Chapter 5 Project Cost Management PDF

Chapter 5 Project Cost Management What’s Coming Ahead… Project Cost Management: Big Picture Estimating Project Costs Determining Project Budget Controlling Cost Measuring Performance Scope, Schedule, and Cost: The Triple Constraint Introduction You need resources to execute the project schedule. For...

Chapter 5 Project Cost Management What’s Coming Ahead… Project Cost Management: Big Picture Estimating Project Costs Determining Project Budget Controlling Cost Measuring Performance Scope, Schedule, and Cost: The Triple Constraint Introduction You need resources to execute the project schedule. For example, you need team members— the human resources—to perform project activities, such as a computer programmer to design and develop the program. Furthermore, you also need financial resources to support these human resources and to make purchases and acquisitions required for the project. These financial resources are managed in the form of cost in project management. Some of the expected outcome items of the project will be developed by the project team, and others will be purchased or acquired—a process called procurement, which may also include items that are needed to complete the project and are not necessarily the end product of the project. Planning the cost includes estimating the cost and determining the budget. Once the budget for the project has been determined, the cost needs to be controlled, which includes measuring the project performance. Cost is intimately connected to schedule and scope. The intrinsic relationship between scope, schedule, and cost is called the triple constraint. So, the core question in this chapter is: How do you manage the project cost? This issue breaks down into three avenues that we will explore: the triple constraint; estimating cost and determining budget; and controlling cost, which includes performance measurements. Project Cost Management: Big Picture Project cost management consists of estimating costs, determining budget, and controlling costs. First of all, we need to distinguish between cost and budget. Cost is the value of the inputs that have been (or will be) used up to perform a task or to produce an item: product, service, or result. This value is usually measured in units of money. For example, you paid two programmers $1,000 each for developing a software program, and you paid $100 to a tester to test the program. So, the cost for the task of developing and testing the software program is $2,100. You can add the costs of components of a system, and the sum will represent the cost of the system, but it’s still a cost, not a budget. Budget is an aggregated cost with a timeline. You aggregate the costs of all the resources needed to perform the project and put a timeline on it: the availability of funds over time. That is called the budget. As illustrated in Figure 5.1, cost management consists of estimating project costs, determining budget from the cost estimates, and controlling the cost while the project is being executed. Estimating Project Costs 169 FIGURE 5.1 Big picture of cost management. Table 5.1 lists the processes of cost management along with their process groups and major output. Table 5.1 Processes of Cost Management Mapped to the Process Groups Cost Management Process Process Group Major Output Estimate Costs Planning Activity cost estimates Determine Budget Planning Cost performance baseline Control Costs Monitoring and controlling Work performance measurements and budget forecasts Cost management starts with making cost estimates. Estimating Project Costs Estimating project cost means developing an estimate for the monetary resources needed to complete the project work—that is, activities. These estimates are based on the information available at a given time. The estimates in the beginning are less accurate—for example, their accuracy may be only as good as ±50%. For example, if you say the cost will be $100,000, it could be anywhere from $50,000 to $150,000. As the project moves along and more information becomes available, the cost estimates can be improved to get better estimates. In other words, cost estimating is an iterative process and is a good example of progressive elaboration, introduced in Chapter 1. A project in the initiating stage may have an estimate with uncertainty of ±50%, as explained earlier. This estimate is called a rough order of magnitude (ROM). At later stages of the project, as more information becomes available, the accuracy may improve, say to 10%. Different organizations may expect different degrees of accuracy at different stages or phases of a project. 170 Chapter 5 PROJECT COST MANAGEMENT FIGURE 5.2 The Estimate Costs process: input, tools and techniques, and output. The standard process used to estimate costs is called the Estimate Costs process and is illustrated in Figure 5.2. Estimating project cost means estimating the costs required to complete the project scope by executing schedule activities. Therefore, you need the scope baseline and the schedule baseline for estimating costs. Recall that the scope baseline is made up of the scope statement, WBS, and WBS dictionary, and the schedule baseline is the approved project schedule. These and other items that you may need to determine the costs are discussed in the following list: ◆ Human resource plan. The information in the human resource plan that is useful for estimating costs includes the list of roles and responsibilities, personnel rates, and recognitions and rewards. ◆ Project schedule. The approved project schedule will give you the information about the resources needed to complete the project work. This information is crucial for making the cost estimates. As you learned in the previous chapter, activity resources are estimated by performing the Estimate Activity Resources process. Therefore, the Estimate Costs process should be closely coordinated with the Estimate Activity Resources process, which in turn depends on the Estimate Activity Durations process, because an activity duration is determined for the given resources. ◆ Scope baseline. All the three components of the scope baseline—scope statement, WBS, and WBS dictionary—are useful in estimating the project cost. The scope statement will provide the cost-relevant information, such as project and product acceptance criteria, assumptions and constraints, product description, key deliverables, and project boundaries around the scope. An example of a cost-related assumption is if we are only counting the direct cost of the project or if we are also counting the indirect cost. The indirect costs are those costs that cannot be directly traced to a specific project and therefore are usually shared by multiple projects and determined by some approved accounting procedure. An example would be a utility bill of a building or a computer network shared by many projects in the company. The WBS