Unit 11 Cost Planning and Performance
Why do Some Projects Overrun the Budgets?
According to Arid Sigurdsen, a project management consultant in Norway who has more than 20
years of experience working with large development projects, poor cost control is what often puts
a project in danger of exceeding the budget. Sigurdsen believes that we are still a long way to go
before the largest pitfalls in cost control are removed. However, he offers the following insights
into why these pitfalls occur:
 Many cost overruns stem from poor cost estimates.
 In many companies there is no standardization of rules for developing cost estimates and
cost-control techniques, and neither is given much importance.
 Many people believe that because of the huge number of variables in a project, overruns are
simple unavoidable —a devastating way of thinking, especially since it is not true.
 Project plans and controls often don’t take into account probabilistic measures.
Project Cost Estimates
It is during the development of the proposal by the contractor of project team that project costs are
estimated. In some cases, the proposal will indicate only the total bottom-line cost for the
proposed project. In other cases, the customer may request a detailed breakdown of various costs.
The cost estimate may include the following elements: labor; materials; subcontractors and
consultations; equipment and facilities rental; travel.
In addition to the above terms, the contractor or project team may include an amount for
contingencies, to cover unexpected situations that may come up during the project.
It is good practice to have the person who will be responsible for the costs associated with the
work make the cost estimates. This generates a commitment from the responsible person and
prevents any bias that might result from having one person make all the cost estimates for the
entire project.
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Project Budgeting
First, the project cost estimate is allocated to the various work packages in the project work
breakdown structure. Second, the budget for each work package is distributed over the duration of
the work package so that it’s possible to determine how much of its budget should have been spent
at any point in time.
There are two approaches to establishing the total budgeted cost, TBC, for each work
package. One is top-down approach, in which total project budgets are reviewed in relation to the
work scope for each work package. The other is a bottom-up approach, which is based on an
estimate of the costs for the detailed activities associated with each work package. The project cost
is usually estimated when the proposal for the project is prepared, but detailed plans are not
usually prepared at that time. At the start of the project, however, detailed activities are defined
and a network plan is developed. The TBC for each work package will be the sum of the costs of
all the activities that make up that work package.
Once a total cost has been established for each work package, the second step in the
projecting process is to distribute each TBC over the duration of its work package. When the TBC
for each work package is spread out by time period, it can be determined how much should have
been spent at any point in time. This amount is calculated by adding up the budgeted costs for
each time period up to that pointing time. This total amount, known as the cumulative budgeted
cost (CBC), is the amount that was budgeted to accomplish the work that was scheduled to be
performed up that point in time. The CBC is the baseline that will be used in analyzing the cost
performance of the project.
Determining the Actual Cost
Once the project starts, it is necessary to keep track of actual cost and committed cost so that they
can be compared to the CBC. To keep track of actual cost on a project, it is necessary to set up a
system to collect, on a regular and timely basis, data on funds actually expended. In many projects,
large dollar amounts are extended for materials or services that are used over a period of time
longer than one cost reporting period. These committed costs need to be treated in a special way
so that the system periodically assigns a portion of their total cost, rather than waiting until the
materials ore services are finished to charge the total actual costs.
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As data are collected on actual cost, including portions of any committed cost, they need to
be totaled by work package so that they can be compared to the cumulative budgeted cost. For the
packaging machine project, the following figure shows actual cost by time period for each work
package through week 8. Also shown is the period-by-period actual cost for the entire project, as
well as the cumulative actual cost (CAC).
Actual Cost Period for the Packaging Machine Project
(Amounts are in thousands of dollars)
Period
Week
Element
1
2
3
4
5
Design
2
5
9
5
1
2
8
Build
Total
6
7
8
Expended
22
10
14
12
Install & Test
46
0
Total
2
5
9
7
9
10
14
12
68
Cumulative
2
7
16
23
32
42
56
68
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Determining the Value of Work Performed
Earned value, the value of the work actually performed, is the key parameter that must be
determined throughout the project.
Comparing the cumulative actual cost to the cumulative budgeted cost tells only part of the
story and can be wrong conclusions about the status of the project. The fact that half the budget
was actually expended doesn’t necessary mean that half the work was performed. If the work
performed isn’t keeping up with the actual cost, there is trouble, even if the actual cost is in line
with the CBC.
Determining the earned value involves collecting data on the percent complete for each work
package and then converting this percentage to a dollar amount by multiplying the TBC of the
work package by the percentage completed. The following table explains the cumulative percent
completed by period with the Packaging Machine Project. In the table, we can see that design was
100 percent completed within 5 weeks, and build was 50 percent completed at the 8th week, and
however, install and test have no work performance within 8 weeks.
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Cumulative Percent Complete by period for the Packaging Machine Project
(Amounts are cumulative percentages complete)
Period
Week
Element
1
2
3
4
Design
10
25
80
90
100 100
100 100
Build
0
0
0
5
15
40
50
Install & Test
0
0
0
0
0
0
5
6
7
25
0
0
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At the same time, the cumulative earned value (CEV) is also of great importance. In the
following table, CEV is shown for each work package for the Packaging Machine Project.
Cumulative Earned Value by period for the Packaging Machine Project
(Amounts are in thousands of dollars)
Period
Week
Element
TBC
1
2
Design
24
2.4
6
Build
60
Install & Test
16
Cumulative
100
3
4
19.2 21.6
3
2.4
6
19.2 24.6
5
6
7
8
24
24
24
24
9
15
24
30
33
39
48
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Cost Performance Analysis
The following four cost-related measures are used to analyze project cost performance: TBC (total
budget cost), CBC (cumulative budgeted cost), CAC (cumulative actual cost), CEV (cumulative
earned value). They are used to determine whether the project is being performed within budget
and whether the value of the work performed is in line with the actual cost. In analyzing the tables
for the packaging machine project at the end of week 8, we see that

$64,000 was budgeted through the end of the week 8 to perform all the work scheduled to be
performed during the first 8 weeks.

