Chapter 7:

Project Cost Management

Munawar
moenawar@gmail.com
 Learning Objectives
ƒ Understand the importance of project cost
management.

ƒ Explain basic project cost management principles,

concepts, and terms.

ƒ Discuss different types of cost estimates and methods

for preparing them.

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 Learning Objectives
ƒ Understand the processes involved in cost budgeting
and preparing a cost estimate and budget for an
information technology project.

ƒ Understand the benefits of earned value management

and project portfolio management to assist in cost
control.

ƒ Describe how project management software can assist

in project cost management.

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 The Importance of Project Cost
Management
ƒ IT projects have a poor track record for meeting budget
goals.
ƒ The 2003 CHAOS studies showed the average cost
overrun (the additional percentage or dollar amount by
which actual costs exceed estimates) was 43 percent.
ƒ U.S. lost $55 billion in IT projects in 2002 from cancelled
projects and overruns compared to $140 billion in 1994.*

*The Standish Group, “Latest Standish Group CHAOS Report Shows Project Success Rates
Have Improved by 50%,” A Standish Group Research Note (3/25/03).

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 What is Cost and Project Cost
Management?
ƒ Cost is a resource sacrificed or foregone to achieve a
specific objective, or something given up in exchange.

ƒ Costs are usually measured in monetary units, such as

dollars.

ƒ Project cost management includes the processes

required to ensure that the project is completed within
an approved budget.

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 Project Cost Management Processes
ƒ Cost estimating: Developing an approximation or
estimate of the costs of the resources needed to
complete a project.

ƒ Cost budgeting: Allocating the overall cost estimate

to individual work items to establish a baseline for
measuring performance.

ƒ Cost control: Controlling changes to the project

budget.

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 Basic Principles of Cost
Management
ƒ Most members of an executive board have a better
understanding and are more interested in financial terms
than IT terms, so IT project managers must speak their
language.
ƒ Profits are revenues minus expenses.
ƒ Life cycle costing considers the total cost of ownership,
or development plus support costs, for a project.
ƒ Cash flow analysis determines the estimated annual
costs and benefits for a project and the resulting annual
cash flow.

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 Table 7-1. Cost of Software
Defects*

It is important to spend money up-front on IT projects

to avoid spending a lot more later.

*Collard, Ross, Software Testing and Quality Assurance, working paper (1997).

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 Basic Principles of Cost
Management
ƒ Tangible costs or benefits are those costs or benefits that an
organization can easily measure in dollars.
ƒ Intangible costs or benefits are costs or benefits that are
difficult to measure in monetary terms.
ƒ Direct costs are costs that can be directly related to producing
the products and services of the project.
ƒ Indirect costs are costs that are not directly related to the
products or services of the project, but are indirectly related to
performing the project.
ƒ Sunk cost is money that has been spent in the past; when
deciding what projects to invest in or continue, you should not
include sunk costs.

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 Basic Principles of Cost
Management
ƒ Learning curve theory states that when many items are
produced repetitively, the unit cost of those items decreases
in a regular pattern as more units are produced.
ƒ Reserves are dollars included in a cost estimate to mitigate
cost risk by allowing for future situations that are difficult
to predict.
ƒ Contingency reserves allow for future situations that may be
partially planned for (sometimes called known unknowns)
and are included in the project cost baseline.
ƒ Management reserves allow for future situations that are
unpredictable (sometimes called unknown unknowns).

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 Cost Estimating
ƒ Project managers must take cost estimates seriously if
they want to complete projects within budget
constraints.

ƒ It’s important to know the types of cost estimates, how

to prepare cost estimates, and typical problems
associated with IT cost estimates.

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 Table 7-2. Types of Cost
Estimates

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 Cost Management Plan
ƒ A cost management plan is a document that describes
how the organization will manage cost variances on the
project.

ƒ A large percentage of total project costs are often labor

costs, so project managers must develop and track
estimates for labor.

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 Table 7-3. Maximum Departmental
Headcounts by Year

A large percentage of the costs of many IT projects are

human resource costs.

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 Cost Estimation Tools & Techniques
ƒ Basic tools and techniques for cost estimates:
ƒ Analogous or top-down estimates: Use the actual cost of
a previous, similar project as the basis for estimating the
cost of the current project.
ƒ Bottom-up estimates: Involve estimating individual work
items or activities and summing them to get a project
total.
ƒ Parametric modeling: Uses project characteristics
(parameters) in a mathematical model to estimate project
costs.
ƒ Computerized tools: Tools, such as spreadsheets and
project management software, that can make working with
different cost estimates and cost estimation tools easier.
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 Constructive Cost Model
(COCOMO)
ƒ Barry Boehm helped develop the COCOMO models for
estimating software development costs.

