Cost Management

Topic 4
Cost Management

Paulo Faroleiro
Project Management
Part IV
Cost Management Cost Management

1. Price Estimation
2. Cost Control

Parts Copyright 2014 Wiley

PRICING AND ESTIMATING

Many managers regard this as an art !

Information available to one bidder is

generally available to others.

This is an essential part of the planning process.

Forms the basis for establishing standards for budgets, man-
hours, material costs, contingencies, etc.
Specific pricing strategies must be developed for each
situation.
TWO TYPES OF ACQUISITION
POLICIES

Type I acquisition: One-of-a-kind contract with little or no

follow-on potential
Objective:
-Win the contract
-Execute it profitably

Type II Acquisition: One of many contracts

An entry point to larger follow-up project contracts
Objective:
-Win the contract
-Perform with excellence
TYPES OF ESTIMATES

Order of magnitude estimates

• Made without any detailed engineering data
• May use past experience
• Accuracy +- 35% within the scope of the project
Approximate (rule of thumb) estimates
• Made without any detailed engineering data
• May use previous similar projects --
• Accuracy +- 15%
Definitive (or detailed) estimates
• Prepared from well-defined engineering data, vendor quotes, unit
prices, etc. Accuracy +- 5%
Estimating manual
• Developed over time
• Use to price out “effort”. Accuracy +-10%
ADDITIONAL ESTIMATING
METHODS

Direct Estimate
• Estimate/experienced person
• Requires judgement
Estimate by analogy
• Compare with similar activities
• Requires judgement
Factored method
• Based on historical data
• Requires equipment lists, sizes
• Starts with equipment quotes
Gross proration method
• Based on historical data
• Near duplicate information
Detailed estimate
- Uses the WBS
- Takes the WBS down several levels
Quotation method
- Compare three quotations
- Select the best quotation
Handbook manuals
Learning curves
 Construction
Cost Estimates
COST FOUNDATIONS

• Actual costs to date and estimates to completion

• Proposal data
• Marketing intelligence
• Management goals
• Past performance and trends
Establishing The
Project Budget
PRICING OUT A PROJECT

1. Provide a complete definition of the work to be done.

2. Develop/construct a Logic Network Diagram.
3. Construct the WBS and estimate the activities (time/cost).
4. Review these (time/cost) with the respective functional
managers.
5. Decide on a course of action .
6. Establish acceptable costs for each WBS-activity.
7. Review the base costs with your sponsor.
8. Develop the pricing cost report.
9. Document this in the project file.
PRICING METHOD

• Work is priced out at the department average, and all work

performed is charged to the project at the department average
salary, regardless of who accomplished the work.

• Work is priced out at the department average, but all work

performed is billed back to the project at the actual salary of
those employees who perform the work.

• The work is priced out at the salary of those employees who

will perform the work, and the cost is billed back the same
way.!!
 Do Project
Managers Control
Costs, Monitor
Costs Or Both?
COST MANAGEMENT

Cost estimating
Cost accounting
Project cash flow
Company cash flow
Direct labor costing
Overhead rate costing
Others, such as incentives, penalties, and profit-sharing
COST AND CONTROL SYSTEM

WORK DATA CUSTOMER AND

COST
PLANNING AUTHORIZATION COLLECTION MANAGEMENT
ACCOUNTING
AND RELEASE AND REPORTING REPORTING

PHASE I PHASE II PHASE III PHASE IV PHASE V

PLANNING OPERATING CYCLE

CYCLE
COST CONTROL REQUIREMENTS

Measure resources consumed

Measure status and accomplishments
Compare measurements to projections and standards
Provide the basis for diagnosis and re-planning!!
COST CONTROL REQUIREMENTS

Thorough planning of the work to be performed to complete

the project
Good estimating of time, labor, and costs
Clear communication of the scope of required tasks
A disciplined budget and authorizations of expenditures
Timely accounting of physical progress and cost
expenditures
Periodic re-estimation of time and cost to complete
remaining work
Frequent, periodic comparison of actual progress and
expenditures to schedules and budgets, both at the time of
comparison and at project completion!!
WHEN TO IMPLEMENT A COST
MANAGEMENT SYSTEM

Possible cost
reductions

Cost of change
PROJECT
COSTS

PROJECT LIFE CYCLE PHASES

CONCLUSION
A cost management system should be implemented right at
the beginning of the life cycle of the project.
CAPACITY PLANNING
 The Work
Authorization Form
 WORK AUTHORIZATION FORM
WBS: 31.03.02 Work order no: D1385

