.i.3 Productivity is the measurement of labour efficiency when compared to an established base. It is also used to measure equipment effectiveness, drawing productivity, etc.
3.j Corrective Action is the development of changes in plan and approach to improve the performance of the project.
4. Cost Applications are the processes of applying cost data to other techniques that have not been described in the other processes.
4.a Historical Data Banks are the data stored for future reference and referred to on a periodic basis to indicate trends, total costs, unit costs and technical relationships, etc. Different applications require different data base information. This data can be used to assist in the development of future estimates.
4.b Responsibility Charting is the activity of clearly identifying personnel and staff responsibilities for each task within the project.
4.c Post Project Evaluation is the activity of appraising the costs and technical performance of a completed project and the development of new applications in project management methods to overcome problems that occurred during the project life to benefit future projects.
4.d Life Cycle Costing is the concept of including all costs within the total life of a project from concept, implementation, start up to dismantling. It is used for making decisions between alternatives and is a term used principally by the government to express the total cost of an article or system. It is also used in the private sector by the real estate industry.
4.e Value Analysis is an activity devoted to optimizing cost performance. It is the systematic use of techniques which identify the required functions of an item, establish values for those functions and provide the functions at the lowest overall cost without loss of performance (optimum overall cost).
4.f Computer Cost Applications are the computer assisted techniques to handle, analyze, and store the volume of data accumulated during the project life that are essential to the cost management function. The areas associated with cost management are:
  • Cost Estimating Data Base
  • Computerized Estimating
  • Management Reports
  • Economic Analysis
  • Analysis of Risk and Contingency
  • Progress Measurements
  • Productivity Analysis and Control
  • Risk Management
  • Commitment Accounting
  • Integrated Project Management Information Systems

Figure D-l Function Chart Cost Management

Function Chart Cost Management

*See Risk Management

Function Impact Matrix Chart COST MANAGEMENT

Figure D-2 Function Impact Matrix Chart COST MANAGEMENT

References

1. Archibald, R.D., Managing High Technology Programs and Projects. New York: Wiley, 1976.

2. Baumgartner, J.S. Systems Management. Wash., D.C.: The Bureau of National Affairs Inc., 1979.

3. Clark, F.D. & Lorenzoni, A.B. Applied Cost Engineering. Marcel Dekker Inc., 1985.

4. Cleland, D.I., & King, W.R. Systems and Analysis and Project Management. New York: McGraw-Hill, 2nd Ed., 1975.

5. Horngren, C.T. Cost Accounting: A Managerial Emphasis. Prentice-Hall, 3rd Ed. 1972.

6. Humphreys, K.K. Project and Cost Engineers' Handbook. Marcel Dekker Inc., 1984.

7. Jelen, F.C. & Black, J.H. Cost Optimization Engineering. McGraw-Hill Book Co., 1983.

8. Kerzner, H. Project Management: A Systems Approach to Planning, Scheduling and Controlling. New York: Van Nostrand Reinhold, 1979.

9. Meredith, J.R., & Mantel, S.J., Jr. Project Management: A Managerial Approach. New York: Wiley, 1985.

10. Stewart, R.D. Cost Estimating. NY: John Wiley & Sons, 1982.

11. Webster, F.M. Ways to Improve Performance on Projects. Project Management Quarterly, Vol. XII, No. 3, September 1981, pp. 21-26.

12. Wideman, R.M. Cost Control of Capital Projects and the Project Cost Management System Requirements, Vancouver, B.C.: AEW Services, 1983.

13. Wideman, R.M. ESA and All That. Project Management Journal, March, 1985 XVI, 1, 34-42.

14. __________. Proceedings of the Annual Seminar/Symposiums. Drexel Hill, PA: The Project Management Institute.

15. __________. Project Management Journal (Quarterly), Drexel Hill, PA: The Project Management Institute.

This material has been reproduced with the permission of the copyright owner. Unauthorized reproduction of this material is strictly prohibited. For permission to reproduce this material, please contact PMI.

THE PM NETWORK August, 1987

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