ƒ Parameters include:
ƒ Function points: Technology-independent assessments of
the functions involved in developing a system.

ƒ Source Lines of Code (SLOC): A human-written line of

code that is not a blank line or comment.

ƒ Boehm suggests that only parametric models do not suffer

from the limits of human decision-making.
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 Typical Problems with IT
Cost Estimates
ƒ Developing an estimate for a large software project is a
complex task that requires a significant amount of effort.

ƒ People who develop estimates often do not have much

experience.

ƒ Human beings are biased toward underestimation.

ƒ Management might ask for an estimate, but really desire

a bid to win a major contract or get internal funding.

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 Sample Cost Estimate
ƒ See pages 262-266 for a detailed example that
describes how to create a cost estimate for the Surveyor
Pro project described in the opening case.
ƒ Before creating an estimate, know what it will be used
for, gather as much information about the project as
possible, and clarify the ground rules and assumptions
for the estimate.
ƒ If possible, estimate costs by major WBS categories.
ƒ Create a cost model to make it easy to change and
document the estimate.

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Figure 7-1. Surveyor Pro Project Cost Estimate

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 Figure 7-2. Surveyor Pro Software Development
Estimate

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 Cost Budgeting
ƒ Cost budgeting involves allocating the project cost
estimate to individual work items over time.

ƒ The WBS is a required input for the cost budgeting

process because it defines the work items.

ƒ Important goal is to produce a cost baseline:

ƒ A time-phased budget that project managers use to

measure and monitor cost performance.

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 Figure 7-3. Surveyor Pro Project
Cost Baseline

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 Cost Control
ƒ Project cost control includes:

ƒ Monitoring cost performance.

ƒ Ensuring that only appropriate project changes are

included in a revised cost baseline.

ƒ Informing project stakeholders of authorized changes to

the project that will affect costs.

ƒ Many organizations around the globe have problems with

cost control.
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 Earned Value Management (EVM)
ƒ EVM is a project performance measurement technique
that integrates scope, time, and cost data.
ƒ Given a baseline (original plan plus approved
changes), you can determine how well the project is
meeting its goals.
ƒ You must enter actual information periodically to use
EVM.
ƒ More and more organizations around the world are
using EVM to help control project costs.

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 Earned Value Management Terms
ƒ The planned value (PV), formerly called the budgeted cost of
work scheduled (BCWS), also called the budget, is that portion
of the approved total cost estimate planned to be spent on an
activity during a given period.
ƒ Actual cost (AC), formerly called actual cost of work
performed (ACWP), is the total of direct and indirect costs
incurred in accomplishing work on an activity during a given
period.
ƒ The earned value (EV), formerly called the budgeted cost of
work performed (BCWP), is an estimate of the value of the
physical work actually completed.
ƒ EV is based on the original planned costs for the project or
activity and the rate at which the team is completing work on
the project or activity to date.
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 Rate of Performance
ƒ Rate of performance (RP) is the ratio of actual work
completed to the percentage of work planned to have been
completed at any given time during the life of the project or
activity.
ƒ Brenda Taylor, Senior Project Manager in South Africa,
suggests using this approach for estimating earned value.
ƒ For example, suppose the server installation was halfway
completed by the end of week 1. The rate of performance
would be 50 percent (50/100) because by the end of week
1, the planned schedule reflects that the task should be 100
percent complete and only 50 percent of that work has been
completed.
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 Earned Value
ƒ Suppose you just signed a contract with a consulting firm called
Dewey, Cheatem, and Howe for developing an IS.
ƒ Project Budget, Schedule, Tasks
ƒ $40,000
ƒ 4 months
ƒ 20 Tasks (evenly divided over 4 months)
ƒ $2,000 per task
ƒ 5 tasks per month
ƒ Therefore , you plan to pay $10,000/month. This is called
budgeted cost of work scheduled (BCWS).

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 Planned Budget-Budgeted Cost of
Work Scheduled (BCWS)

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 Invoice

End of Month 1
Dewey, Cheatem, & Howe Actual Cost of
Work
Amount Due: $8,000 Performances
Payment due immediately! (ACWP)

page 1 of 2

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 BCWS Versus ACWP

Is your project
ahead of budget
$2,000 ?

