It’s crucial that cost variances and inefficiencies be identified early so that

© 2018 Cengage®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Determining Costs, Budget, and Earned Value

7

(Premium)

Teaching Strategies

The two vignettes reinforce the requirement to use lessons learned to inform the next project, increase consideration of risk management, have change control strategies, set appropriate responsibilities, have a communication plan, have procedures for addressing common issues, organize project sites, and align stakeholders. The goal is to detect and curb systematic cost underestimation and manage scope changes to avoid cost and schedule overruns. The first vignette explores a tidal project that incorporated lessons learned from a demonstration project and listened to key stakeholders to build trust. The second vignette reinforces the need to examine the relationships among scheduling, costs, benefits, and earned value in order to have successful projects
Tell students a story of a project that spent its entire budget but has not finished all the tasks.
Have students determine what could have been done to avoid the situation, remedy the situation, or absorb the cost overruns.
Have students use a work breakdown structure to work out the costs of a project they will complete during the semester.
Have students estimate the earned value at different stages of the project life cycle.
Have students simulate actual completion dates for the consumer market study in Microsoft Project to see how they accumulated actual costs and earned value change over time.
Optional Supplemental Activities

Have the students read the real-world vignettes for the chapter and create plans for managing the costs of projects.
Have the student read the chapter and answer all of the Reinforce Your Learning questions and the end-of-chapter questions.
Have students read the Plan of Attack vignette from Chapter 4.
The project manager worked through the project plan to have the cost of the project to be within the sponsor's budget by deleting any "nice to have" features and keeping the essential features.
Explore the articles on the PMFORUM site and in the PWWorldToday website. Have the students try to contact the author of an article to ask questions about how the author manages costs associated with a project.
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Chapter Concepts

Estimating the costs of activities

Determining a time-phased baseline budget

Determining the earned value of the work performed

Analyzing cost performance

Forecasting project cost at completion

Controlling project costs

Managing cash flow

Chapter Concepts

Based on the material in this chapter, students will become familiar with:

Estimating the costs of activities
Determining a time-phased baseline budget
Determining the earned value of the work performed
Analyzing cost performance
Forecasting project cost at completion
Controlling project costs
Managing cash flow
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Learning Outcomes

Estimate the cost of activities

Aggregate the total budgeted cost

Develop a time-phased baseline budget

Describe how to accumulate actual costs

Determine the earned value of work performed

Calculate and analyze key project performance measures

Discuss and apply approaches to control the project budget

Explain the importance of managing cash flow

Learning Outcomes

After studying this chapter, students should be able to:

Estimate the cost of activities
Aggregate the total budgeted cost
Develop a time-phased baseline budget
Describe how to accumulate actual costs
Determine the earned value of work performed
Calculate and analyze key project performance measures
Discuss and apply approaches to control the project budget
Explain the importance of managing cash flow
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Project Cost Management

Project Management Knowledge Areas from PMBOK® Guide

Project Management Knowledge Areas from PMBOK® Guide

Concepts in this chapter support the following Project Management Knowledge Areas of the PMI Guide to the Project Management Body of Knowledge (PMBOK® Guide):

Project Cost Management

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Managing Costs of Tidal Feasibility

Renewable Projects
Increased investment
Traditional - solar power, wind power, hydroelectric, waste-to-energy, and biofuels
New – ocean’s tides
Locations
Wales
Scotland
China
Netherlands
Tidal Project
Newer technologies
Harsh and complicated environmental conditions
Demonstration projects successful
Avoid marine environment impact
Benefits to bay, carbon emissions, and employment
Vignette A: Managing Costs of Tidal Feasibility

Projects that have new proof of concept are deemed to be higher risk than projects with proven processes. Within the project plan for these proof of concept projects are feasibility studies and budget investments for the research and development. If the proof of concept project is deemed feasible, then the larger project is developed with its full budget. If it is not feasible, then the next concept is tested or the project is terminated. These decisions are based on the finances for the support of the research and development and on a comparison between the budget for actual costs of project investment and potential benefits.

Renewable energy projects have experienced increasing investment even though the prices of oil and gas have declined.
The types of investments have included projects related solar power, wind power, hydroelectric, waste-to-energy, and biofuels.
One source of renewable energy that has captured much new investment has been energy from the oceans’ tides.
From a project planning and budgeting standpoint, the ocean’s tides are relatively consistent whereas the amount of sun or wind for solar and wind energy projects is variable and, at times, unpredictable.
Tidal Project
Include funds for newer technologies, testing in harsh and complicated environmental conditions, and testing for strength, performance, and durability of the materials to be used for turbines and their support structures.
Smaller demonstration projects related to tidal stream and tidal barrage technologies have been successful.
Dam-like structures impact a number of environmental aspects such as water quality, fish migration, and noise pollution.
Benefits of the project included a reduction of debris in the bay, reduced carbon emissions, and increases in employment.
Other projects
Scotland
China
Netherlands
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What Comes First, Schedule Delay or Cost Overrun?

