Basic Principles of Cost Management Project cost management

Basic Principles of Cost Management • Project cost management is traditionally a weak area in many projects • Project Managers must work to improve their ability to deliver projects within approved budgets • This requires the ability to prepare detailed budgets with clearly documented assumptions • Project Managers need to couple an overall understanding of cost management with a detailed understanding of organisational cost management polices and procedures

Basic Principles of Cost Management • Most Project Sponsors and senior project stakeholders have a better understanding of financial terms than project terms • A primary focus will be the financial benefits of project outcomes and the overall business case for a project • Project managers need to develop a sophisticated understanding of cost management in order to – ü Prepare, track and monitor all cost elements associated with a project, and to ü Manage the expectations of the Project Sponsor and stakeholders 2

Organisational Process Assets • It is critical that Project Managers understand the cost management policies and procedures within the organisation where they are executing the project • These can differ vastly between organisations • Inform yourself of the policies and procedures, follow them and document any assumptions Research & Development Policies Accounting Policies & Capitalisation Procedures Policies Cost Policies & Procedures Budgeting Tools & Reporting Planning & Budgeting Cycle Budgeting Policies & Procedures Adapted from PMBOK 5 th Edition

Cost Management Terms for Projects Profit – ü revenue (income) minus expenses (costs) Life Cycle Costing – ü considers the total cost of ownership for an asset and is commonly applied to projects. Total of execution and development costs plus ongoing support costs. Cash Flow Analysis – ü determines the estimated annual costs and benefits for a project and the resulting annual cash flow. Return on Investment – ü is the expected overall positive benefit of a project over a defined time period. Included in a business case. RO I

Cost Management Terms for Projects Sunk Cost – ü Costs that have already been incurred, the money has been spent in the past and cannot be recovered. Useful when deciding which projects to finish and which to cancel. Contingency – ü Allowances for future situations that may be partially planned for and are included in the project cost baseline. ü Often related to overall project risk Business Case – ü Process of analysing and documenting overall costs and benefits, both quantifiable and unquantifiable. Supports project selection and prioritisation 5

Different Types of Costs There are many different costs that need to be planned and tracked in order to fully manage the costs of a project. It is critical that a Project Manager understands ALL the types of costs that may be applied to their project budgets Fixed Costs Variable Costs Direct Costs Intangible Costs Running Costs Indirect Costs Sunk Costs Tangible Costs Operational Costs Capital Costs

Different Types of Cost Direct Costs or Tangible Costs – ü Obvious costs that can easily be measured in dollars e. g. human resources, tools and equipment, interest charges Indirect Costs or Intangible Costs ü Less obvious costs that are harder to quantify, these are often recharged or levied on the project by a central accounting area or relate to unquantifiable factors e. g. %age allocation for It support per head, loss of customer goodwill due to reduced service Many inexperienced Project Managers get caught out by Indirect Costs, these can be a major factor in cost overruns.

Different Types of Cost Capital Costs – ü Costs related to the purchase or creation of an asset that is used to create goods or provide services, these costs can be depreciated in the future. Often applied to the tangible end products of a project. Operational Cost – ü On-going support and maintenance (running) costs for a capital asset e. g. it might cost $100, 000 to develop a new IT system and then $10, 000 per annum of operational costs to maintain the IT system. Capital Costs need to be planned and tracked explicitly in order to depreciate assets and to claim tax, and research and development, concessions.

Different Types of Cost Fixed Cost – ü Costs that remain the same regardless of the size or duration of the project. They are independent of the project or business activity. E. g. rent, unlimited software licence Variable Cost – ü Costs that increase as the size or duration of the project increases. They are dependent on project or business activity. E. g. project staff salary costs will increase if the project is extended The impact on project Variable Costs should be included in the impact analysis and approval of Change Requests

Total Cost of a Project Total Cost • The total cost of a project equals the fixed costs plus the variable costs • Fixed and variable costs can be made up of both direct and indirect costs Variable Costs • Example fixed costs ü Capital purchases ü One off purchases Fixed Costs • Example variable costs ü Salary costs Time ü Overheads based on time

Example Project Budget – High Level

Example Project Budget - Detailed

Staying on Budget To stay on budget, Project Managers must – ü Be knowledgeable about internal cost management policies ü Understand all the cost elements of the project ü Prepare a detailed budget and carefully document assumptions ü Diligently control Project Scope ü Re-baseline the Project Budget after any Change Requests are approved ü Ensure accurate capture of actual costs ü Closely monitor the Critical Path activities ü Urgently resolve or escalate risks and issues on the Critical Path ü Renegotiate the baseline Project Budget whenever it changes due to external factors ü Manage stakeholder expectations closely ü Evaluate performance against the agreed and re-baselined Project Budget

Project Cost Management Processes PMBOK Project Cost Management Processes - 7. 1 Plan Cost Management 7. 2 Estimate Costs 7. 3 Determine Budget 7. 4 Control Costs Related processes from Project Integration Management – 4. 2 Develop Project Management Plan 4. 6 Close Project PMBOK 5 th Edition