Order 1328631: Project Management

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2018-02-25

Project Management Class – 6

Budgeting the Project

Learning Outcomes

Ø What is project cost management process?

Ø Defining different project costs and how to estimating project costs

Ø Defining project budget and discussing different methods of project budgeting

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Project Cost Management Process

Ø In cost management process, costs are estimated using resource planning.

Ø The estimated costs are budgeted by an organization, and the project manager controls the budget.

Ø A project manager has to control schedule, performance, scope, value, and resources in order to control the costs.

Resource Planning

Cost Estimating

Budgeting Cost Control

Source: Project Management Process, Technology, and Practice by Ganesh Vaidyanathan

Resource Planning

Ø The planning of the resources used to execute the project

Ø To accomplish resource planning:

§ List the required resource

§ Quantify the required resource

§ Construct a resource schedule, and

§ Level the resources

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List Resources

Ø List all required resources based on WBS. Each task listed in WBS demands particular skills or knowledge. Based on this information, resources can be identified and listed.

Ø Labor: Identify all the roles involved in undertaking the project, including all full-time, part-time and contracting roles.

Ø Equipment: Identify all of the equipment involved in undertaking the project; may include personal computers, photocopiers, mobile phones, telecommunications equipment, etc.

Ø Materials: Identify all non-consumable materials to complete project activities such as office materials and materials required for construction including lumber, steel and concrete.

Quantify Resources

Ø All identified resources are subject to some specification:

Ø Labor: List skills and experiences required by all roles and quantify how many of such resources are needed.

Ø Equipment: List the specification of all equipment, the total quantity needed, and dates of requirement.

Ø Materials: List the specification of all required materials and the total quantity.

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Construct Schedule

Equipment and Materials Resource Schedule Activity Description Required

resources Required resources

Timeframe Requirements per week

Quantity consumed per week

D Project planning Frank PC, MS Office, MS Project, Printer

11/24/10 to 12/14/10 40 hrs

D Prototype design Ian PC, AutoCad 12/15/10 to ¼/11 40 hrs Jake PC, AutoCad 12/15/10 to ¼/11 40 hrs Katie PC, AutoCad 12/15/10 to ¼/11 40 hrs

E Prototype implementation

Linda Wood, Nails & Screws

2/16/11 to 3/22/11 40 hrs Wood: 300 ft Fasteners: 100 Glue: 5 lbs.

Mary Wood, Nails & Screws

2/16/11 to 3/22/11 40 hrs Wood: 300 ft Fasteners: 100

F Testing of prototype Nancy Tester 3/23/11 to 4/19/11 40 hrs Oliver Tester 3/23/11 to 4/19/11 40 hrs

G Presenting prototype to customer

Pam PC, MS PowerPoint

4/20/11 to 5/3/11 40 hrs

Source: Project Management Process, Technology, and Practice by Ganesh Vaidyanathan

Resource Leveling

Ø When the project is large and contains many resource over-allocations, resource leveling must be accomplished: § A technique in which start and finish dates are adjusted based

on resource constraints with the goal of balancing demand for resources with the available supply.

§ Purpose is to create a smoother distribution of resource usage. Ø Resource leveling aims to minimize the period-by-period variations in

resource loading by shifting tasks within their slack allowances.

Ø Leveling is done by delaying or splitting tasks until the resources assigned to them are no longer over-allocated.

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Project Costs

Ø Cost is a resource expended to achieve a specific objective; in our case, a project.

Ø Cost management in projects (i.e., budgeting) is the process by which companies control and plan the costs of implementing projects.

Ø Before a project is started, the anticipated costs should be identified.

Ø Profits are the revenues of an organization minus the costs borne by the organization, including project costs.

Ø In order for an organization to increase its profits, its project costs have to decrease, its revenues increase, or both.

Ø Therefore, it is important to identify different project costs.

Project Costs (Cont.)

Ø Direct costs: Direct material and labor costs used solely for a project Ø Indirect costs: Any material and labor costs that are not used in a single

project Ø Fixed costs: Remain constant regardless of changes in the level of project

activities (rent, insurance, property taxes, …) Ø Variable costs: Vary in direct proportion to changes in the level of project

activities (mainly Direct material and direct labor cost) Ø Overhead costs: Primarily those indirect costs associated with project

implementation (laboratories, health insurance, paid leave time, …) Ø General and administrative costs: Costs primarily associated with general

management and administration of the project

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Cost Estimation

Ø Estimating is the process of determining the cost of a project.

