Project Cost Management
Mohammad A. Rob
The Importance of Project Cost
Management
IT projects have a poor track record for
meeting cost goals
1995 CHAOS Report:
– Average cost overrun was 189% of the
original estimates
– In 1995, cancelled IT projects cost the U.S.
over $81 billion
Cost of Software Defects
When Defect is Detected
User Requirements
Coding/Unit Testing
System Testing
Acceptance Testing
After Implementation
Typical Cost of Correction
$100-$1,000
$1,000 or more
$7,000 - $8,000
$1,000 - $100,000
Up to millions of dollars
It is important to spend money up-front on IT
projects to avoid spending a lot more later.
What is Project Cost Management?
 Project cost management is primarily concerned
with the cost of the resources needed to
complete project activities
 It includes several processes that ensure that
the project is completed within an approved
budget
 In most cases, predicting the financial
performance of the project’s product (return on
investment, cash flow, payback analysis) is
done outside the project.
Project Cost Management Processes
 Resource planning: determining what resources
(people, equipment, materials) and quantities of
them should be used
 Cost estimating: developing an estimate of the
costs and resources needed to complete a
project
 Cost budgeting: allocating the overall cost
estimate to individual work items to establish a
baseline for measuring performance
 Cost control: controlling changes to the project
budget
Project Cost
Management Processes
Basic Principles of Cost Management
 Benefits and costs can be tangible or intangible, direct
or indirect
– Tangible cost and benefits can easily be measured in
dollars
– Direct cost and benefits can be traced back
(salary/salary savings, hardware/software cost)
 Sunk cost is money that has been spent in the past
 Life cycle cost means the cost of a project over its entire
life (development + operation)
 Cash flow analysis is a method of determining the
estimated annual costs and benefits for a project and
the resulting cash flow
1. Resource Planning
 Resource planning involves determining:
– what physical resources (people, equipment,
materials) are needed
– what quantities of each should be used, and
– when they would be needed to perform project
activities
 The nature of the project (construction,
automobile, retail) and the organizational
knowledge will affect resource planning
1. Resource Planning
 The inputs to the resource planning are: work
breakdown structure, scope statement,
historical information, and policies
 Expert judgment is the real tool for resource
planning
 The main output is a list of resource
requirement including people, equipment, and
materials
2. Cost Estimating
 Cost estimating involves developing an
approximation (estimate) of the costs of the
resources needed to complete project activities
 The inputs to the cost estimating are:
– WBS (list of task), resource requirement (type of
resources for each task) and resource rate (cost per
hour/item).
2. Cost Estimating
 There are several types of cost estimates:
– Rough order of magnitude: It provides a rough idea
of what a project will cost
– Budgetary: It is used to allocate money into an
organizational budget well ahead of time
– Definitive: It provides an accurate estimate of project
cost. (Most accurate)
Types of Cost Estimates
Type of Estimate
Rough Order of
Magnitude (ROM)
Budgetary
Definitive
When Done
Why Done
How Accurate
Very early in the
project life cycle,
often 3–5 years
before project
completion
Early, 1–2 years out
Provides rough
ballpark of cost for
selection decisions
–25%, +75%
Puts dollars in the
budget plans
–10%, +25%
Later in the project, <
1 year out
Provides details for
purchases, estimate
actual costs
–5%, +10%
Cost Estimation Techniques
There are three basic techniques of cost
estimation:
– Analogous or top-down
– Bottom-up
– Parametric modeling
Cost Estimation Techniques
Analogous or top-down
– Use the actual cost of a previous, similar
project as the basis for the new estimate.
– It is based on expert judgment and hence
less accurate.
– It is reliable for similar projects
Cost Estimation Techniques
 Bottom-up
– Estimate individual work items and summing them to
get a total estimate.
– If a detailed WBS is available, then cost can be
estimated from the bottom of the WBS for each
individual and then these estimates can be added in
the higher-level WBS to get a total project estimate.
– It is more accurate as individual items are considered
– This method requires time and hence becomes
expensive to develop
Cost Estimation Techniques
 Parametric modeling
– It uses project characteristics (parameters) in a
mathematical model to estimate costs
– Once popular parametric model is the Constructive
Cost Model (COCOMO), which is used for estimating
software development cost based on parameters
such as the source lines of code or function points
– Function points are technology-independent
assessments of the functions involved in developing
a system. For example, number of inputs and
outputs, number of files/tables, number of processes
– Barry Boehm helped develop the COCOMO models
Cost Estimation Example
Business Systems Replacement Project
Category
Objective
Scope
Assumptions
Description
Install a suite of packaged financial applications
software which will enable more timely
information for management decision-making,
easier access to data by the ultimate end user, and
allow for cost savings through productivity
improvements throughout the company.
The core financial systems will be replaced by
Oracle financial applications. These systems
include:
 General Ledger
 Fixed Assets
 Ops Report [AU: spell out Ops]
 Accounts Payable
 Accounts Receivable
 Project Accounting
 Project Management
Oracle's software provides


Cost/Benefit Analysis
& Internal Rate of Return (IRR)
Minimal customization
No change in procurement systems during
accounts payable implementation
BSR was broken down into a three-year cash
outlay without depreciation. Costs are
represented in thousands. Capital and expenses
are combined in this example.