Date of original release: 03 Feb 01

Date of revision: 18 March 01
Revision number: C

Description
- Test Material 2400 150 R4500 1 Aug 15 Sept
- Processing 2610 160 R7500
- Final inspection 2621 140 R3500
- Packaging 2623 46 R 750
- Delivery 2624 R 350

Project office authorization signature:________________

PLANNING AND BUDGETING
WBS Element

Work packages
Work Package
M Org WP______ORG_______
G Org Description of task_____
R Org ____________________
Sched: Start____Stop__
Budget:______________
 COST ACCOUNT CHANGE NOTICE (CACN)

CACN No. _____________ Revision to Cost Account No. ____________ Date ___________

DESCRIPTION OF CHANGE:
____________________________________________________________________________________
____________________________________________________________________________________
____________________________________________________________________________________
____________________________________________________________________________________

REASON FOR CHANGE:

____________________________________________________________________________________
____________________________________________________________________________________
____________________________________________________________________________________
__________________________________________________________________________________

Requested Budget Authorized Budget

Labor Hours _________________ _________________ Period of performance
Materials _________________ _________________ From _____________
ODCS _________________ _________________ To _____________

BUDGET SOURCE:
Funded Contract Change
Management Reserve
Undistributed Budget
Other _________________
INITIATED BY: ____________________________ APPROVALS: Program Mgr. ________
Prog. Control ________
TYPES OF BUDGETS COST DATA
Distributed budget Labor
Management budget Material
Undistributed budget Other direct charges
Contract changes Overhead
VARIANCE ANALYSES
COST DATA COLLATION AND
REPORTING FLOW CHART

Actuals Monthly Total

Program Effort
BCWP
Labor
Weekly Labor
Reports
ACWP Computer
MCCS Comparison
Inventory reports To All Execs
Accounts
BCWS

Variance Report
VARIANCES

The cost variance compares deviations only from the budget and
does not provide a measure of comparison between work
scheduled and work accomplished.
The scheduling variance provides a comparison between
planned and actual performance but does not include costs.
VARIABLES FOR VARIANCE
ANALYSIS
BUDGETED COST FOR WORKED SCHEDULED (BCWS) IS THE BUDGETED AMOUNT
OF COST FOR WORD SCHEDULED TO BE ACCOMPLISHED PLUS THE AMOUNT OF
LEVEL OF EFFORT OR APPORTIONED EFFORT SCHEDULED TO BE ACCOMPLISHED
IN A GIVEN TIME PERIOD.

BUDGETED COST FOR WORK PERFORMED (BCWP) IS THE BUDGETED AMOUNT OF

COST FOR COMPLETED WORD, PLUS BUDGETED FOR LEVEL OF EFFORT OR
APPORTIONED EFFORT ACTIVITY COMPLETED WITHIN A GIVEN TIME PERIOD. THIS
IS SOMETIMES REFERRED TO AS AN “EARNED VALUE.”

ACTUAL COST FOR WORK PERFORMED (ACWP) IS THE AMOUNT REPORTED AS

ACTUALLY EXPENDED IN COMPLETING THE WORK ACCOMPLISHED WITHIN A GIVEN
TIME PERIOD.

COST VARIANCE = BCWP – ACWP

SCHEDULE/PERFORMANCE VARIANCE = BCWP - BCWS

COST DATA COLLATION AND REPORTING FLOW
CHART

ACWP: ACTUAL COST OF WORK PERFORMED

ACTUAL COST INCURRED FOR THE WORK PERFORMED IN A GIVEN PERIOD,
INCLUDING ALL LABOR, MATERIALS, OTHER DIRECT COSTS, OVERHEADS, ETC.

BCWP: BUDGETED COST OF WORK PERFORMED

MEASURE OF THE AMOUNT OF MONEY BUDGETED TO COMPLETE THE ACTUAL
WORK PERFORMED AS OF THE DATA DATE.
REPRESENTS THE VALUE OF WORK PERFORMED, RATHER THAN THE COST OF
THE ACTUAL WORK PERFORMED.
IN CURRENT EARNED VALUE MANAGEMENT SYSTEM USAGE, IT IS REFERRED TO
AS "EARNED VALUE" OR EV.

