Cost Management

Cost Management Summary

In a total program performance model, cost is a critical success factor. Cost management begins with project scope and definition upon which quality cost estimates are based. Cost estimates are used as baselines for control. Actual costs are monitored, and cost analyses are conducted to determine underlying causes of cost variances. The intent is that project managers are aware of cost issues in a timely manner so that corrective action can be taken that will positively impact outcomes. Cost reports are prepared to ensure that program participants are aware of cost status on an ongoing basis, and to provide a measure of program performance.

Effective cost management accomplishes the following objectives:

• track and report actual costs according to an approved classification of expenditures so that the organization can meet minimum reporting requirements
• enable accurate capitalization of assets,
• quantify project cost for use as a measure of project performance,
• help identify scope of current work,
• help ensure that actual cost is aligned to budgeted cost,
• identify and resolve systemic cost performance issues,
• perform cost-benefit analysis for proposed projects,
• help accelerate completion dates (when required) by identifying least-additional-cost activities,
• help answer “what if’ questions,
• establish an historical cost database,
• Provide cost information for management and executive sponsors to facilitate effective and timely decision-making.

Basis of Estimates

A basis-of-estimate documents the scope, definition, and assumptions upon which costs are based. It provides support to show how the cost estimate was developed, and provides a basis for changing the cost as projects are further defined. A basis of estimate includes the following elements:

• Estimating methodology
• Allowances:  costs added to the estimate for items or conditions that the estimator knows will occur, but whose scope or degree is poorly defined.
• Exclusions:  items or conditions that a sponsor may expect to occur or be a part of the project, but that are not included in the estimate for various reasons.
• Contingency: describes any contingency included in the estimate. Any risk analysis performed to estimate the contingency will be referenced here.
• Accuracy range: the accuracy range is defined as the upper and lower limits for project cost fluctuation, prior to applying contingency.  Depends on design completion, and complexity.
• Reference documents: any system architecture drawings, technical manuals, texts, notes, specifications, and other reference used in the development of the estimate.
• Benchmarking: benchmarking identifies improvement opportunities in a project by comparing past results of comparable work with current estimates.

Accuracy Range

The plan will always be wrong, … unless it’s expressed in terms of probabilities or ranges, in which case it can never be said to be conclusively wrong.  Cost estimates should be expressed in terms of ranges in order to instill credibility.  Point estimates are “precisely wrong”, and range estimates are “approximately right”.

The accuracy range of an estimate is a probabilistic assessment of how far a project’s actual costs can be expected to vary from the estimate for a given scope. The +% range value represents an upper limit or “worst case”. In probabilistic terms, 95% of the time you can expect actual costs to be less than this value. The -% lower limit range or “best case” value represents where 5% of the time you can expect actual costs to be less. An example might be a project cost expressed as $500,000 +30%, -10% (cost as a function of project definition).  Use of ranges may be allowable if they are expressed as a point estimate plus or minus a confidence interval. However, many CFOs balk at use of ranges because ranges may not support specific appropriations. 

You can only plan to a level for which information is available.  Estimate accuracy improves as the accuracy of the estimate basis (project scope definition) improves. The degree of scope definition is primarily a function of the amount of design progress.

Cost Risk Analysis

Cost risk analyses are studies performed to determine the amount of contingency required for a cost estimate. Using risk analysis, the amount of contingency varies depending on the degree of risk management is willing to take for any given project. Contingency is a cost element of an estimate designed to cover a statistical probability of the occurrence of unforeseen events within defined project scope. Contingency does not cover changes in scope. Cost risk analysis is typically expressed in terms of probability distributions of possible cost outcomes. As you increase the amount of contingency, you decrease the risk of overrunning project funding.

Contingency is intended to cover items such as disruptions, changes in market conditions, regulatory risk, lack of definition resulting in estimating inaccuracy, errors and omissions, abnormal implementation or deployment problems, unforeseen safety requirements, unanticipated price changes, minor design errors, and external consultant contract difficulties.

Traditional risk analysis produces a probability distribution of possible cost outcomes. Every degree of risk or confidence internal will have an associated total project cost value. The basic concept of risk analysis is straightforward: as you increase the amount of contingency, you decrease the risk of overrunning the project funding.  Contingency should be included in the funding request, and is part of the approved budget. However, it is used only for those circumstances shown in the above list, and must not be spent for out of scope work like enhancements.  During implementation, contingency is expressed as a percentage of forecast to-complete dollars. Contingency should not exceed a reasonable percent of cost to-­complete.

Cost Analysis and Reporting

Cost analysis involves comparison of actual cost data to a number of benchmarks to give meaning to actual cost performance.  In general, there are three general variance analyses. 1) Comparison of actual spending rates to the spending rate base-lined in the funding request.  2) Comparison of actual cost to the amount we would have spent if work had progressed as scheduled (earned).  3) Comparison of an estimate at-completion (calculated by projecting the cost of remaining work and adding it to actual to-date costs), to an approved budget to calculate total project cost variance.

Use of earned value as a performance measure requires some measure of project progress, typically percent complete. One easy way (not necessarily accurate, but better than no measure of progress) to establish a quantitative metric for project progress is to use weighted milestone progress measurement. We then use that metric to calculate earned value, and earned value to calculate cost performance.

Earned value (also called “budgeted cost of work performed” or BCWP) is a method of measuring project performance by comparing the amount of work planned with what was actually accomplished to get a true picture of cost and schedule performance. Cost performance indices are a ratio measure of cost performance calculated by dividing earned value by actual expenditures (greater than 1 is better). Earned value requires level-of-effort progress measures as indicators of percent complete.

Cost reports vary depending on the level of detail required by the customer.  A simple cost report includes budget, actual, percent complete, forecast to-complete, and estimate at-completion.  A more thorough format that lends itself to detailed analysis may also include accruals, % budget expended, % EAC expended, earned value, cost variance, variance at-completion, and cost performance index.

A useful reporting tool that can most effectively communicate project performance on a single sheet is the project performance chart (PPC). A PPC combines targeted, budgeted, actual, earned, forecasted and revised costs in an easy to read format that includes a time-scaled spending plan. A PPC readily answers key sponsor questions including “are we going to live within the budget”, and “will we be done on time?”