Project Cost Management

What is Cost and Project Cost

Management?
⚫Cost is a resource sacrificed or fore-gone to
achieve a specific objective or something given up
in exchange
⚫Costs are usually measured in monetary units like
birr, dollar, etc
⚫Project cost management includes the processes
required to ensure that the project is completed
within an approved budget
⚫Project managers must make sure their projects are
well defined, have accurate time and cost estimates
2 and have a realistic budget that they were involved in
 The Importance of Project Cost
Management
⚫Software projects have a poor track record for
meeting budget goals.
⚫The CHAOS studies found the average cost
overrun (the additional percentage or dollar amount
by which actual costs exceed estimates) ranged from
180% in 1994 to 43% in 2002; other studies found
overruns to be 33-34%
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 Reasons for Cost Overruns
⚫ Not emphasizing the importance of realistic project cost
estimates from the outset.
⚫Many of the original cost estimates for IT projects are low
to begin with and based on very unclear project
requirements
⚫ Many software professionals think preparing cost estimates is a
job for accountants when in fact it is a very demanding and
important skill that project managers need to acquire.
⚫ Many software projects involve new technology or business
processes which involve untested products and inherent risks.
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 Project Cost Management Processes
1. Resource planning: determining what resources
and quantities of them should be used.
2. Cost estimating: developing an estimate of the costs
and resources needed to complete a project.
3. Cost budgeting: allocating the overall cost estimate to
individual work items to establish a baseline for
measuring performance.
4. Cost control: controlling changes to the project
budget.
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 Basic Principles of Cost Management

⚫ Life cycle costing is estimating the cost of a project

over its entire life.

⚫ Cash flow analysis is determining the estimated

annual costs and benefits for a project.

⚫ Sunk cost are retrospective (past) costs that have

already been incurred and cannot be recovered

⚫ Sunk costs should not be a criteria in project
6
selection
 Cost of Software Defects
Phase of Software Development Relative Cost to Repair Defects
Requirements and Analysis 1🞩
Coding and Unit Test 5🞩
Integration and System Test 10🞩
Beta Test 15🞩
Post-Product Release 30🞩
NB: 🞩 is a normalized unit of cost and can be expressed in dollars, person-hours, et.

⚫ It is much more cost-effective to spend money on defining user

requirements and doing early testing on IT projects than to wait
for problems to appear after implementation
⚫ If it would cost $1,000 to repair a software defect in the
requirements and analysis phase but it would cost $30,000 to fix it
7 in the post-product release phase
 Resource Planning
⚫ The nature of the project and the organization will
affect resource planning
⚫ Some questions to consider:
⚫ How difficult will it be to do specific tasks on the
project?
⚫ Is there anything unique in this project’s
scope
statement that will affect resources?
⚫ What is the organization’s history in doing
similar tasks?
⚫ Does the organization have or can it acquire the
8 people, equipment, and materials that are capable and
 Cost Estimating

⚫ An important output of project cost management

is a cost estimate.
⚫ There are several types of cost estimates, and tools and
techniques to help create them.
⚫ It is also important to develop a cost management plan
that describes how cost variances will be managed on
the project

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 Types of Cost Estimates
Type of Estimate When Done Why Done How Accurate
Rough Order of Very early in the Provides rough –25%, +75%
Magnitude project life ballpark of cost
(ROM) cycle, often 3–5 for selection
years before decisions
project
completion
Budgetary Early, 1–2 years out Puts dollars in –10%, +25%
the budget plans
Definitive Later in the project, Provides details for –5%, +10%
< 1 year out purchases, estimate
actual costs
• A ROM estimate that actually cost $100,000 would range between $75,000 to $175,000.
• A budgetary estimate that actually costs $100,000 would range between $90,000 to
$125,000.
• A definitive estimate that actually costs $ 100,000 would rang between $95,000 to
10 $110,000.
 Cost Estimation Tools and Techniques

⚫3 basic tools and techniques for cost estimates:

⚫ Analogous or top-down: use the actual cost of a

previous, similar project as the basis for the new

estimate
⚫ Bottom-up: estimate individual work items and

sum them to get a total estimate

⚫ Parametric: use project characteristics in a

11 mathematical model to estimate costs

 Typical Problems with Cost Estimates
⚫ Developing an estimate for a large software project is a
complex task requiring a significant amount of effort.
Remember that estimates are done at various stages of the
project
⚫ Many people doing estimates have little experience doing
them. Try to provide training and mentoring
⚫ People have a bias toward underestimation. Review estimates
and ask important questions to make sure estimates are not
biased
⚫ Management wants a number for a bid, not a real estimate.