BCWS: BUDGETED COST OF WORK SCHEDULED

THE SUM OF THE BUDGETED COSTS FOR ALL PLANNED WORK SCHEDULED TO
BE COMPLETED TO-DATE, OR ON ANY GIVEN DATE.
COST VARIANCE CALCULATION

A NEGATIVE VARIANCE INDICATES A COST OVERRUN

CV = BCWP - ACWP
SCHEDULE VARIANCE
CALCULATION

A NEGATIVE VARIANCE INDICATES

A BEHIND SCHEDULE CONDITION

SV = BCWP - BCWS
MANAGEMENT RESERVE

CONTRACTED COST
MANAGEMENT
ACTUAL COST RESERVE

RELEASED BUDGET
$

TIME
PROJECT VARIANCE ANALYSIS

VARIANCE UPPER BOUNDARY

PROJECTED COST

ACTUAL COST VARIANCE

$

VARIANCE LOWER BOUNDARY

R&D QUALIFICATION DEVELOPMENT
PHASE I PHASE II PHASE III
TIME
VARIANCE PERCENTS

SV
SCHEDULE VARIANCE % =
(SVP) BCWS X 100

CV
COST VARIANCE % =
(CVP) BCWP X 100
 Trend
Analyses
INFORMATION REQUIREMENTS
• Budgeted cost for work scheduled (BCWS)
• Budgeted cost for work performed (BCWP)
• Actual cost for work performed (ACWP)
• Estimated cost at completion
• Budgeted cost at completion
• Cost and schedule variances/explanations
• Traceability
VARIANCE ANALYSIS QUESTIONS

• What is the problem causing the variance?

• What is the impact on time, cost, and performance?
• What is the impact on other efforts, if any?
• What corrective action is planned or under way?
• What are the expected results of the corrective action?
VARIANCE REPORTING

Variance reporting is accomplished at each reporting

interval. However, the variance threshold reports are
exception reports and occur only when the variances exceed
the upper and lower boundaries of the project variances
envelope.
REPORTING INTERVALS

Depends on the type of organization and characteristics of

the projects.
Project-driven organization - weekly.
Non-project-driven organization - monthly
Cost account no/cam Reporting level
WBS/Description As of
Cost performance data Variance At completion
BCWS BCWP ACWP SCHED COST Budget EAC Var.
Month to date ($)
Contract to
date ($k)
Problem cause and impact

Corrective action (including expected recovery date)

Cost account Date Cost center Date WBS element Date Date
Mgr. Mgr. Mgr.
The 50/50 Rule
THE 50/50 RULE

HALF OF THE BUDGET FOR EACH ELEMENT IS

RECORDED AT THE TIME THAT THE WORK IS
SCHEDULED TO BEGIN AND THE OTHER HALF AT THE
TIME THE WORK IS SCHEDULED TO BE COMPLETED.

FOR A PROJECT WITH A LARGE NUMBER OF

ELEMENTS THE AMOUNT OF DISTORTION FROM SUCH
A PROCEDURE IS MINIMAL.
ANALYSIS
Scheduled (BCWS)
BUDGETED COST FOR WORK
Performed (BCWP)

Budget - 6 Cost account budget = 100

8 (thousands)
14
12

10

12 Work packages

8
BCWS = 38 12
BCWP = 49
SCHED. VARIANCE = +11 10
8
50-50 rule used for work in process
J F M A M J J A S O N D
USING THE 50-50 RULE

4,000
TIME LINE
10,000
LEGEND
12,000
COMPLETED
4,000
NOT COMPLETED
6,000
BCWS = 34,000
BCWP = 33,000 6,000
BAC = 52,000
10,000

TIME
EARNED VALUE STATUS
REPORTING

TIME LINE
CUMMULATIVE COST, $

BCWS
SV
ACWP
CV

BCWP
TIME
Estimated Cost At
Completion
ESTIMATE AT COMPLETION (EAC)

EAC = ACWP X Budget at completion

BCWP
(BAC)

The estimate at completion is the best

estimate of the total cost at the completion of
the project.

The EAC is a periodic evaluation of the status

of the project - usually on a monthly basis or
until a significant change has been identified.
 STATUS
REPORTING IS
MORE THAN
JUST A
COMPUTER
PRINTOUT.
 INTRANET
STATUS
REPORTING
REPORTING
FAVORABLE
STATUS
 REPORTING
UNFAVORABLE
STATUS
PROGRESS REPORTING

Progress reporting needs to answer four fundamental

questions:
1. Where are we today (time and cost)?
2. Where will we end up (time and cost)?
3. What are the present and future risks?
4. Are there any special problems that need to be
addressed and what can management do to help?
2. ESTIMATE AT COMPLETION (EAC)
EAC = (360/340) X 579,000 = $613,059
Overrun = 613,059 - 579,000 = $34,059
3. COST SUMMARY
Costs are running approximately 5.9% over budget due to
higher salaried labor.
4. SCHEDULE SUMMARY
The 24.4% behind schedule condition is due to subtasks 4
and 6 which have not yet begun due to lack of raw materials
and the 50/50 method for booking costs. Overtime will get us
back on schedule but at an additional cost of 2.5% of direct
labor costs.
 DATA ACCUMULATION
WBS
Organization