Ø In order to have an accurate project cost estimate: § Have an accurate estimate on the number of

people needed § Have an accurate estimate of time to

complete the tasks Ø Project estimates are derived by totaling the

estimates for individual project elements.

Work Element Costing

Ø Determine resource requirements and then costs for each task § Fixed costs § Labor time and labor rate § Equipment time and equipment rate § Overhead, general, sales, and administrative

Ø Example: A certain task is expected to require § 16 hours of labor at $10 per hour § Required materials cost $235 § The organization charges overhead for the use of utilities, indirect labor, and

so forth at a rate of 50 percent of direct labor. § The total task cost will be

$𝟐𝟑𝟓 + 𝟏𝟔 𝐡𝐫 × $𝟏𝟎/𝐡𝐫 ×𝟏.𝟓 = $𝟒𝟕𝟓

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Project Budget

Ø A budget must be developed in order to obtain the resources needed to accomplish the project’s objectives

Ø A budget is a plan for allocating organizational resources to the project activities

Ø A budget acts as a tool for upper management to monitor and guide the project

Ø Recall that project planning process was about dividing plan’s elements to smallest possible pieces that could be sequenced, assigned, scheduled, and budgeted.

Ø The project budget is the project plan, based on the WBS, expressed in monetary terms and it becomes a part of the project charter.

Budgeting

Ø Budgeting is forecasting what resources the project will require, what quantities of each will be needed, when they will be needed, and how much they will cost.

Ø Most businesses employ experienced estimators who can forecast resource usage very well. § A bricklayer can usually estimate the number of bricks required to construct a

brick wall of given dimensions. § A painter can estimate the number of hours needed to paint a wall of given

dimensions Ø Budgeting a project is more difficult than budgeting more routine

activities § Estimating the number of hours needed to develop control system for a new

military aircraft is a difficult task

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Budgeting Problems

Ø Project are unique activities § No history to aid estimators § The estimation of similar past projects are not necessarily the same

Ø Projects may be multi-year with cost escalations § Changes in technology, materials, prices

Ø Organization tradition impacts project budgeting § How overhead and indirect costs are charged § Specific legal issues and ethical codes

Ø Project managers see costs differently than accountants § Accountants treat costs linearly § Unexpected overhead charges, indirect expenses may suddenly appear

when PM least expect it

Methods of Budgeting: Top-Down Budgeting

Ø Based on collective judgments and experiences of top and middle managers concerning similar past projects

§ Managers estimate the overall project cost by estimating the costs of major tasks § Lower level of managers split up the budget among the tasks under their control § They continue until all the work is budgeted Ø Advantages

§ Overall budget costs can be estimated with fair accuracy § Errors in funding small tasks need not be individually identified

Ø Disadvantage § The decision made by the upper managers might be inaccurate due to limited

knowledge causing potential for underperformance § Order of Magnitude: -25% +75%

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Methods of Budgeting: Bottom-Up Budgeting

Ø Work breakdown structure (WBS) identifies elemental tasks Ø Those responsible for executing these tasks estimate resource requirements Ø Advantage § Clear and detailed information § Get involved all employees → Higher level of morale and motivation

Ø Disadvantage § Top management has little influence over budgeting process § Risk of overlooking tasks by the lower-level managers § Time consuming and costly § Order of Magnitude: -5% +10%

Methods of Budgeting: Parametric Estimating

Ø Project broken down to major elements (WBS Level 1 or 2) Estimate = quantity x rate

Ø Advantage § More accurate than the top-down § Quick to do

Ø Disadvantage § Missing costs § Based on historical information § Order of Magnitude: -10% +25%

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Example – Top Down

Ø You are a general contractor and this is your first meeting with a potential client who wants to add a second floor on to their house. Your past 3 second floor renovations cost: 1. $320,000 2. $350,000 3. $330,000

Ø What do you tell the client?