will be useful by providing the relationships among the different components of the projects, which must be understood to make the cost estimates. The WBS dictionary will provide the description of the work. Estimating Project Costs 171 ◆ Risk register. Both kinds of risks—threats and opportunities—may have an impact on the cost, for example, in the form of risk mitigation costs and revenues or savings from the opportunities. ◆ Enterprise environmental factors. Enterprise environmental factors relevant to estimating costs include market conditions and published commercial information that will provide the cost of resources, including human resources, material, and equipment. This will also provide information related to the availability of products and services and their cost and rates. Supply and demand conditions can also influence the project cost. ◆ Organizational process assets. This includes the organization’s policies regarding cost estimates, cost estimating templates, and information from previous projects, including lessons learned. Some tools and techniques that can be used in cost estimating and budgeting are discussed in the following list. Analogous estimation. Analogous cost estimation is a technique that uses cost-related variables, such as rate, cost of a component, cost of an activity from similar tasks and activities in previous projects, or cost of a similar project from the past to measure the same variable in the current project. This technique is useful when a very limited component of information is available, especially in the beginning of a project, and is usually used for estimating the gross values and not the detailed component-based values. It’s generally less costly and less time consuming than other techniques, but it’s also less accurate. Its accuracy and reliability improve if the person making the estimate is an expert and the components or activities being compared are actually similar. Parametric estimation. This is a technique that uses some parameters and statistical relationships among them to make the estimate. For example, if the unit cost is known, say from historical data, the cost of the whole package containing a number of units can be calculated. This technique can generate quite accurate results depending on the accuracy of the quantity of resources and other data that goes into the estimation. Bottom-up estimation. This technique involves estimating the cost of the parts of a component and then aggregating the cost of those parts to calculate the cost of the whole component. This technique can generate accurate results when you can generally make a better estimate of a part than the whole, which is usually the case when enough information is available. STUDY CHECKPOINT 5.1 Problem: An activity cost estimate goes like this: It will take 20 hours of a programmer’s time to write this program. The average rate to hire a programmer is $50 per hour. Therefore, the cost of writing this program, assuming that everything else needed to write the program, such as a computer, is in place, is 20⫻$50=$1,000. What kind of estimation technique is at work here? 172 Chapter 5 PROJECT COST MANAGEMENT Contingency reserve analysis. The following two problems are associated with estimates: ◆ Estimates are approximations, and approximations imply uncertainty, which means risk. ◆ Some stakeholders will always be pushing the envelope on the project scope, and each organization has some tolerance for overrunning the objectives—that is, flexibility or uncertainty in the scope. This will mean more cost. You will need some funds to deal with both of these situations. What comes to your rescue here is called contingency reserve. The contingency reserve, in general, is an amount of resource (funds or time) allocated in addition to the calculated estimates to reduce the risk arising from various sources—for example, from the overruns of project objectives—to a level acceptable to the performing organization. In other words, the contingency reserves are the funds reserved to deal with events that are anticipated but not certain. Contingency reserves can be used at the discretion of the project manager. The overall cost estimate should include the contingency reserves. CAUTION Contingency reserves may artificially raise the overall cost estimates. So if they are included in the cost estimates, they should be put into a separate category. These contingency reserves are usually not part of the budget that is included in the cost baseline used to evaluate the project performance. Vendor bid analysis. The bids from qualified vendors on parts of the project or even the whole project can help estimate the project cost. Even if the whole project is being awarded to a vendor under a competitive process, the project team of the awarding organization will need to do some work to estimate the cost of individual deliverables of the project in order to justify the overall project cost. Cost of quality. Cost of quality, discussed in Chapter 8, “Project Quality Management,” should also be considered when making cost estimates. Cost of quality is the total qualityrelated cost during the lifecycle of the product. Three-point estimates. Three-point estimates, discussed in the previous chapter for duration estimates, can also be applied in the same way to cost estimates. It’s illustrated in Study Checkpoint 5.2. Estimating Project Costs 173 TIP Note that the accuracy of cost estimates depends on many other estimates, such as activity duration estimates and resource requirement estimates, which go into developing the schedule baseline used for making cost estimates. It is important to keep this dependency in mind just in case you need to change any of these estimates. STUDY CHECKPOINT 5.2 The pessimistic cost estimate for an activity is $5,000, the optimistic estimate is $3,000, and the most likely estimate is $4,000. Calculate the expected estimate by using the PERT technique. The output of the Estimate Costs process consists of the items discussed in the following list. Activity cost estimates. These are the quantitative estimates of various costs required to complete the project work. Depending on the project and the stage of the project, the cost estimates may be documented in summary form or in details. These estimates include costs for all resources needed to complete the project work, including equipment, facilities, information technology, labor directly applied to the project work, material, and services. Indirect costs and special categories, such as allowances and contingency reserves, must also be included. Estimate bases. It’s important to document what the bases of the cost estimates were. These may highly depend on the application area of the project. At a higher level, the following elements must be included in the documentation: ◆ Assumptions made in making the estimates—for example, the labor rate and where this data came from. ◆ Constraints that affected the estimates—for example, a milestone must be met by a certain date. ◆ The methods used to develop the estimate—for example, a three-point estimate. ◆ The uncertainty, such as ±10%, and the confidence level must be assigned to an estimate. In a nutshell, the outcome of estimating costs will include a cost estimate for each project activity and the basis for that estimate, which can be used to determine the project budget. 