$68,000 was actually expended by the end of week 8.

$54,000 was earned value of work actually performed by the end of week 8.
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A quick analysis indicates that the actual cost is exceeding the budgeted cost. Aggravating the
situation further is the fact that the value of the work performed isn’t keeping up with the actual
cost.
Cost Performance Index
Another indicator of cost performance is the cost performance index (CPI), which is a measure of
the cost efficiency with which the project is being performed. The formula for determining the
CPI is
CEV
CPI =
CAC
In the packaging machine project, the CPI as of week 8 is given by
CPI =$54,000/$68,000 =0.79
This ratio indicates that for every $1.00 actually expended, only $0.79 of earned value was
received. Trend in the CPI should be watched carefully. When the CPI foes below 1.0 or gradually
gets smaller, corrective action should be taken.
Cost Variance
Another indicator of cost performance is cost variance (CV), which is the difference between the
cumulative earned value of the work performed and the cumulative actual cost. The formula for
determining the cost variance is
CV =CEV – CAC
Like the CPI, this indicator shows the gap between the value of the work performed and the
actual cost, but the CV is expressed in terms of dollars. In our project, the cost variance of week 8
is given by
CV = $54,000 – $68,000 = –$14,000
This calculation indicates that the value of the work performed through week 8 is $14,000
less than the amount actually expended. It is another indication that the work performed is not
keeping pace with the actual cost.
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Cost Forecasting
Based on analysis of actual cost performance throughout the project, it is possible to forecast what
the total costs will be at the completion of the project or work package. There are three different
methods for determining the forecast cost at completion (FCAC).
The first method assumes that the work to be performed on the remaining portion of the
project or work package will be done at the same rate of efficiency as the work performed so far.
The formula for calculating the FCAC using the first method is
TBC
FCAC =
CPI
For the packaging machine project, the forecasted cost at completion is given by
FCAC =$100,000/0.79 =$126,582
A second method for determining the forecasted cost at completion assumes that, regardless
of the efficiency rate the project has experienced in the past, the work to be performed on the
remaining portion of the project will be done according to the budget. The formula for calculating
the FCAC using this method is
FCAC = CAC + (TBC –CEV)
For the packaging machine project, the forecasted cost at completion is given by
FCAC = $68,000 + ($100,000 – $54,000) = $114,000
A third method for determining the forecasted cost at completion is to re-estimate the costs
for all the remaining work to be performed and then add this re-estimate to the cumulative actual
cost. The formula for determining the FCAC using this third method is
FCAC = CAC + Re-estimate of remaining work to be performed
This approach can be time consuming, but it may be necessary if the project experiences persistent
deviations from the plan of if there are extensive changes.
Cost Control
The key to effective cost control is to analyze cost performance on a regular and timely basis. It is
crucial that cost variances and inefficiencies be identified early so that corrective action can be
taken before the situation gets worse. Once project costs get out of control, it may be very difficult
to complete the project within budget. Cost control involves the following:
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
Analyzing cost performance to determine which work packages may require corrective
action.

Deciding what specific corrective action should be taken.

Revising the project plan –including time and cost estimates –to incorporate the planned
corrective action.
When evaluating work package that have a negative cost variance, you should focus on
taking corrective action to reduce the costs of two types of activities:

Activities that will be performed in the near term. Don’t plan to reduce the costs of
activities that are scheduled sometime in the distant future. You will get more timely feedback
on the effects of corrective actions if they are done in the near term. As the project progresses,
less and less time remains in which corrective actions can be taken.

Activities that have a large cost estimate. Taking corrective measures that reduce the cost of
a $20,000 activity by 10 percent will have a larger impact than totally eliminating a $300
activity. Usually, the larger the estimated cost for a activity, the greater the opportunity for a
large cost reduction.
There are various ways to reduce the costs of activities. One way is to substitute less
expensive materials that meet the required specifications. May be another supplier can be found
who can supply the same material but at a lower cost. Another approach is to assign a person with
greater expertise or more experience to perform or help with the activity so as to get it done more
efficiently.
Reducing the scope or requirements for the work package or specific activities is another way
to reduce cost. For example, a contractor might decide to put only one coat of paint on a room
rather than two coats, as originally planned. Increasing productivity through improved methods or
technology is yet another approach to reduce cost. For example, by renting automatic paint
spraying equipment, a contractor may substantially reduce the cost and time of painting a room.
Reference
Jack Gido; James P. Clements: Successful Project Management, South-Western College
Publishing, A Division of Thompson Learning, 1999; 机械工业出版社 2002 年。
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