Research Findings

Increased costs when workarounds and solutions to avoid schedule delays
Increased costs with labor and rate charges without a change in schedule
Schedule delay without cost overrun
Lessons Learned

Relationships have been found
No causation
Root causes need examined
Awareness in organization of relationships among scheduling, costs, benefits, and earned value
Vignette B: What Comes First, Schedule Delay or Cost Overrun?

Schedule delays have occurred in many projects that have experienced cost overruns. There are many projects that have had cost overruns that also have had schedule overruns. One could think that if a project had a cost overrun, it must have had a schedule overrun, or, the other order, if a project had a schedule overrun then it must have had a cost overrun.

Researchers from several institutions examined data from years of complex projects, their schedules, their costs, and other factors such as unrealistic estimates, supply chain failures, scope changes, scheduling practices and margins, risk events, and project manager experience.
Do schedule delays cause cost overruns? Do cost overruns cause schedule delays? Are they only related and not causing each other?
By implementing workarounds and solutions to avoid schedule delays, the costs of the projects increased.
The costs associated with labor and rate charges that impacted the cost overruns had nothing to do with the schedule.
Projects with sufficient margins of funds and time had experienced schedule delays but did not experience cost overruns.
Although there has been a relationship between schedule delays and cost overruns, there has been no causation.
Even though statistics suggest that cost overruns and schedule delays are directly related to each other, project managers need to look for the root causes for each and create an awareness in their organizations of other factors that could lead to either or both overruns. This effort could help to improve understanding of the relationships among scheduling, costs, benefits, and earned value.

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Estimate Activity Costs

Elements

Labor
Materials
Equipment
Facilities
Subcontractors and consultants
Travel
Reserve
Good Practices

Have the person responsible estimate costs
Use historical data to inform current project
Be reasonable and realistic
Estimate near-term activities more accurately
Elaborate other costs as additional information known
Estimate Activity Costs

The total project cost is often estimated during the initiating phase of the project, or when the project charter or a proposal is prepared.

The estimated cost for each specific activity can include the following elements:
Labor: Estimated costs for the various classifications of people who are expected to work on the project
Are based on the estimated work time (not necessarily the same as the activity estimated duration) and the dollar labor rate for each person or classification
Materials: Are the estimated costs of materials that the project team or contractor needs to purchase for the project
Equipment: The equipment that must be purchased as part of the project
Facilities: Special facilities or additional space for the project team; for security reasons; to store materials; or to build, assemble, and test the project end item (deliverable)
Subcontractors and consultants: Are outsourced when project teams or contractors do not have the expertise or resources to conduct certain project tasks
Travel: Travel (other than local travel) may be required during the project
Reserve (also referred to as contingency): Funds set aside to cover unexpected situations that may come up during the project
Such as items that may have been overlooked when the initial project scope was defined, activities that may have to be redone because they may not work the first time (redesigns), or a high probability or high impact risk that may occur
There are a number of good practices that project managers should keep in mind when estimating costs
Have the person responsible for the task estimate costs
Use historical data to inform the current project because you can learn from past projects’ mistakes
Be reasonable and realistic
Estimate near-term activities as accurately as possible
Although, at the beginning of the project, it may not be possible to estimate the costs for all activities with a high degree of confidence regarding accuracy.
This is especially true for longer-term projects
Elaborate other costs as additional information becomes available
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Consumer Market Study Project
Estimated Costs

Consumer Market Study Project Estimated Costs

The figure on this slide depicts the estimated costs for each activity in the consumer market study project.
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Describe the two steps of the project budgeting process.

Student Discussion

Describe the two steps of the budgeting process.

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Possible responses to Student Discussion

First step

Allocate costs to the work packages in the work breakdown structure

Second step

Distribute the cost of the work package over the duration of the work package

Describe the two steps of the project budgeting process.

The project budgeting process involves two steps.