174 Chapter 5 PROJECT COST MANAGEMENT Determining Project Budget Determining project budget is the process of aggregating the cost estimates for all project activities and assigning a timeline to them. Cost aggregation is the technique used to calculate the cost of a whole by summing up the costs of the parts of which the whole is made. You can use the bottom-up estimation technique to aggregate the costs of all the components and activities to calculate the total cost of the project. The timeline assigned to this cost will be important to reconcile the expenditure with the funding limits. The reconciliation may require rescheduling some activities. The budget is determined by using the Determine Budget process illustrated in Figure 5.3. Most of the items in the input to this process were already described in this chapter. Organizational process assets may include organizational policies and tools for determining the budget. The reserve analysis at budget level includes the management reserve in addition to the contingency reserve, and you must understand the difference between the two. Contingency reserves are the funds that can be used to deal with the unplanned events that can potentially transpire in case one or more identified risks occurs. Management reserves, on the other hand, are the funds that can be used in the case of yet unplanned but future changes in some aspects of the project, such as the project scope. Depending on the performing organization, the project manager may be required to obtain approval before spending the management reserves. FIGURE 5.3 The Determine Budget process: input, tools and techniques, and output. The approved budget that includes the aggregated cost with the timeline is called the cost baseline. The cost performance of the project is monitored, measured, and controlled against this baseline. This is why it’s also called the cost performance baseline. Funding requirements for the project are derived from the cost baseline and the reserve analysis. Do not leave out the cost of the internal employees of the organization who will work on the project. They are not free for two reasons: The organization pays for them, and they do not have infinite numbers of hours to put into the project. Their cost to the project will be determined just like any other project role based on the hours of work they will put into the project. Determining Project Budget 175 In the process of determining the budget, you may need to update the project schedule, cost estimates, and the risk register. CAUTION The standard practice is not to include the reserves in the cost baseline, but they may be included in the overall budget of the project. That means the reserves will not be used in the calculations of earned value measurements discussed further on in this chapter. Once the project cost is determined and the budget is approved, you need to control the cost as the project progresses. STUDY CHECKPOINT 5.3 Rajinder Preeti is in the process of estimating costs and preparing a budget for her project. In the following table, match each of her activities in the first column with the corresponding technique in the second column. Activity A. Rajinder discovered that there are many unknowns about an activity and that it could cost a lot more than estimated because it could take longer. So she puts some money aside to deal with this situation. B. There is a complicated activity for which there are many disagreements among the team about its cost estimate. So, Rajinder made an estimate by taking the average of the most optimistic estimate, the most pessimistic estimate, and the most realistic estimate. C. Rajinder showed this estimate (in Point B above) to her supervisor. The supervisor expressed her doubts about the final figure. Rajinder then split the complex activity into smaller pieces, estimated the costs of each piece, and added up the cost to reach the final figure. D. For another activity, Rajinder just multiplied the number of work hours by the hourly rate for each in the activity and added those numbers to reach the final cost estimate for the activity. E. Rajinder added up cost estimates for all the activities of the project in order to determine the budget. F. Rajinder discovered that the overall budget is not consistent with the availability of funding. So, she is having a careful look at the schedule to solve this problem. Technique 1. Parametric estimation 2. Reserve analysis 3. Cost aggregation 4. Reconciliation of funding limits 5. Bottom-up estimating 6. Three-point estimate 176 Chapter 5 PROJECT COST MANAGEMENT Controlling Cost Controlling cost means monitoring and controlling updates and changes to costs, budget, and the cost baseline of the project. Monitoring and controlling costs has two dimensions to it: expenditure of project funds and the work performed as a result of those expenditures. One major aspect of cost monitoring and controlling is to determine the relationship between the expenditures and the accomplishments. The cost performance lies in this relationship. The other main aspect is to control the changes to the approved cost performance baseline. CAUTION Like any other change, changes in cost and budget must be processed through the integrated change control process and should only be implemented after approval. To be more specific, monitoring and controlling the project cost includes the following: ◆ Influence the factors that can create changes to the approved cost baseline. ◆ Monitor the following: ◆ Work performed against the funds expended. ◆ Variance of cost performance from the approved baseline. ◆ Prevent unapproved changes from creeping into cost reports and expenditures. ◆ Act to keep cost overruns within the planned acceptable limits. ◆ Ensure the following: ◆ Change requests are dealt with in a timely fashion and managed as they occur. ◆ Expenditures do not exceed the approved budget—that is, by period and by total amount. Any change to the budget must be approved before implementation. ◆ Communicate with the appropriate stakeholders about the cost associated with the approved changes. Cost is monitored and controlled by using the Control Cost process illustrated in Figure 5.4. The input items to this process are the project management plan, work performance information, project funding requirements, and organizational process assets. The items in the project management plan useful for controlling the cost are the cost management plan and the cost