Assessing Risk

MGT 3302, Introduction to Project Management 1

Course Learning Outcomes for Unit VI Upon completion of this unit, students should be able to:

5. Analyze factors impacting control of project costs. 5.1 Discuss creating a budget for a project.

Course/Unit Learning Outcomes

Learning Activity

5.1 Unit Lesson Chapter 7, pp. 242–269 Unit VI Course Project

Required Unit Resources Chapter 7: Determining Costs, Budget, and Earned Value, pp. 242–269

Unit Lesson In the previous unit, we discussed resource planning, resource utilization, and creating and managing a Gantt chart. If you remember from Unit I, the three main constraints of the project are scope, time, and budget. Activities and resources fit under the scope component. However, resources also fit under the budget component. One of our biggest expenses for a project involves the resources we use. Regardless, we have to calculate our total project cost. Estimating Activity Cost Estimating activity cost is a very important part of the budgeting process. Once we have identified our specific activities, then we can estimate the resources needed and the cost for those activities. Until now, we have referred to employees who will perform the activities as resources. However, for the purpose of budgeting, resources could be people, materials, equipment, facilities, or licenses. Any activity could have multiple costs associated with it. For example, painting a room would have labor costs, material costs, and equipment costs. Other types of costs are facility costs, travel costs, or contingency costs. As another example, let’s suppose we need to send an information technology (IT) professional to training. The cost associated with this resource’s activities would be labor costs and travel costs. Let’s discuss some of the details of these different costs. Labor costs: As mentioned, labor cost can be one of the highest costs in a budget. How many people will we need to work on this project? How many hours will each person need for the project? How much will we pay each individual person? How will we account for technical experts or skilled workers versus administrative personnel? Will we have overhead? Overhead costs are those costs that are not specifically attributed to work performed. For example, how will we account for health benefits or 401(k) donations? What about training costs? Materials costs: In our fair project, the cost of materials might be fairly high. But let’s suppose we were undertaking an IT project. The cost of materials might be fairly low. If our project involved building a house, the cost materials would definitely be high.

UNIT VI STUDY GUIDE

The Project Budget

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Equipment costs: What if we have to rent some machinery in order to complete our project? For example, what if some of the activities in our project required the installation of some computers? In a building project, what if we had to rent a crane? Facility costs: Facility costs involve the special facilities needed for the project. In a building project, what if we needed to rent a storeroom for our materials? What if our project is remote, and we needed to set up temporary office space? Subcontractor costs: What if we have to hire subcontractors or consultants? Would this cost fit under labor costs? The answer is no. We need a separate category for personnel outside of our organization. Travel costs: What if we have some employees who we have to send offsite? For example, suppose our organization involves convenience stores, and we have specific employees to scout potential build sites. The costs associated with sending the employee to another location would be categorized as travel costs and would include lodging, meals, and airfare. Other cost classifications: It is also important to note that some organizations are very detailed in their classification of costs. For example, some organizations may have direct costs versus indirect costs. For example, paying an employee is an example of a direct cost. Contributing to an employee’s health care or 401(k) plan would be considered an indirect cost. There are also recurring and nonrecurring costs. Recurring costs are those that continue over the life of the project. Nonrecurring costs are those that occur one time. An example of a nonrecurring cost might be sending an employee to a training class. There are also fixed or variable costs. For example, renting a building would be an example of a fixed cost. Fuel or oil is an example of a variable cost because it completely depends on how much equipment needs fuel or oil and for how long. Finally, there are also normal or expedited costs. Normal costs are those for which we plan. Expedited costs are those occurring because we have to speed up a project. For example, if we have to pay overtime pay, then that is an expedited cost. Whether or not you have to account for each of these costs separately would likely depend on the organization for which you work. Many organizations require PMs to develop a time-phased budget. A time- phased budget is simply a budget that distributes certain costs over the life of the project. For example, if we know we are going to need concrete in week 1, then the concrete cost is accounted for in week 1. But, if we know we are not going to need paint until week 6, then we will not account for that cost until later. The same principle applies to labor. We can distribute the cost of our labor throughout the life of the project. Again, the type of budget needed depends on the organization. Some organizations may only need totals for each category and then a total budgeted cost (TBC). According to Gido et al. (2018), the TBC is “the aggregate amount of the estimated cost of all the specific activities to perform and complete a work package or the project” (p. 247). Calculating Labor Cost Any resource could have its own hourly rate, hours needed, and overhead rate. If we had specific resources who all had the same hourly rate, hours, and overhead rate, then we could calculate total direct labor cost very easily.