The project cost estimate is allocated to the various work packages in the project work breakdown structure.
The budget for each work package is distributed over the duration of the work package.
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Aggregate Total Budgeted Cost

Establish a TBC for each work package
Determine the process
Top-down
Bottom-up
If sum of initial estimates exceeds sponsor budget, then reduce costs and recalculate
Aggregate Total Budgeted Cost

Allocating total project costs to the appropriate work packages will establish a total budgeted cost (TBC) for each work package.
There are two approaches to establishing the TBC for each work package: top-down and bottom-up.
Often, the sum of the initial estimated costs is greater than the sponsor’s budget sponsor.
Several iterations of working out the costs may b required to reduce the costs to within an acceptable level.
The figure on this slide illustrates the cost allocations for a $600,000 project.
The costs are assigned to each work package.
When the budgets for all the work packages are summed up, they cannot exceed the total project budgeted cost.
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Packaging Machine Project
Aggregate Total Budgeted Cost

Packaging Machine Project Aggregate Total Budgeted Cost

The two figures on this slide depict the network diagram and the work breakdown structure, with costs assigned.
You will see this example repeatedly throughout the remainder of this chapter.
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Develop Cumulative Budgeted Cost

Distribute each total budgeted cost (TBC) over work package duration

Create the time-phased budget

Calculate cumulative budgeted cost

Provides a baseline against which actual cost and work performance are measured

Develop Cumulative Budgeted Cost

Once a total budgeted cost has been established for each work package, the second step in the project budgeting process is to distribute each TBC over the duration of its work package.

The cost determined for each period is based on when the activities that make up the work package are scheduled to be performed to create the time-phased budget.
The cumulative budgeted cost (CBC) is the amount that was budgeted to accomplish the work that was scheduled to be performed up to that point in time.
The CBC for the entire project or each work package provides a baseline against which actual cost and work performance can be compared at any time during the project.
It is important to use the cumulative budget as the standard against which actual cost is compared.
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Packaging Machine Project
Develop Cumulative Budgeted Cost

Determine budgeted cost by period
Graph the cumulative budgeted cost curve
Packaging Machine Project Develop Cumulative Budgeted Cost

The two figures on this slide depict the development of the cumulative budgeted cost for a packaging machine project.
The figure on the top shows the budgeted cost by period for the packaging machine project.
The figure on the bottom shows the cumulative budgeted cost curve for the packaging machine project.
The points on the graph correspond to the cumulative total shown in the figure on the top.
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Determine Actual Cost

Actual Cost

Collect data regularly for funds actually expended

Charge to work package numbers

Committed Costs

Periodically assign portion of total cost to actual cost

Include costs for items that will be paid for later

Compare Actual Cost To Budgeted Cost

Calculate cumulative actual cost

Compare to cumulative budgeted cost

Determine Actual Cost

Once the project starts, it is necessary to keep track of actual cost and committed cost so that they can be compared to the CBC.
To keep track of actual cost on a project, it is necessary to set up a system to collect, on a regular and timely basis, data on funds actually expended.
Large projects have charge codes assigned to different work package numbers to determine how the actual costs compare to the planned costs.
In many projects, large dollar amounts are expended for materials or services (such as on subcontractors or consultants) that are used over a period of time longer than one cost reporting period.
These committed costs need to be treated in a special way so that the system periodically assigns a portion of their total cost to actual cost.
Committed costs are also known as commitments or encumbered costs.
Costs are committed when an item is ordered even though actual payment may take place at some later time.
Cumulative actual cost (CAC) should be then be calculated.
As data are collected on actual cost, including portions of any committed cost, they need to be totaled by work package so that they can be compared to the cumulative budgeted cost.
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Packaging Machine Project
Determine Actual Cost

End of Week 8
Planned cost = $64,000
Actual cost = $68,000
Compare CAC with CBC
Packaging Machine Project Determine Actual Cost

The figure on the top indicates that at the end of week 8 of the packaging machine project, $68,000 has actually been expended, although only $64,000 was budgeted.
With the CAC values, it’s possible to draw a cumulative actual cost curve, which you see in the figure on the bottom of this slide.
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Determine Value of Work Performed

Example Project

Paint 10 similar rooms
Total budgeted cost of $2,000
Budget is $200 per room
At Day 5

$1,000 has been spent
3 rooms have been painted
Earned value =
0.30 X $2,000 = $600
Have expended $400 more than the Earned Value
Determine Value of Work Performed

Let’s take a moment to think about an example of determining the value of work performed.

Consider a project that involves painting ten similar rooms over ten days (one room per day) for a total budgeted cost of $2,000.
This makes the budget $200 per room.
At of the end of day 5, you determine that $1,000 has been spent, which is on track monetarily. The problem is that only three rooms have been painted.
Earned value, the value of the work actually performed, is a key parameter that must be determined throughout the project.