performance baseline. The cost management plan describes how the cost will be monitored and controlled. The cost performance baseline—cost baseline, for short—is an approved budget; that is, the cost with the timeline attached to it for the project. Work performance information contains the performance-related data from the execution of the project, including how much cost has been incurred in performing certain tasks. This cost can be compared to the planned cost to make the cost performance measurements. Project funding requirements are part of the cost baseline. Organizational process assets that can influence the cost controlling Measuring Performance 177 FIGURE 5.4 The Control Cost process: input, tools and techniques, and output. include cost control–related policies, procedures, and guidelines; monitoring and reporting methods; and tools used in controlling cost. The Control Cost process converts the cost-related project performance information into the project performance measurements by using some tools and techniques, such as the earned value technique, variance analysis, and forecasting. These tools and techniques are discussed in the next section. Performance reviews compare the actual progress to the planned progress. Project management software can be used for earned value management. Work performance measurements made by comparing the work performance information to the planned performance are the obvious outputs of the Control Cost process. The analysis of the project performance can result in making some change requests to keep the project on track. The budget forecasts can be made from the earned value analysis. The causes of the variance of the progress from the planned progress and the lessons learned become part of the organizational process assets that can be used in future experiments. A common input to controlling scope, schedule, and cost is work performance information, and a common output is work performance measurements. That means that these three processes use the work performance information to make performance measurements. Measuring Performance Project performance is measured by comparing the project execution against the performance measurement baseline, which is an approved integrated plan for scope, schedule, and cost for the project, as explained here: ◆ Cost baseline. This is the planned budget for the project over a time period, used as a basis against which to measure, monitor, and control the cost performance of the project. The cost performance is measured by comparing the actual cost to the planned cost over a time period. 178 Chapter 5 PROJECT COST MANAGEMENT ◆ Schedule baseline. This is a specific version of the project schedule developed from the schedule network analysis and the schedule model data, discussed in Chapter 4. This is the approved version of the schedule with a start date and an end date, and it is used as a basis against which the project schedule performance is measured. ◆ Scope baseline. This is the approved project scope that includes the approved project scope statement, the WBS based on the approved project scope statement, and the corresponding WBS dictionary. The elaborate nature of the performance measurement analysis can be seen in the cost control process. Performance Measurement Analysis for Cost Control As mentioned earlier, cost control includes influencing the factors that can create changes to the cost baseline. But to detect the arising changes, you need to detect and understand variances from the cost baseline by monitoring cost performance. In general, variance is a measurable deviation in the value of a project variable (or parameter), such as cost or schedule, from a known baseline or expected value. Variance analysis is a technique used to assess the magnitude of variation in the value of a variable, such as cost from the baseline or expected value, determine the cause of the variance, and decide whether a corrective action is required. A common technique to assess the cost variance is called the earned value technique (EVT), also called earned value management (EVM). It is a commonly used method of performance measurement that has various forms. Most commonly, it integrates the scope, schedule, and cost performance by comparing the baselines to the actual progress made. For example, you calculate the cumulative value of the budgeted cost of work performed in terms of the originally allocated budgeted amount and compare it to the following: 1. Budgeted cost of work scheduled—that is, planned 2. Actual cost of work performed Don’t worry if these terms sound confusing right now; I will go through an example soon. However, as you will see, the greatest difficulty in understanding EVT (or EVM) stems from the coupling of cost and schedule. You must realize that the project cost and the project schedule are inherently related to each other. Schedule relates to performing certain work over a certain time period, whereas cost refers to the money spent to perform the work on a project (or a project activity) over a certain period of time. The relationship between cost and schedule can be realized by understanding that it costs money to perform a schedule activity. The “time is money” principle is at work here. For example, a project activity can be looked upon in terms of an amount of work that will be needed to complete it or in terms of its monetary value, which will include the cost of the work that needs to be performed to complete the activity. Measuring Performance 179 CAUTION As you delve into EVM, remember there are only three parameters that need to be monitored and developed closely: planned value (PV), earned value (EV), and actual cost (AC). The rest of the parameters and the earned value analysis are largely based on these three fundamental parameters. The EVT involves calculating some variables where you will see the interplay of schedule (work) and cost. I will work through an example to help you understand the variables. Assume you are a project manager for the construction of a 16-mile road. Further assume that the work is uniformly distributed over 12 weeks. The total approved budget for this project is $600,000. At the end of the first four weeks of work, $125,000 has been spent, and four miles of road have been completed. I will use this example to perform the cost performance analysis and the schedule performance analysis in terms of cost. Cost Performance Cost performance refers to how efficiently you are spending money on the project work, measured against the expectations set in the project management plan—that is, the cost baselines. The total cost approved in the baseline is called the budget at completion (BAC). NOTE The variables discussed here, such as BAC, EV, and AC, can be calculated either for the whole project or for a part of the project, such as a project activity. Budget at completion (BAC). This is the total budget authorized for