𝟑𝟐𝟎𝑲 + 𝟑𝟓𝟎𝑲 + 𝟑𝟑𝟎𝑲 𝟑

= 𝟑𝟑𝟑𝑲 -25% and 75% => 250K to 583K

Example – Bottom Up

Ø The detail working drawings are now done and you are preparing the detail estimates. You have contacted the suppliers and have the following prices:

§ Sub trades: $200,000 § Material: $50,000 § General Labour $50,000

Ø In addition there is a 10% fee for overhead and 20% for profit and contingency (excluding overhead)

Ø What do you tell the client? 𝟐𝟎𝟎𝑲 + 𝟓𝟎𝑲 + 𝟓𝟎𝑲 = 𝟑𝟎𝟎𝑲 → 𝟑𝟎𝟎𝑲 + 𝟎.𝟏 + 𝟎.𝟐 ×𝟑𝟎𝟎𝑲 = 𝟑𝟗𝟎𝑲 → -5% and 10% => 370K to 430K

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Example – Parametric

Ø After you first meeting, you now have a better idea of what has to be done:

§ The second floor is about 1,000 sq ft of new construction § There is renovation of 500 sq ft on the first floor

Ø Based on your records, you have the following rates § Second floor new construction: $200/sf § First floor renovation: $300sf

Ø What do you tell the client? 2nd floor → $𝟐𝟎𝟎×𝟏,𝟎𝟎𝟎 𝐟𝐭𝟐 = 𝟐𝟎𝟎𝑲 1st floor → $𝟑𝟎𝟎×𝟓𝟎𝟎 𝐟𝐭𝟐 = 𝟏𝟓𝟎𝑲 → -10% and 25% => 315K to 440K

Improving Estimates and Forecasts

Ø Let us discuss a number of ways for improving the process of cost estimating and a way of measuring its accuracy.

§ Forms

§ Learning curves

§ Tracking signals

Ø These improvement can be applied to almost all of the areas in project management that concern estimating or forecasting any aspect of a project that is measured numerically.

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Forms

Ø A form for project resource needs might include information about: § People – managers, technical and non-technical § Materials – facilities, equipment, tools, space § Special services

Ø And might identify: § Person to contact and how should be contacted § When needed § How many/much needed § Whether available

Form for Gathering Data on Project Resource Needs

Ø The information can be collected for each task on an individual form and then aggregated for the project as a whole.

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Learning Curves (Motivation)

Ø A firm wins a contract to supply 25 units (that has never produced) of a complex electronic device to a customer. § The PM knows if they were to build many such devices it would

take 4 hours of direct labor per unit produced. § The required time to produce the initial units will take much longer

than 4 hours each! § The PM estimates that building the prototype may take as high as

10 hours, but applying this estimate to all 25 units give a too high result!

Learning Curves

Ø Humans learn when they repeat a task. Ø It has been found that unit performance improves by a fixed percent

each time total production doubles. Ø Each time the output doubles, the worker hours per unit decrease by a

fixed percentage of their previous value. Ø This percentage is called the learning rate.

r n nTT 1=

Tn = the time required to complete the nth unit

T1 = the time required to complete the first unit

r = exponent of learning curve; 𝐥𝐨𝐠(𝐥𝐞𝐚𝐫𝐧𝐢𝐧𝐠 𝐫𝐚𝐭𝐞) 𝐥𝐨𝐠 𝟐

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Learning Curves (Example)

Ø 𝑇B = 𝑇C𝑛E; 𝑟 = GHI J.K GHI L

= −0.3219

Ø Building the prototype takes 10 hours T1 = 10 (1)-.3219 = 10 (1) = 10 hr T2 = 10 (2)-.3219 = 10 (.80) = 8 hr T3 = 10 (3)-.3219 = 10 (.7021) = 7.02 hr T4 = 10 (4)-.3219 = 10 (.6400) = 6.4 hr . T23 = 10 (23)-.3219 = 10 (.3644) = 3.644 T24 = 10 (24)-.3219 = 10 (.3594) = 3.594 T25 = 10 (25)-.3219 = 10 (.3547) = 3.547

ØFor every doubling of output, the time of the new output is 80% of the prior output.

Tracking Signals

Ø Random error: there is a roughly equal chance that estimates are above or below the true value

§ Random errors cancel out

Ø Bias: if the over/under chances are not equal or the over/under errors are not the same size

Ø A tracking signal number can reveal if there is a systematic bias in cost and other estimates and whether the bias is positive or negative

Ø By observing their own errors a project manager can learn to make unbiased estimates

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Tracking Signals Example Ø If the cumulative percent

error at the bottom is positive, it means the actuals are usually greater than the estimates.

Ø The forecaster is unbiased if the sum of the ratios is about zero.

Ø The forecast underestimates if the ratio is positive and overestimates if it is negative.

Tracking Signals Example (Cont.) Ø Mean Absolute Ratio (MAR)

is the running average of the absolute ratio values.