Hourly rate: $25/hr

Hours of work: 240

Overhead rate: 30%

Hourly rate x Hours needed x Overhead charge = Total direct labor cost $25 x 240 x 1.35 = $8,100.00

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It cannot be that simple, can it? No, it is likely not going to be that simple. Most of the time, employees make different hourly wages. Different levels of employees will have different overhead rates, and we certainly will not need all of the employees for the exact same number of hours. So we just need to create a table to calculate the total direct labor cost.

Name Project Hours Overhead Hourly rate Total Direct Labor Cost for Project

Bob 120 1.25 $25

Annie 80 1.30 $40

Michele 60 1.35 $35

James 100 1.50 $32

Total

Our completed table would look like the one below.

Name Project Hours Overhead Hourly rate Total Direct Labor Cost for Project

Bob 120 1.25 $25 $3,750.00

Annie 80 1.30 $40 $4,160.00

Michele 60 1.35 $35 $2,835.00

James 100 1.50 $32 $4,800.00

Total Labor Cost

360 $15,545.00

Once you have calculated the total labor cost, then you can add other costs that are associated with each activity to get the TBC. Then, once you have the TBC, you can spread the cost over the life of the project to get a time-phased budget. For example, if your organization requires a weekly breakdown, then you would add up all of the costs of activities performed during each week. The advantage of this method is that you can also determine how much of the budget should have been spent in a given week and compare to actual costs. Also, you can calculate the cumulative budgeted cost (CBC) or planned value (PV) if you add up all of the budgeted costs up to a specific point in time. The CBC or the PV will be used to analyze the cost performance of the project. Essentially, this just means that you are comparing actual to budget. Earned value (EV) is similar to PV, but you are calculating the cost of actual work rather than budgeted work. Doing this type of calculation can help you to determine if your project is on track or not. Are you ahead of budget or behind budget? Below are some other values to know. The cumulative earned value (CEV) is the value of work up to a certain point in time. The cumulative actual cost (CAC) is the actual cost of work performed. If you divide the CEV by the CAC, you get a cost performance index (CPI), which is a ratio and the measure of cost efficiency. CPI = CEV/CAC For example, consider that our CEV is $10,000 and our CAC is $12,000. CPI = 10,000/12,000 CPI = .8333 This ratio means that for every $1 spent, there is only $.83 of earned value. Oops. We are behind budget. If the ratio were 1.12, then we could say we are ahead of budget.

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Now that we know we are behind budget, what can we do? Perhaps we can reduce costs by getting a better deal on our materials or equipment? Perhaps we can change one of our resources to someone who can work faster? This might be an option in an IT project. If we use someone who has more expertise in a specific technology, then we might get that task completed sooner. On the other hand, that expert may need to be paid more per hour. In each instance, the measures taken will need to be reviewed thoroughly for a cost- benefit analysis. In our next unit, we will learn about the risks associated with project management.

Reference Gido, J., Clements, J. P., & Baker, R. (2018). Successful project management (7th ed.). Boston, MA:

Cengage Learning.

Suggested Unit Resources In order to access the following resources, click the links below. The following video walks you through how to create a project budget. Project Management Videos. (2017, January 16). How to create a project budget – Project management

training [Video file]. Retrieved from https://www.youtube.com/watch?v=LwnLNMTOQFk Transcript for How to Create a Project Budget – Project Management Training video The following video explains the fundamentals of cost management. Project Management Videos. (2018, February 19). The basics of project cost management – Project

management training [Video file]. Retrieved from https://www.youtube.com/watch?v=EyPFi0YO32M Transcript for The Basics of Project Cost Management – Project Management Training video

Learning Activities (Nongraded) Nongraded Learning Activities are provided to aid students in their course of study. You do not have to submit them. If you have questions, contact your instructor for further guidance and information. In each chapter, there are questions to “Reinforce Your Learning” found in the left margin on some of the pages. For example, in Chapter 7, questions are found on pp. 245, 246, 247, 248, 249, 253, 255, 256, 257, 258, 259, 260, 261 and 262. Answer the questions to check your knowledge. The answers may be found starting on page 487.