performing the project work (or a project activity), also called the planned budget. In other words, it is the cost originally estimated in the project management plan. You use this variable in defining almost all the following variables. In our example, the value of BAC is $600,000. Earned value (EV) or budgeted cost of work performed (BCWP). This is the value of the actually performed work expressed in terms of the approved budget for a project or a project activity for a given time period. In this variable, you see the relationship of schedule (work) and cost in action. BAC represents the total value of the project. But when you perform some work on the project, you have earned some of that value, and the earned value is proportional to the fraction of the total work performed, as shown by the formula here: EV = BAC ⫻ (work completed/total work required) 180 Chapter 5 PROJECT COST MANAGEMENT So, in our example, EV can be calculated as: EV = $600,000 (4 miles/16 miles) = $150,000 This is the earned value of the work, which may or may not be equal to the actual money that you spent to perform this work. Actual cost (AC) or actual cost of work performed (ACWP). This is the total cost actually incurred until a specific point on the timescale in performing the work for a project. In our running example, $125,000 has already been used up to this point. So the actual cost at this point in time is $125,000. This cost is to be compared to the earned value to calculate the cost variance and cost performance. Cost variance (CV). This is a measure of cost performance in terms of deviation of reality from the plan, and it is obtained by subtracting the actual cost (AC) from the earned value (EV), as shown in the formula here: CV = EV – AC So, in our example, CV can be calculated as shown here: CV = $150,000 – $125,000 = $25,000 The expected value of CV is zero because we expect the earned value to be equal to the actual cost. The positive result indicates better cost performance than expected, whereas a negative result indicates worse cost performance than expected. Deviation is one way of comparison, and ratio is another. Cost performance index (CPI). Earned value represents the value of the work completed, and actual cost represents the money spent. So, the CPI indicates whether you are getting a fair value for your money. This is a measure of cost efficiency of a project calculated by dividing earned value (EV) by actual cost (AC), as shown in the formula here: CPI = EV AC So, the CPI for our example can be calculated as: CPI = $150,000 / $125,000 = 1.2 This means you are getting $1.20 worth of performance for every dollar spent. A value of CPI greater than one indicates good performance, whereas a value less than one indicates bad performance. The expected value of CPI is one. So both the CV and the CPI indicate that you are getting more value for each dollar spent. Hold back a little before opening the champagne, though. If you read the text of our example again, note that 4 out of 12 weeks have already passed, and only 4 out of 16 miles of road have been built. That means that only one-fourth of the work has been accomplished in one-third of the total scheduled time. This means we are lagging behind in our schedule. Although cost performance is good, schedule performance needs to be investigated, too. Measuring Performance 181 Schedule Performance in Terms of Cost Schedule performance refers to how efficiently you are executing your project schedule as measured against the expectations set in the project management plan. It can be measured by comparing the earned value to the planned value, just like cost performance is measured by comparing the earned value to the actual cost. Planned value refers to the value that we planned to create in the time spent so far. Planned value (PV) or budgeted cost for the work scheduled (BCWS). This is the authorized cost for the scheduled work on the project or a project activity up to a given point on the timescale. The planned value is also called the budgeted cost for the work scheduled (BCWS). PV is basically how much you were authorized to spend in the fraction of schedule time spent so far, as shown in the formula here: PV = BAC ⫻ (time passed / total schedule time) Therefore, the planned value for the project in our example at the end of the first four weeks is calculated as shown here: PV = $600,000 ⫻ (4 weeks / 12 weeks) = $200,000 So, PV represents the planned schedule in terms of cost. You can calculate the schedule performance by comparing the planned schedule to the performed schedule in terms of cost. CAUTION Note that the total planned value (PV) of the project is the same as the budget at completion (BAC). The calculations shown here are for a planned value at a given stage of the project. In answering the questions, be careful about this distinction. Note that the total planned value for the project is equal to the budget at completion. Schedule variance (SV). This is the deviation of the performed schedule from the planned schedule in terms of cost. No confusion is allowed here because you already know that the schedule can be translated to cost. SV is calculated as the difference between EV and PV, as shown in the formula here: SV = EV – PV So, the SV in our example can be calculated as: SV = $150,000 – $200, 000 = –$50,000 The negative value means we are behind schedule. Deviation represented by schedule variance is one way of comparison, and ratio represented by schedule performance index is another. 182 Chapter 5 PROJECT COST MANAGEMENT Schedule performance index (SPI). Earned value represents the portion of work completed in terms of cost, and planned value represents how much work was planned by this point in time in terms of cost. So, the SPI indicates how the performed work compared to the planned work. This is a measure of the schedule efficiency of a project calculated by dividing earned value (EV) by planned value (PV), as shown in the formula here: SPI = EV PV So, the SPI for our example can be calculated as shown here: SPI = $150,000 / $200,000 = 0.75 This indicates that the project is progressing at 75% of the planned pace—not good. You should note that all these performance variables except the BAC are calculated at a given point in time. As shown in Figure 5.5, you can maintain a graphic that presents the values of these variables against points in time as the project progresses. Note that the value of the BAC does not change with time because it is the cost at completion time. Further note that given the BAC, the PV can be calculated at any point in time, even before the project execution starts, and that the total planned value is equal to the BAC. EV and EC are accumulated as the project execution progresses. FIGURE 5.5 The behavior of some performance variables as the project progresses in time. The variable BAC is independent of time. By using the variables discussed so far, you