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 Invoice
Dewey, Cheatem, & Howe Complete only 3
Work Completed for Month from 5 tasks
1
Task A - $2,000
Task B - $3,000 Spent $8,000 to
Task C - $3,000 achieve only
page 2 of 2 $6,000 of actual
work

6,000 is Earned Value

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Comparison of BCWS, ACWP, and Budgeted
Cost of Work Performed (BCWP)

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 Cost Variance
Baseline
Progress

Cost Variance

t ual
Ac

Update Date

Time

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 Schedule Variance
Baseline
Progress

Cost Variance
Schedule Variance

l
tua
Ac

Update Date

Time

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 The Full Story
Progress BCWS

Schedule
Variance

t ual
Ac WP)
C Cost
(A
Variance

BCWP

Update Date

Time
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Table 7-4. Earned Value Calculations
for One Activity After Week One

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Table 7-5. Earned Value Formulas

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 Definitions
ƒ Budgeted Cost of Work Scheduled (BCWS)
ƒ Planned expenditure cash flows based on the completion
of tasks in accordance with the project’s budget and
schedule
ƒ Actual Cost of Work Performed (ACWP)
ƒ Actual Project Expense based on completed tasks
ƒ Earned Value or Budgeted Cost of Work Performed
(BCWP)
ƒ The amount of the budget that we should have spent for
a given amount of work completed

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 Cost/Performance Indicators

BCWS BCWP ACWP

1 month 1 month 1 month

$1000 $6000 $4000 $8000 $2000

Scheduled/Budgeted Schedule slippage

Actual cost of
to do $1000 work permits only
work performed = $8000
over 3 tasks/$6000
ACWP = $8000
5 tasks in a month work to be
Actual cost
window performed
variance = $2000
BCWS = $1000 BCWP = $6000
Schedule variance =
$4000

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 Cost Metrics
ƒ Cost Variance (CV)-The difference between a task’s
estimated cost and its actual cost:
ƒ CV = BCWP - ACWP
ƒ Negative Value = over budget and/or behind schedule
ƒ Positive Value = under budget and/or ahead of schedule
ƒ Cost Performance Index (CPI)-percentage of work
completed per dollar spent
ƒ CPI = BCWP ÷ ACWP
ƒ ratio > 1 = ahead of schedule and/or under budget
ƒ ratio < 1 = behind schedule and/or over budget

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 Schedule Metrics
ƒ Schedule Variance (SV) – the difference in terms of
cost between the current progress and our originally
scheduled progress
ƒ SV = BCWP – BCWS
ƒ Schedule Performance Index (SPI) – a ratio of the work
performed to the work scheduled.
ƒ SPI = BCWP ÷ BCWS
ƒ ratio > 1 = ahead of schedule and/or under budget
ƒ ratio < 1 = behind schedule and/or over budget

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 Earned Value Metrics
ƒ Minimum Funds Needed if things do not get worse
ƒ Minimum funds = Original total budget ÷ CPI
ƒ Funds Needed if things continue to get worse at the
same level of slippage
ƒ Funds Needed = Original total budget ÷ (CPI x SPI)

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 Figure 7-4. Earned Value Calculations for
a One-Year Project After Five Months

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 Figure 7-5. Earned Value Chart
for Project after Five Months

If the EV
line is
below the
AC or PV
line, there
are
problems
in those
areas.

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 Project Portfolio Management
ƒ Many organizations collect and control an entire suite
of projects or investments as one set of interrelated
activities in a portfolio.
ƒ Project portfolio management has five levels:
1. Put all your projects in one database.
2. Prioritize the projects in your database.
3. Divide your projects into two or three budgets based
on type of investment.
4. Automate the repository.
5. Apply modern portfolio theory, including risk-return
tools that map project risk on a curve.

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Benefits of Portfolio Management
ƒ Schlumberger saved $3 million in one year by organizing 120
information technology projects into a portfolio.
ƒ META Group research shows that:
ƒ Organizations that evaluate information technology projects by
what their business impacts are and what their potential business
values will be implement projects that result in 25 percent more
improvement to the bottom line.
ƒ By 2005-2006, more than 50 percent of the CIOs for Global 2000
companies will adopt project portfolio management tools and
techniques for IT projects, asset management, and budget planning
and monitoring.
ƒ Business executives state that using project portfolio management
allows managers to make decisions faster and with more
confidence.*
*META Group, “IT Investment Management: Portfolio Management Lessons Learned,” A
META Group White Paper (www.metagroup.com) (2002).

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 Using Software to Assist in Cost
Management
ƒ Spreadsheets are a common tool for resource planning,
cost estimating, cost budgeting, and cost control.

ƒ Many companies use more sophisticated and

centralized financial applications software for cost
information.

ƒ Project management software has many cost-related

features, especially enterprise PM software.

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 Figure 7-6. Sample Project Portfolio
Management Screen Showing Project Health

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