Determining the earned value involves collecting data on the percent completed for each work package and then converting this percentage to a dollar amount by multiplying the TBC of the work package by the percent complete.
In many cases, the estimate is subjective.
It is important that the person estimating the percent complete not only assess how much work has been performed. but also consider what work remains to be done.
For example, in the project involving painting ten rooms for $2,000:

If three rooms are completed, that means that 30 percent of the work has been performed.
The earned value is: 0.30 x $2,000 = $600
This means that the project has expended $400 more than the earned value by day 5.
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Packaging Machine Project
Determine Value of Work Performed

Packaging Machine Project Determine Value of Work Performed

Here we see three figures that will help us understand how to determine the value of work performed on the packaging project.

The figure in the top left depicts the cumulative percent complete by period for the packaging machine project.
The figure on the bottom left depicts the cumulative earned value by period for the packaging machine project.
To help you understand the different costs visually, the figure on the right illustrates the CBC, CAC, and CEV for the entire project.

You will note that the CAC is running above the CBC, and the CEV is running below the CBC.
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Analyze Cost Performance

Four cost-related measures

TBC – total budgeted cost

CBC – cumulative budgeted cost

CAC – cumulative actual cost

CEV – cumulative earned value

Use to analyze project cost performance

Plot CBC, CAC, and CEV curves on the same graph

Reveal any trends toward improving or deteriorating cost performance

Analyze Cost Performance

There are four cost-related measures that are used to analyze project cost performance:
TBC (total budgeted cost)
CBC (cumulative budgeted cost)
CAC (cumulative actual cost)
CEV (cumulative earned value)
One can analyze cost performance by plotting the CBC, CAC, and CEV curves on the same graph, as we just saw in the previous slide.
Plotting the curves can help to reveals trends toward improving or deteriorating cost performance.
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Packaging Machine Project
Analyze Cost Performance

Packaging Machine Project Analyze Cost Performance

This figure shows the packaging machine project status, as of the end of week 8:

64% of funds were budgeted to have been spent
68% of overall funds were actually spent
54% of the total work was completed
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Cost Performance Index

Measure of the cost efficiency with which the project is being performed

Cost performance index =

Cumulative earned value/Cumulative actual cost

CPI = CEV/CAC

Cost Performance Index

The cost performance index (CPI) is a measure of the cost efficiency with which the project is being performed.
The formula for determining the CPI is:
Cost performance index = Cumulative earned value/Cumulative actual cost (or CPI = CEV/CAC)
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Packaging Machine Project
Cost Performance Index

End of Week 8

$64,000 was budgeted
$68,000 was actually expended
$54,000 was the earned value of work actually performed
CEV = $54,000
CAC = $68,000
Determine CPI

CPI = CEV/CAC
= $54,000/$68,000

= 0.79

For every $1.00 actually expended, only $0.79 of earned value was received.

Packaging Machine Project Cost Performance Index

Let’s take a minute to look at the CPI for the packaging machine project.
Remember that the CPI is calculated by: Cost performance index = Cumulative earned value/Cumulative actual cost (CPI = CEV/CAC)
In the packaging machine project, the CPI as of week 8 is: CPI = $54,000/$68,000 = 0.79
This ratio indicates that for every $1.00 actually expended, only $0.79 of earned value was received.
When the CPI dips below 1.0 or is trending smaller, corrective action should be taken.
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Cost Variance

Indicator of cost performance

Difference between the cumulative earned value of the work performed and the cumulative actual cost

Cost variance =

Cumulative earned value – Cumulative actual cost

CV = CEV – CAC

Cost Variance

Another indicator of cost performance is cost variance (CV), which is the difference between the cumulative earned value of the work performed and the cumulative actual cost.

Cost variance = Cumulative earned value – Cumulative actual cost (or CV = CEV – CAC)
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Packaging Machine Project
Cost Variance

End of Week 8

$64,000 was budgeted
$68,000 was actually expended
$54,000 was the earned value of work actually performed
CEV = $54,000
CAC = $68,000
Determine CV

CV = CEV – CAC
= $54,000 – $68,000

= – $14,000

The value of the work performed through week 8 is $14,000 less than the amount actually expended.

Packaging Machine Project Cost Variance

In the packaging machine project, the cost variance as of week 8 is: CV = $54,000 – $68,000 = –$14,000

This calculation indicates that the value of the work performed through week 8 is $14,000 less than the amount actually expended.