Cost Estimation Example
Business Systems Replacement: Cash Flow Analysis
Costs
Oracle/PM Software
(List Price)
60% Discount
Oracle Credits
Net Cash for Software
Software Maintenance
Hardware & Maintenance
Consulting &Training
Tax & Acquisition
Total Purchased Costs
Information Services &
Technology (IS&T)
Finance/Other Staff
Total Costs
FY95
FY96
FY97
($000)
($000)
($000)
992
8 Year Internal
Rate of Return
Future Annual
Costs/Savings
($000)
0
1492
0
250
270
0
50
570
0
(595)
(397)
0
0
0
205
0
205
500
0
500
90
270
320
150
1330
1850
250
270
0
80
600
1200
(595)
(397)
500
340
540
525
230
2135
3550
200
905
990
4170
580
2380
1770
7455
570
(101)
(160)
(88)
0
(349)
(483)
(1160)
(384)
(25)
(2052)
(584)
(1320)
(472)
(25)
(2401)
(597)
(2320)
(800)
(103)
(3820)
3821
328
5054
(3250)
Savings
Mainframe
Finance/Asset/PM
IS&T Support/Data Entry
Interest
Total Savings
Net Cost (Savings)
500
3 Year
Total
($000)
905
35%
3. Cost Budgeting
 Cost budget involves allocating the project cost estimate to
individual work items or work packages and providing a cost
baseline
 The inputs are:
– WBS: The work items are based on the project work breakdown
structure
– The project schedule is also required when cost is allocated
over time
Cost Budgeting Example
 For example, in the previous example of the
Business Systems Replacement project, there
was a total estimate of $1.8 Million for FY97:
– Purchased cost: $600,000
– Information Services and Technology: $1.2
million
 Next we need to allocate the cost estimate to
individual work items.
Business Systems Replacement Project: $1.8 M
Budget Estimates for FY97 and Explanations
Budget Category
Headcount (FTE)
Cost Allocation to
Individual Items
Compensation
Consultant/Purchased
Services
Travel
Depreciation
Rents/Leases
Other Supplies
and Expenses
Total Costs
Estimated Costs
Explanation
13 Included are 9 programmer/analysts, 2
database analysts, 2 infrastructure
technicians.
$1,008,500 Calculated by employee change notices
(ECNs) and assumed a 4% pay increase in
June. Overload support was planned at
$10,000.
$424,500 Expected consulting needs in support of the
Project Accounting and Cascade
implementation efforts; maintenance
expenses associated with the HewlettPackard (HP) computing platforms;
maintenance expenses associated with the
software purchased in support of the BSR
project.
$25,000 Incidental travel expenses incurred in
support of the BSR project, most associated
with attendance of user conferences and
off-site training.
$91,000 Included is the per head share of
workstation depreciation, the Cascade HP
platform depreciation, and the depreciation
expense associated with capitalized
software purchases.
$98,000 Expenses associated with the Mach1
computing platforms.
$153,000 Incidental expenses associated with things
such as training, reward and recognition,
long distance phone charges, miscellaneous
office supplies.
$1,800,000
4. 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 analysis is an important tool for cost
control
Earned Value Analysis (EVA)
 EVA is a project performance measurement
technique that integrates scope, time, and cost
data
 Given a baseline (original plan plus approved
changes), one can determine how well the
project is meeting its goals
 One must enter actual information (percent of
work completed, how much it was cost)
periodically to use EVA.
Earned Value Analysis Terms
 Planned Value (PV):
– Also called budgeted cost of work scheduled (BCWS) or budget,
is that portion of the approved total cost estimate planned to be
spent on an activity during a given period
 Actual cost (AC):
– Also called actual cost of work performed (ACWP), is the total
direct and indirect costs incurred in accomplishing work on an
activity during a given period
 Earned Value (EV):
– Also called budgeted cost of work performed (BCWP), is the
percentage of work actually completed multiplied by the planned
value (PA): EV = PV * Percent of Work Completed
Earned Value Analysis Terms
 Cost Variance (CV):
– It is the difference between the estimated cost of an activity and
the actual cost of that activity (CV = EV - AC).
– If cost variance is negative, it means that performing the work
cost more than planned
– If it is positive, it means that performing the work cost less than
planned
 Schedule Variance (SV):
– It is the difference between the scheduled completion of an
activity and the actual completion of that activity (SV = EV - PV)
– A negative schedule variance means that it took longer than
planned to perform the work
– A positive SV means that it took less time than planned to
perform the work
Earned Value Analysis Terms
 Cost Performance Index (CPI):
– It is the ratio of earned value to actual cost (CPI = EV/AC)
– It can be used to estimate the project cost of completing the
project
– If CPI is one or 100%, the planned and actual costs are actual
– If it is less than 100%, the project is over budget
– If it is more than 100%, the project is under budget
 Schedule Performance Index (SPI):
– It is the ratio of earned value to planned value (SP = EV/PV)
– It can be used to estimate the projected time to complete the
project
– An SPI of 1 means the project is on schedule, less than one
mean behind the schedule, and more than one means ahead of
schedule
Earned Value Calculations for One Activity
After Week One
EV
Activity
PV
AC
Week 1
Week 2
Purchase web server
10,000
0
10,000
Weekly Plan (BCWS)
Weekly Actual (ACWP)
Cost Variance (CV)
Schedule Variance (SV)
Cost Performance
Index (CPI)
Schedule Performance
Index (SPI)
10,000
15,000
-7,500
-2,500
50%
0
5,000
10,000
20,000
75%
Total
% Complete
after Week 1
EarnedValue
after Week 1
(BCWP)
75%
7,500
Earned Value Calculations for a One-Year
Project After Five Months
Earned Value Chart for Project After
Five Months
BAC
100,000
90,000
80,000
70,000
BCWS
$
60,000
50,000
ACWP
40,000
30,000
BWCP
20,000
10,000
1
2
3
4
5
6
7
8
9
10
Month
BCWS or Cumulative Plan
ACWP or Cumulative Actual
BCWP or Cumulative EV
11
12