Budget
BCWS SCHED
VAR
BCWP
COST
VAR
ACWP
FINANCIAL
CLOSE-OUT
COST PROBLEMS

• Poor estimating techniques and/or standards, resulting in

unrealistic budgets
• Out-of-sequence starting and completion of activities and
events
• Inadequate work breakdown structure
• No management policy on reporting and control practices
• Poor work definition at the lower levels of the
organization!
COST PROBLEMS (CONTINUED)

• Management reducing budgets or bids to be competitive

or to eliminate “fat”
• Inadequate formal planning that results in unnoticed, or
often uncontrolled, increases in scope of effort
• Poor comparison of actual and planned costs
• Comparison of actual and planned costs at the wrong
level of management
• Unforeseen technical problems
• Schedule delays that require overtime or idle time costing
• Material escalation factors that are unrealistic!!
PROBLEM AREAS IN COST
CONTROL
Organization:
• Inadequate Work Breakdown Structure
• Poor work definition at working levels
• Lack of formal system procedures
Planning and budgeting:
• Inadequate forward planning
• Over-allocation of budget
• Poor integration of budget, schedule, work authorization
Accounting:
• Inability to account for cost of material on applied basis
Analysis:
• Determination of status not based on work package completion
• Comparison of actual vs. planned costs at improper level
Revisions:
• Failure to maintain valid measurement baseline!!
COST PROBLEMS PER PHASE

Proposal Phase
• Failure to understand customer requirements
• Unrealistic appraisal of in-house capabilities
• Underestimating time requirements

Planning phase
• Omissions
• Inaccuracy of the work breakdown structure
• Misinterpretation of information
• Use of wrong estimating techniques
• Failure to identify and concentrate on major cost elements
• Failure to assess and provide for risks!!
COST PROBLEMS PER PHASE

Negotiation phase
• Forcing a speedy compromise
• Procurement ceiling costs
• Negotiation team that must “win this one”

Contractual phase
• Contractual discrepancies
• SOW different from RFP requirements
• Proposal team different from project team!!
COST PROBLEMS PER PHASE

Design phase
• Accepting customer requests without management approval
• Problems in customer communications channels and data
items
• Problems in design review meetings

Production phase
• Excessive material costs
• Specifications that are not acceptable
• Manufacturing and engineering disagreement
SUMMARY

1. A cost estimate is 2. There are four types of

prepared estimate of increasing
• As a basis for control accuracy requiring
proportionately more work
• To assess the project’s to prepare:
viability
• Proposal estimate
• To obtain funding
• Budget estimate
• To allocate resources
• Sanction estimate
• To estimate durations
• Control estimate!!
• To prepare tenders for
bespoke contracts
SUMMARY

3. The proposal estimate is prepared at the concept stage to commit

resources to the feasibility. The budget estimate is prepared during
feasibility to initiate the project, and commit resources to design. The
sanction estimate is prepared during design to gain funding for the
project, or approval from the project sponsor. The control estimate is
prepared during implementation planning.

4. There are several types of cost to be estimated, including:

•Labour
•Materials, plant, and equipment
•Subcontract
•Management, overhead and administration
•Fees and taxation, inflation, and other contingency!!
SUMMARY

5. The cost control cube, a three-dimensional matrix of the WBS × OBS ×

CBS provides a structure for estimating and controlling costs. The
estimate is prepared by breaking the work down to an appropriate level of
WBS, and then estimating the cost of each element in the cost control
cube. Effectively we estimate each type of cost for each cell in the
responsibility chart at that level. Spreadsheets can be used to support
this process.

6. There are five techniques for estimating cost:

•Detailed or bottom up
•Computer supported
•Comparative
•Functional
•Parametric!!
SUMMARY

7. Cost is most easily controlled by forecasting cost at completion, by

adding the actual work to date to the estimated cost of work remaining,
and comparing that to the original estimate.

8. Cost can also be controlled by comparing the earned value, a measure

of the amount of work performed to date, to the actual expenditure to
date. A comparison of earned value to the originally planned cash flow
helps to control elapsed time. S-curves provide a visual representation.
Part IV
Cost Management

1. Topic 5 and 6
Quality and Risk Management