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W4N1: Cost Management Overview

Cost management is a critical component of any project.  It is very rare that there is no concern over what a project will cost!  

Reliable cost estimates are required for responsible fiscal management at each stage of a project.  Unreliable estimates and resulting budgets typically cause significant problems within an organization -- particularly for large enterprise projects.   Cost management is closely related to time management because when projects overrun schedule there are typically cost overruns as well.  

There are varying degrees of budgetary estimates at different stages of a project.  At each stage, cost estimates must be accurate, transparent and reliable to the degree possible at that particular stage. Budgetary estimates (before the project is approved) will be high level, but should be based on a high level understanding of scope and approach.  By the time that project budgets are established just prior to execution, much more detail is known and the estimates can be provided with more clarity.  The degree of uncertainty should be defined with each estimate.   Management needs the best information available on which to base decisions about the project.  The degree of estimation detail and the basis of the estimates improves over time.

Cost estimates are not static -- estimating costs is not an exact science and actual costs must be regularly reviewed and tracked to budgetary estimates. The estimates do, however, set expectations and affect management decisions.  A successful project manager is expected to establish a budget for a project and then manage the project to that budget. Any changes in the overall cost to complete a project must be discussed with management and key project stakeholders. If an initial budgetary estimate made during project initiation is extremely different from the budget planned for project execution (or worse from what it actually takes to complete the project in the late stages), management must rethink whether or not the project should proceed. 

W4N2: Cost Estimating

There are various methods for estimating project costs.  Sometimes historical data is available to support cost estimates, sometimes teams define the cost estimate in a “bottom up” manner by estimating what it will cost to perform  each project work activity and then summing up the activities for the project, and for some specialty areas there may be industry or corporate formulas or guidelines that can help guide estimates.  Various tools, from cost models, to project management systems, to complex excel spreadsheets typically support the development of cost estimates.

Based on the activity resource and duration estimates, the cost estimates define the cost of completing the work of the project.  Cost estimates include labor, materials, services, equipment and any other direct costs for performing project activities.  There are many factors that should be considered when preparing cost estimates, including:

· The planned execution strategy for the project

· The overall duration of the project

· Complexity of the solution

· Phasing of when work will be performed

· The cash flow of the project (when money is required)

· Escalation that may occur over the course of the project in such factors as labor rates, facility costs, materials, currency fluctuation, cost of money (e.g., interest), etc.

· Where the work will be performed and any local practices and/or productivity variables associated with the location

· How the organization accounts for overhead costs (what labor, services, and equipment need to be included in the project cost estimate; sometimes organizations have items like IT service center costs, purchasing overhead, facility costs or management costs applied to overhead and other times they need to be included in the budget of the project).

Cost baselines represent the budget that has been approved by management and stakeholders and represents the budgetary estimates used to determine whether or not project costs are occurring according to plan.

W4N3: Contingencies and Reserves

Reserves are used to prepare for unplanned events that occur over the course of a project.  They are calculated based on risks assessed for the project.  There are two types of reserves:

· Contingency Reserves are an allowance for unplanned but potentially required changes.  They are based on the items contained in the project’s Risk Register.

· Management Reserves are budgets for unplanned changes to project scope and cost that are not part of the project cost baseline and not included in any earned value calculations.  Typically the project manager needs approval from management to spend these reserves.

[if !supportLists]         [endif]Most project estimates include a contingency reserve in the estimate to account for uncertainty.  The reserve can be a percentage of estimated cost, a fixed amount or can be developed with quantative analysis methods.

[if !supportLists]         [endif]Any reserve must be clearly identified so it can be adjusted as more information becomes available over the course of the project.  The reserve should not be padding in individual estimates. The way in which reserves are created and released are often driven by organizational processes and policies.  As a project manager it is important to understand how these operate.