can monitor the project performance as the time progresses. Not only that, you can also make predictions about future performance based on past performance. Measuring Performance 183 Forecasting Techniques Forecasting refers to predicting some information about the project in the future based on the performance in the past. The forecasting is regularly updated as the project progresses and more data of the past performance becomes available. Estimate to complete (ETC) at budgeted rate. This is the prediction about the expected cost to complete the remaining work for the project or for a project activity. The future work is assumed to be completed at the budgeted rate. Therefore, the value of the ETC is obtained by subtracting the earned value (EV) from the budget at completion (BAC), as shown in the formula here: ETC = BAC – EV So, in our example, the value of ETC can be calculated as: ETC = $600,000 – $150,000 = $450,000 This is true if the current variances are seen as atypical and the future performance is expected to be as planned. If the current trend, however, continues, then we need to take CPI into account, as shown next. Estimate to complete (ETC) at the present CPI. This is a prediction about the expected cost to complete the remaining work at the present CPI. Therefore, in that case, the ETC is given by: ETC = BAC – EV CPI The next question that can be asked about the future is how much it will cost to complete the whole project. STUDY CHECKPOINT 5.4 In our running example, calculate the ETC at the present CPI. Estimate at completion (EAC) at the budgeted rate. This is the estimate made at the current point in time for how much it will cost to complete the whole project or a project activity from beginning to end. It is assumed that the future work will be performed at the budgeted rate. Therefore, the value of the EAC is obtained by adding the value of ETC at the budgeted rate to AC, as shown in the formula here: EAC = AC + ETC (budgeted rate) Accordingly, the value of EAC for our example can be calculated as: EAC = $125,000 + $450,000 = $575,000 184 Chapter 5 PROJECT COST MANAGEMENT Another useful prediction to be made is how much performance you need in the future to complete the remaining work within budget. STUDY CHECKPOINT 5.5 Prove the validity of the following equation: EAC = AC + BAC – EV The EAC calculated thus far is correct under the assumption that in the future the cost will be incurred as it was budgeted or performance will be made as planned. If, however, the current variance trend is assumed to continue, then EAC is calculated as discussed next. Estimate at completion (EAC) at the present CPI. This is the estimate made at the current point in time for how much it will cost to complete the whole project or a project activity from beginning to end. It is assumed that the future work will be performed at the current CPI. Therefore, EAC is calculated as follows: EAC = AC + ETC (at current CPI) EAC = AC + BAC – EV CPI STUDY CHECKPOINT 5.6 In our running example, calculate the EAC at the present CPI. As stated earlier, performance is an integrated measure of progress in the areas of scope, schedule, and cost. Just measuring one of these parameters may be misleading. For example, in our running example, we are performing better in cost but poorly in schedule. This is why sometimes EAC is measured by taking into account both CPI and SPI, as shown below: EAC = AC + BAC – EV CPI ⫻ SPI STUDY CHECKPOINT 5.7 In our running example, calculate the EAC at the present CPI and SPI. To complete performance index (TCPI). This is the variable to predict the future performance needed to finish the work according to a specified goal—for example, either within the planned budget (BAC) or at the completion cost currently predicted (EAC). If the goal is to complete Measuring Performance 185 it within BAC, it is calculated as the ratio of the remaining work to the remaining budget, as shown in the formula here: TCPI = Remainingwork BAC – BCW WP BAC – EV = = Remainingfunds BAC – ACWP BAC – AC Therefore, the value of TCPI in our example can be calculated as: TCPI = ($600,000 – $150,000) / ($600,000 – $125,000) = 450,000 / 475,000 = 0.95 = 95% If it is realized that BAC is not attainable, then it is replaced with EAC. Accordingly, TCPI will be given by: TCPI = Remainingwork BAC – EV = C – AC Required funds EAC Table 5.2 summarizes most of these performance variables. Table 5.2 Performance Variables Used in the Earned Value Technique Analysis Variable Abbreviation Description Formula Budget at completion BAC Total planned cost None Earned value or budgeted cost of work performed EV or BCWP Fraction of the completed work in terms of the planned budget at a given point in time EV = BAC ⫻ (Work completed / Total work required) Actual cost AC or ACWP The money spent on the work until a given point in time The sum of all the costs until a given point in time Cost variance CV The difference between what you planned to spend and what is actually spent until a given point in time CV = EV – AC Cost performance index CPI The work performed per actual cost CPI = EV / AC Planned value or budgeted cost of work scheduled PV or BCWS The fraction of work planned to be completed at a given point in time PV = BAC ⫻ (Time passed / Total schedule time) Schedule variance SV The difference between the work actually completed and the work planned to be completed at a given point in time SV = EV – PV (continued on next page) 186 Chapter 5 PROJECT COST MANAGEMENT Table 5.2 (continued) Variable Abbreviation Description Formula Schedule performance index SPI The actual work performed per planned work performed in terms of cost SPI = EV / PV Estimate to complete ETC Estimate of what will be spent on the remaining project (or a project activity) based on the performance so far and the planned cost ETC = BAC – EV Estimate at completion EAC Estimate of what will be spent EAC = ETC + AC on the whole project (or a project activity) based on the performance so far and the planned cost To complete performance index TCPI Calculates the efficiency: remaining work per remaining funds (BAC – EV) / (BAC – AC) The success of a project depends on completing the project according to the schedule with full planned scope and within the planned cost. These three parameters—scope, schedule, and cost—are intrinsically related to one another. Scope, Schedule, and Cost: The Triple Constraint The nutshell of running a project is delivering the scope according to some schedule, and it’s going to cost someone. Completing a project successfully includes delivering the planned scope according to the planned schedule and within the planned budget. The fundamental parameters for budget and schedule are cost and time, respectively: Budget is the cost with a timeline, and schedule is determined from the time estimates for completing the schedule activities. So scope, time, and cost make the heart of any