Ø The Tracking Signal (TS) is the ratio of the running sum of the ratio values (Column D) divided by the MAR.

Ø TS warns when there are unexpected departures of the actuals from the forecasts; the larger bias, the higher TS.

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Earned Value Management

§ Earned Value Management (EVM) is an industry standard method of measuring a project's progress at any given point in time, forecasting its completion date and final cost, and analyzing variances in the schedule and budget as the project proceeds.

§ It is primarily used to measure and track costs and schedules in a project.

§ EVM is a snapshot in time, which can be used as a management tool as an early warning system to detect deficient progress.

§ The analysis uses “work in progress” to indicate the future of a project.

Earned Value Management Definitions

§ Planned Value (PV): Budgeted amount of cost for work scheduled to be accomplished on a given activity for a given period of time

§ Earned Value (EV): Budgeted amount of cost for completed work of a given activity for a given period of time

§ Actual Cost (AC): Actual amount spent in completing the work accomplished within a given time period

§ Cost Variance (CV): The cost variance compares deviations only from the budget and does not include schedule into account

§ Schedule Variance (SV): The schedule variance compares deviations only from the schedule and does not include cost into account

§ Cost Performance Index (CPI): Ratio of earned value to actual cost; if CPI>1 , project under budget

§ Schedule Performance Index (SPI): Ratio of earned value to planned value; if SPI >1, then project ahead of schedule

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Earned Value Management Definitions (Cont.)

Earned Value Earned Value Equation PV: Planned Value Planned completion % * Budget at completion EV: Earned Value Actual completion % * Budget at Completion AC: Actual Value Actual costs CV: Cost Variance EV – AC SV: Schedule Variance EV – PV CPI: Cost Performance Index EV / AC SPI: Schedule Performance Index EV / PV EAC: Estimate at Completion (AC / EV) * BAC (Budget at completion) ETC: Estimate to Complete EAC – AC VAC: Variance at Completion Budget at Completion – EAC

EVM Example

§ TRSM outsources the renovation of the conference theatre to ABC company.

§ The ABC team has suggested the following plan to install 1000 theatre seats to TRSM: o 100 seats every day o Budgeted cost per seat $30 o Total budget $30,000

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EVM Example

Ø After 2 days… § 140 seats were installed (the team found that the bolts and nuts for

the seats were not match with the holes dug in floor by the previous team)

§ Total cost was $5,000 (the team had to rent a special machine at $400/day to resize the holes)

§ Simple EVM calculation: → Earned value = $𝟑𝟎,𝟎𝟎𝟎×𝟏𝟒𝟎/𝟏𝟎𝟎𝟎 = $𝟒,𝟐𝟎𝟎 → Planned value = 𝟐𝟎𝟎×$𝟑𝟎 = $𝟔,𝟎𝟎𝟎 → Actual cost = 𝟏𝟒𝟎×$𝟑𝟎 + 𝟐×𝟒𝟎𝟎 = $𝟓,𝟎𝟎𝟎

EVM Example – After 2 Days

We spent this much (AC)

We should have been here! (PV)

We achieved this value (EV)

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EVM Example – Cost Variance & Performance

Cost Variance: CV = EV – AC

= $4,200 – $5,000 = – $800 < 0

We are over budget and have spent $800 more

than anticipated!

Cost Performance Index: CPI = EV / AC

= $4,200 / $5,000 = 0.84

EVM Example – Earned Value Situation

We have achieved this much value…

But we should have achieved it much earlier!

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EVM Example – Schedule Variance & Performance

Schedule variance in days

Schedule Variance in dollars: SV = EV – PV

= $4,200 – $6,000 = – $1,800 < 0

We are late and have only performed

4200/6000 = 70% of the work planned!

Schedule Performance Index: SPI = EV / PV

= $4,200 / $6,000 = 0.70

EVM Example – Forecasting Cost at Completion

Budget at completion BAC = 30,000 Estimate at completion

EAC = BAC / CPI = 30,000 / 0.84 = 35,714

Variance at Completion: BAC = $30,000 EAC = $35,714 VAC = - $5,714 We expect to be almost $6000 over budget!

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EVM Example – Forecasting Duration at Completion

Project slip 4.29 days

Cost overrun = $5,714

Duration at completion = Duration / SPI = 10 days / 0.70 = 14.29 days Note: Better to review plan vs actual on Gantt chart to predict end date.