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Project managers must negotiate with project sponsors to
create realistic cost estimates
 Cost Budgeting

⚫Cost budget involves allocating the project cost

estimate to individual work items and

providing a cost baseline
⚫For example, in the Business Systems
Replacement project, there was a total purchased
costs estimate for FY97 of $600,000 and another
$1.2 million for Information Services and
13 Technology.
 Cost Control
⚫Project cost control
includes:
⚫monitoring cost performance
⚫ensuring that only appropriate project changes
are included in a revised cost baseline
⚫informing project stakeholders of authorized
changes to the project that will affect costs
⚫Earned value management is an important
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tool for cost control
 Earned Value Management (EVM)

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 Earned Value Management (EVM)

⚫EVM is a project performance measurement technique

that integrates scope, time, and cost data

⚫Given a baseline (original plan plus approved changes),

you can determine how well the project is meeting its

goals
⚫You must enter actual information periodically to use

EVM.
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 Earned Value Management

⚫Earned V alue Analysis is an industry standard way

to:
• measure a project’s progress,
• forecast its completion date and final cost, and
• provide schedule and budget variances along the way.
⚫By integrating three measurements, it provides
consistent, numerical indicators with which you can
evaluate and compare projects.
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 EMV enables

1. Knowing where you are on

schedule?

2. Knowing where you are on

budget?

3. Knowing where you are on

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work accomplished?
 Earned Value Management Terms
⚫ 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.
⚫ 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.
⚫ Earned value (EV), formerly called the budgeted cost of work
performed (BCWP), is the percentage of work actually
completed multiplied by the planned value

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 Earned Value Formulas
TERM FORMULA

Earned Value EV = BAC 🞩 Percent Completed

Cost Variance CV = EV – AC

Schedule Variance SV = EV – PV

Cost Performance Index CPI = EV/AC

Schedule Performance Index SPI = EV/PV

To estimate what it will cost to complete a project or how long it will take
based on performance to date, divide the budgeted cost or time by the
appropriate index.
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 Rules of Thumb for EVA
Numbers
⚫ Negative numbers for cost and schedule variance indicate problems

in those areas.
⚫ The project is costing more than planned or taking longer than planned

⚫ Zero variance shows that the project is running according to the plan

⚫ CPI and SPI > 1.0 indicate exceptional performance

⚫ CPI and SPI < 1.0 indicate poor performance

⚫ If CPI or SPI = 1, it shows that the project is performing according to

its plan
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 Exampl
e⚫ Suppose you have a software project which is planned to
be completed in 9 months with a budget of Birr
900,000.
⚫ After a month,10% of the project is completed at a
total expense of Birr 100,000, but the planned
completion was 15%.
⚫ Given:
⚫Budget At Complete (BAC) = Birr 900,000
⚫AC = Birr 100,000
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 Compute
a) PV
b) EV
c) CV - interpretation
d) SV - interpretation
e) CPI - interpretation
f) SPI - interpretation
g) Forecast -Budget at complete
h) Forecast - Time at complete
i) Overall project’s traffic light
status
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 …solution

a) Planned Value = Planned Completion (%) *

BAC
= 15% * Birr 900,000
= Birr 135,000
b) Earned = Percent Completed (%) *
Value BAC
= 10% * Birr 900,000
= Birr 90,000
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 …continued
⚫CV = EV – AC The project is
costing more
= 90,000 – than planned
100,000 because CV is
less than zero.
= -10,000
⚫SV = EV – PV
The project is
= 90,000 – taking longer
than planned
135,000 because SV is
less than zero.
= - 45,000
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 …continued
⚫CPI= EV / AC
= 90,000 /
100,000 It shows Poor
Performance
= 0.90 because CPI
and SPI are
⚫SPI= EV/P V less than one.
= 90,000 /
135,000
= 0.67
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 Forecasting Cost
⚫If the project continues at the current
performance, what is the true cost of the
project?
⚫Estimate at Complete
= Budget at Complete (BAC) / CPI
= Birr 900,000 / 0.90 = Birr 1,000,000
⚫At the end of the project, the total project
cost will be Birr 1,000,000
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 Forecasting Time

⚫If the project continues at the current

performance, what is the true time of
the project?
⚫Estimate at Complete
= Original Time Estimate / SPI
= 9 months / 0.67 = 13.43 months
⚫The project will be completed by the
end of
13.34 months.
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 Establish Ranges to Guide Traffic Light
Status

⚫ Traffic light status is useful in conveying overall

project’s
status with one color
⚫ Establish objective SPI and CPI ranges to determine the
true project color.
⚫ Average of CPI & SPI i.e. (CPI+SPI)/2
Green [1.0 - 0.95] Good

Warning
[0.94 -
Bad
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Yello 0.85]
 ⚫Therefore, for the above example,
overall
project’s traffic light status is
= (CPI+SPI)/2
= (0.90+0.67)/2
= Bad
0.78

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