project. These three project parameters comprise a triple constraint that is a framework for evaluating competing demands. A triple constraint is often depicted as a triangle, with each side representing one of these three parameters. Figure 5.6 shows the triple constraint for the scope, time, and cost. This diagram means if one of these parameters changes, at least one of the other two must change as well. Don’t be confused if you see the triple constraint referred to as scope, schedule, and cost constraint or scope, time, and cost constraint. Time and schedule are intrinsically connected. Also note that the triple constraint presented in Figure 5.6 is modeling the situation. It is possible, for example, that you may manage to change the schedule by using fast tracking without changing the scope and cost. But then again, most likely either scope or cost will change with the change in schedule. Scope, Schedule, and Cost: The Triple Constraint 187 FIGURE 5.6 Triple constraint: scope, time, and cost. You cannot change one side of the triangle without changing at least one of the other two sides. For example, assume you are being interviewed by a functional manager for a project manager position. Don’t be surprised if you are asked a question based on the following situation: 1. The project is way behind the schedule. 2. No extra resources, such as money or project team members to perform activities, are available. 3. You have to implement all the planned features. The question is, what will you do to meet the deadline that is approaching within a week? From a project management viewpoint, this situation is a good example of the triple constraint. The project is behind schedule, which means there is a schedule change (or a change in time available to finish the remaining project). Therefore, at least one of the other two parameters must change. If you want to meet the deadline, either you should be allotted more funds to hire more human resources, or the scope of the project should be changed, which means some of the features would be left out. Depending upon the knowledge level of the functional manager about project management, this answer might not get you the job, but as a project manager, you must stand your ground. Project management is not magic; it involves dealing with cold, hard reality in a realistic way, thereby establishing clear and achievable objectives. NOTE While considering the cost-schedule-scope constraint, you should also remember the schedule compression techniques, such as crashing and fast tracking, discussed in Chapter 4. Also, remember that those techniques do not guarantee that no additional cost (or resources) will be required. Although fast tracking is not expected to increase cost, it may result in rework and increased risk and thereby increase cost that way. 188 Chapter 5 PROJECT COST MANAGEMENT The triple constraint presents the core for several interrelated constraints. For example, you can see the relationship of the triple constraint to quality by recalling that a high-quality project delivers the required product on time and within the planned scope and budget. Therefore, while balancing between these three constraints, the quality (and as a result, customer satisfaction) might be affected. Furthermore, because resources and risks are related to cost, they can also be affected by the triple constraint. In a nutshell, balancing the competing project constraints include scope, schedule, cost/budget, quality, resources, and risks. If one of these factors changes, at least one other factor is most likely to change. This discussion of the triple constraint is also a good realization of how one change can give rise to other changes across the project. This highlights the importance of managing and controlling changes. CAUTION Although the PMBOK Guide, Fourth Edition does not mention the triple constraint, it does emphasize the competing constraints of scope, schedule, budget, quality, resources, and risks, and that if one of these factors changes, at least one other factor will likely be affected. I have explained here how that happens. Changes to scope, schedule, and cost are controlled using the Control Scope, Control Schedule, and Control Cost processes, respectively. These three processes are at the center of the project action. As Figure 5.7 illustrates, they take work performance information from the project execution and generate work performance measurements that are used by the quality control process to generate quality control measurements and by the report performance process to generate performance reports. STUDY CHECKPOINT 5.8 Q. Name three processes that convert the work performance data into work performance measurements. The three most important takeaways from this chapter are the following: ◆ Cost control involves converting the cost-related work performance information into performance measurements and comparing those measurements to the cost baseline. ◆ In earned value management (EVM), there are several variables based on three fundamental parameters—namely actual cost (AC), earned value (EV), and planned (PV)—that are used to compare the actual project progress to the planned progress in order to make performance measurements. ◆ Scope, cost, and time make a triple constraint: Change in one of them changes one or both of the others. Summary 189 FIGURE 5.7 The processes to control scope, schedule, and cost in a big picture. Summary Cost management includes estimating cost, determining budget, and controlling cost. You use the scope baseline to estimate the monetary resources needed to complete the project activities. The activity cost estimates and project schedule are used to determine the project budget, which is the cost with a timeline attached to it. The approved budget that includes the aggregated cost with a timeline is called the cost baseline. The cost performance of the project is monitored, measured, and controlled against this baseline. This is why it’s also called a cost performance baseline. The three fundamental parameters of scope, schedule, and cost are intrinsically related to each other. For example, if you change one of them, one or both of the other parameters will change as well. This constraint is known as the triple constraint. Therefore, project performance is 190 Chapter 5 PROJECT COST MANAGEMENT measured by comparing the project execution to the performance measurement baseline, which is an approved integrated plan for scope, schedule, and cost for the project. In other words, the performance baseline includes scope baseline, cost baseline, and schedule baseline. The resources needed to complete the project work include human resources, which need to be managed. Human resource management is the subject of our next chapter. Exam’s Eye View Comprehend ◆ The human resource plan and the project schedule are used to make cost estimates for activities, which are aggregated to