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Project Management from Simple to Complex

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Chapter 9Estimating and Managing Costs

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Learning Objectives

• Describe methods of estimating costs

• Identify the effects of project phase and complexity on the choice of estimating method

• Describe the method of combining cost estimates with a schedule to create a budget

• Describe methods to manage cash flow

• Describe the terms and relationships of budget factors used in earned value analysis

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Learning Objectives

• Calculate and interpret budget and schedule variances

• Calculate and interpret the schedule performance index and the cost performance index

• Calculate and interpret estimates to complete the project

• Calculate the revised final budget

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Estimating Costs to Compare and Select Projects

• Economic factors are an important consideration when choosing between competing projects

• To compare the simple paybacks/internal rates of return between projects, an estimate of the cost of each project is made

• The estimates must be accurate enough so that the comparisons are meaningful

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Estimating Costs to Compare and Select Projects

• Compared to later phases, the methods of estimating project costs during the selection phase:

– Are faster

– Consume fewer resources

– Rely on expert judgment of experienced managers

• Expert judgment: Decisions based on incomplete information made by people who have extensive personal experience

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Estimating Costs to Compare and Select Projects

• Analogous estimate: Budget estimate based on a similar project

• Parametric estimate: Estimates that are calculated by multiplying measured parameters by cost-per-unit values

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Estimating Costs to Initiate Projects

• Vendor bid analysis

– An RFP is issued and sent to a list of qualified vendors

– Vendors respond with a proposal and an estimate of the cost

– The project management team reviews the vendor responses

– The project selection decision might have to be reconsidered if:

• Vendors’ estimates are much higher than expected

• The project cannot be completed for the cost that was used to select the project

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Estimating Costs to Initiate Projects

• Bottom-up estimating: Sum of estimates of each detail of the activity and project

– Very accurate

– Time-consuming

– On projects with low complexity, the cost estimates can be done on spreadsheet software

– On larger projects, software that manages schedules can manage and display costs by activity and category

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Figure 9.2 - Detailed Cost Estimate

Detailed Cost Estimate.PNG

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Figure 9.3 - Sum of Detailed Costs by Type

Sum of Detailed Costs by Type.PNG

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Estimating Costs to Initiate Projects

• Activity-based estimates

– An activity can have costs from more than one vendor plus costs for labor and materials from internal sources

– Detailed estimates from all sources are reorganized

– Costs associated with a particular activity are grouped by adding the activity code to the detailed estimate

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Figure 9.4 - Detailed Costs Associated with Activities

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Estimating Costs to Initiate Projects

• Establishing a Budget

– Determine how much money is needed for:

• Each group of tasks

• The whole project

– Cost aggregation: Sum of component costs

– Transfer of money to the project account must be appropriately timed

– Reconciliation: Matching funds provided with funds spent

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Figure 9.5 - Fund Transfers and Expenditures

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Managing the Budget

• Funding for the project should be available when it is needed

• Financial people prefer to keep the company’s money working in other investments before transferring it to the project account

• The project manager prefers to have as much cash available as possible to use if activities exceed budget expectations

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Managing the Budget

• Contingency reserve: Money held to pay for predictable but unspecified extra costs

– Likely to be spent

– Part of the total budget for the project

• Management reserve: Money available for changing project scope

– Not likely to be spent

– Not part of the project’s budget baseline

– Can be included in the total project budget

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Evaluating the Budget

• Earned value management (EVM): Method of comparing the budgeted and actual costs of a project during the project

– Budgeted cost of work scheduled (BCWS): All the items in the cost estimate

– Planned value (PV): Sum of the items in the BCWS that should have been spent by a particular day

– Budgeted cost of work performed (BCWP): The budgeted cost of work scheduled that has been done

– Earned value (EV): Sum of budgeted expenses up to a particular point in the schedule

– Actual cost (AC): Sum of money spent so far

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Figure 9.7 - Planned Value, Earned Value, and Actual Cost

Planned Value, Earned Value, and Actual Cost.PNG

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Evaluating the Budget

• Schedule variance (SV): Difference between earned value and planned value

– SV = EV − PV

– A negative schedule variance means the project is behind schedule

• Cost variance: Difference between earned value and actual cost

– CV = EV − AC

– A positive CV indicates the project is under budget

Evaluating the Budget

• Schedule performance index (SPI): Ratio of earned value to planned value

– SPI = EV/PV

– A SPI value less than one indicates the project is behind schedule

• Cost performance index (CPI): Ratio of earned value to actual cost

– CPI = EV/AC

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Evaluating the Budget

• Estimate to complete (ETC): Estimate of the amount of money needed to complete the unfinished part of the project

• Atypical cost variance

– ETC = Budget at completion (BAC) − Earned value (EV)

• Budget at completion: Budget for the entire project

• Typical cost variance

– ETC = (BAC – EV)/CPI

• CPI: Cost performance index

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Evaluating the Budget

• Estimate at completion (EAC): Revised project budget based on actual cost to date plus the estimate to complete (ETC)

– EAC = AC + ETC

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Figure 9.9 - Summary of Terms and Formulas for Earned Value Analysis

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