ITPM Chapter-5 Cost Managment PDF

Chapter 5: Project Cost Management 1  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 man...

Chapter 5: Project Cost Management 1  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 and have a realistic budget that they were involved in approving.  It is primarily concerned with the cost of the resources needed to complete schedule activities. 22  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 3 involve untested products and inherent  Project Cost Management Processes Planning cost management involves determining the policies, procedures, and documentation that will be used for planning, executing, and controlling project cost. The main output of this process is a cost management plan. Estimating costs: developing an approximation or estimate of the costs of the resources needed to complete a project Determining the budget: allocating the overall cost estimate to individual work 4 items to establish a baseline for measuring  Basic Principles of Cost Management Most members of an executive board better understand and are more interested in financial terms than IT terms, so IT project managers must speak their language Profits are revenues minus expenditures Profit margin is the ratio of revenues to profits Life cycle costing considers the total cost of ownership, or development plus support costs, for a project. Life cycle costing looks at all costs 5 associated with a project, from initiation  Basic Principles of Cost Management Cash flow analysis determines the estimated annual costs and benefits for a project and the resulting annual cash flow In other words, it is a method to determine the annual cash inflows (benefits) and outflows (costs) for a project, resulting in an annual net cash flow. Tangible costs or benefits are those costs or benefits that an organization can easily measure in dollars. Examples: Equipment purchases, Software 6 licenses, Salaries of project team members, Raw  Basic Principles of Cost Management Direct costs are costs that can be directly related to producing the products and services of the project.  It is a costs directly related to the production of a project's outputs. Examples: salaries of team members dedicated to the project, specific hardware/software purchased for the project. Indirect costs are costs that are not directly related to the products or services of the project, but are indirectly related to performing the project For example, indirect costs would include the cost of electricity, paper towels, and other 7 necessities in a large building that houses 1,000 employees who work on many projects.  Basic Principles of Cost Management Sunk cost is money that has been spent in the past; when deciding what projects to invest in or continue, you should not include sunk costs. Sunk cost is Money that has already been spent and cannot be recovered (e.g., expenses for a canceled phase of a project). Learning curve theory(LCT) states that repetitive production of items results in decreased unit costs over time. Meaning, when many items are produced repetitively, the unit cost of those items decreases in a regular pattern as more units are produced. Example: In a hardware project, producing the 8 first unit might be expensive due to setup and  Basic Principles of Cost Management Reserves are dollars included in a cost estimate to mitigate cost risk by allowing for future situations that are difficult to predict. Meaning, when extra amounts of money included in budgets to manage cost risks we call it Reserves. Contingency Reserves: For planned risks (known unknowns, e.g., scope changes or minor delays). Management Reserves: For unforeseen risks (unknown unknowns, e.g., unexpected global events). 9  Planning Cost Management  The first step in project cost management is planning how the costs will be managed throughout the life of the project.  Project costs, like project schedules, grow out of the basic documents that initiate a project, like the project charter.  The project manager and other stakeholders use expert judgment, analytical techniques, and meetings to produce the cost management plan.  A cost management plan is a document that describes how the organization will manage cost variances on the project  A large percentage of total project costs are often labor costs, so project managers must develop and track estimates for labor 10  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 11 acquire the people, equipment, and  Cost Estimating An important output of project cost management is a cost estimate It is also important to develop a cost management plan that describes how cost variances will be managed on the project Project managers must take cost estimates seriously if they want to complete projects within budget constraints It’s important to know the types of cost estimates, how to prepare cost estimates, 12 and typical problems associated with IT  Types of Cost Estimates  A rough order of magnitude (ROM) estimate provides an estimate of what a project will cost.  A high-level estimate that provides a rough approximation of project costs.  Often used during the early stages of a project when limited information is available.  A budgetary estimate is used to allocate money into an organization’s budget.  A more detailed estimate used to allocate money into an organization’s budget  Helps in medium-term financial planning for the project.  A definitive estimate an accurate estimate of project costs.  A detailed and highly accurate estimate of project costs.  Used during the later stages of a project when detailed information is available. 13  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 (ROM) project life cycle, ballpark of cost for often 3–5 years selection decisions before project completion Budgetary Early, 1–2 years out Puts dollars in the –10%, +25% 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 14 $95,000 to $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 mathematical model to estimate costs 15  Typical Problems with Cost Estimates Estimates are done too quickly Lack of estimating experience Human beings are biased toward underestimation Management desires accuracy 16  Cost Budgeting Cost budgeting involves allocating the project cost estimate to individual work items over time and providing a cost baseline. The WBS is a required input to the cost budgeting process since it defines the work items Important goal is to produce a cost baseline A time-phased budget that project managers use to measure and monitor cost performance 17  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 18 important tool for cost control  Earned Value Management (EVM) EVM is a project performance measurement technique that integrates scope, time, and cost. 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. 19  Earned Value Management  Earned Value 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. 20  EMV enables 1. Knowing where you are on schedule? 2. Knowing where you are on budget? 3. Knowing where you are on work accomplished? 21  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. 22  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 SPI = EV/PV Index 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. 23  Terms  Earned Value tells how much work was done?  Cost Variance is the process of evaluating the financial performance of your project. Formula: CV = EV-AC  Schedule Variance is a method to know whether a project is a head or behind. Formula: SV = EV- PV  Cost Performance Index (CPI) is a method for calculating the cost efficiency and financial effectiveness of a specific project Formula: CPI = EV/AC  Schedule performance Index (SPI) is a measure of how close the project is to being completed compared to the schedule. 24 Formula: SPI = EV/PV  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 2525  Example  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 Percent Completed = 10% Planned Completion = 15% 26  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 27  …solution A) Planned Value = Planned Completion (%) * BAC = 15% * Birr 900,000 = Birr 135,000 B) Earned Value = Percent Completed (%) * BAC = 10% * Birr 900,000 = Birr 90,000 28  …continued C) CV = EV – AC The project is costing more = 90,000 – 100,000 than planned because CV is = -10,000 less than zero. D) SV = EV – PV = 90,000 – 135,000 The project is = - 45,000 taking longer than planned because SV is less than zero. 29  …continued E) CPI= EV / AC = 90,000 / 100,000 It shows = 0.90 Poor F) SPI= EV/PV Performanc e because = 90,000 / 135,000 CPI and SPI are less = 0.67 than one. 30  G) 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 31  H) 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. 32  I) 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 Yellow [0.94 - Bad 33 0.85]  Therefore, for the above example, overall project’s traffic light status is Bad. = (CPI+SPI)/2 = (0.90+0.67)/2 Bad = 0.78 34  Thank you! 35