determine the project budget. ◆ The accuracy of cost estimates depends on the accuracy of other estimates, such as activity duration estimates and activity resource requirements estimates. ◆ Monitoring and controlling includes monitoring and controlling project performance. ◆ The three project parameters—cost, schedule, and scope—form a triple constraint, which means if one of these three parameters changes, at least one of the other two must change. ◆ Performance baselines and work performance information are the common inputs to monitoring and controlling the scope, schedule, and cost, and work performance measurements and change requests are the common output. ◆ Project performance is measured by comparing the work performance information from the project execution to the performance measurement baseline: scope baseline, schedule baseline, and cost baseline. Look Out ◆ The approved budget that includes the aggregated cost with a timeline is called the cost baseline. The cost performance of the project is monitored, measured, and controlled against this baseline. ◆ The standard practice is not to include the reserves in the cost baseline, but they may be included in the overall budget of the project. That means the reserves will not be used in the calculations of earned value measurements. ◆ Planned value (PV), earned value (EV), and actual cost (AC) are the three key parameters that need to be monitored closely. The rest of the earned value analysis is based on these three fundamental parameters. ◆ Cost variance (CV) is calculated by subtracting the actual cost (AC) from the earned value (EV), and not from the planned value (PV). Summary ◆ Schedule variance (SV) and the schedule performance index (SPI) are calculated in terms of cost: EV and PV. ◆ It is possible for CV and SV to run in opposite directions—for example, CV has a positive value when SV has a negative value. ◆ Total planned value (PV) of the project is the same as the budget at completion (BAC). Memorize ◆ Project budget is the time-phased project cost obtained by aggregating the individual activity costs. ◆ Contingency reserves are used for two purposes: to deal with the uncertainties in the duration used in the schedule and the cost used in the budget and to deal with the overruns of the project objectives to meet the stakeholder expectations. ◆ Analogous estimation is less time consuming but also less accurate than parametric estimation and bottom-up estimation. ◆ For cost performance analysis: EV = BAC ⫻ (Work completed / Total work required) CV = EV – AC CPI = EV /AC ◆ For schedule performance analysis: PV = BAC ⫻ (Time passed /Total schedule time) SV = EV – PV SPI = EV/ PV EAC at the budgeted rate = AC + BAC – EV EAC at current CPI = AC + BAC – EV CPI EAC at current CPI and current SPI = AC + BAC – EV CPI ⫻ SPI TCPI = BAC – EV BAC – AC 191 192 Chapter 5 PROJECT COST MANAGEMENT Review Questions 1. Your project is in the planning stage. You first want to make the cost estimates for the planned project activities, and then you want to aggregate those costs. Which process will you perform first? A. Determine Budget B. Develop Human Resource Plan C. Estimate Costs D. Develop Budget 2. Which of the following processes will you perform first? A. Plan Procurements B. Determine Budget C. Estimate Costs D. Develop Schedule 3. Your supervisor has asked you to put some contingency reserve into your project plans. Which of the following is not true about contingency reserve? A. These are the funds and not the time. B. These are not included in the cost baseline. C. These are included in the budget. D. These are not used in earned value measurements. 4. You are in the process of developing the cost baseline for your project. What is the name of this process? A. Determine Budget B. Develop Cost Baseline C. Estimate Costs D. Develop Budget 5. Assume that you are the project manager for the construction of a 15-mile road. Further assume that the work is uniformly distributed over 12 weeks. The total approved budget for this project is $600,000. At the end of the first three weeks of work, $160,000 has been spent, and five miles of road have been completed. What is the earned value of the project at the end of the first three weeks? A. $160,000 B. $200,000 C. $150,000 D. $600,000 Review Questions 6. Assume that you are the project manager for the construction of a 15-mile road. Further assume that the work is uniformly distributed over 12 weeks. The total approved budget for this project is $600,000. At the end of the first three weeks of work, $160,000 has been spent, and five miles of road have been completed. What is the planned value of the project at this point in time? A. $160,000 B. $200,000 C. $150,000 D. $600,000 7. Assume that you are the project manager for the construction of a 15-mile road. Further assume that the work is uniformly distributed over 12 weeks. The total approved budget for this project is $600,000. At the end of the first three weeks of work, $160,000 has been spent, and five miles of road have been completed. What is the cost variance? A. $40,000 B. $50,000 C. –$40,000 D. $120,000 8. Assume that you are the project manager for the construction of a 15-mile road. Further assume that the work is uniformly distributed over 12 weeks. The total approved budget for this project is $600,000. At the end of the first three weeks of work, $160,000 has been spent, and five miles of road have been completed. What is the schedule variance? A. $40,000 B. $50,000 C. Three weeks D. Twelve weeks 9. A CPI value of 1.25 and an SPI value of 1.33 for a project mean which of the following? A. The project is making slower progress and is costing more than planned. B. The project is making faster progress and is costing less than planned. C. The project is making slower progress and is costing less than planned. D. The project is making faster progress and is costing more than planned. 193 194 Chapter 5 PROJECT COST MANAGEMENT 10. The funds available for your project have been cut due to the severe effect of the economic downturn. Which of the following aspects of your project may be influenced by this cut? A. Scope and schedule only B. Scope, schedule, and quality only C. Scope, schedule, quality, and resources D. Scope, schedule, quality, resources, risk, and possibly some other aspects 11. An influential stakeholder has submitted a request for completing the project earlier than planned. What are the two parameters that are most likely to be affected by this time change? A. Schedule and deliverables B. Quality and risk C. Cost and scope D. Cost and budget 12. You are managing a project in biotechnology code named Mitochondria Eve. You need performance measurements to write the performance reports. Which process(es) will you run? A. Report Performance B. Control Scope, Control Schedule, and Control Cost C. Control Scope and Perform Quality Control D. Monitor and Control Project Work