MG 623: Lecture No.

9
Project Cost Management

NM LEMA
2021

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Contents

• Rationale for Project Cost Management

• Definitions
• Cost Management Processes and Tools
• Earned Value Management
• Contract Cashflow Forecasting

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The Importance of Project Cost Management

Generally, projects have a poor record for meeting cost goals;

Average cost overrun is over of 100% of the original estimates
(based on a study conducted in late 1990s in Tz);
Global statistics indicate that cost overruns is an acute
problem.

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Magnitude of Construction Cost and Schedule Overruns in Public Work
Projects by Pramen P. Shrestha,1 Leslie A. Burns,2 and David R. Shields1

Less than $1
No. 135 Mean 5.83%
million

Project $1 million to
No. 128 Mean 5.59%
size $5 million

Greater than
No. 100 Mean 8.38%
$5 million
Source: Journal of Construction Engineering
Volume 2013, Article ID 935978, 9 pages
Data based in USA Projects

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 Top 10 megaprojects worldwide with the
largest percentage of cost overrun
• Statistics shows the top 10 megaprojects that have exceeded
their original budget estimate by the highest percentage,
worldwide, as of 2014.
• As of 2014, the Egyptian Suez Canal had the highest cost
overrun. Total costs were 1,900 percent higher than anticipated.
• Megaprojects are described as large-scale complex ventures that
cost 1 billion U.S. dollars or more.
 Statistics – Maga-projects Cost Overruns

Project % cost Uverrun

Suez Canal (Egypt) 1900%
Scottish Parliament Building (Scotland) 1600%
Sydney Opera House (Australia) 1400%
Montreal Summer Olympics (Canada) 1300%
Concorde Supersonic Aeroplane(UK/France) 1100%
Troy and Greenfield Railroad (US) 900%
Excalibur Smart Projectile (US/Sweden) 650%
Canadian Firearms Registry (Canada) 590%
Lake Placid Winter Olympics (US) 560%
Medicare Transaction System (US) 560%
 What is Cost and Project Cost Management?

Cost is a resource sacrificed or fore-gone to achieve a specific

objective or something given up in exchange
Costs are usually measured in monetary units like Shs, dollars,
Euro, etc.
Project cost management includes the processes required to
ensure that the project is completed within an approved budget

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 Project Cost Management Processes

• Plan Cost Management: process of defining how the

project costs will be estimated, budgeted, managed,
monitored, and controlled.
• Estimate Costs: process of developing an approximation of the
cost of resources needed to complete project work.
• Cost budgeting: allocating the overall cost estimate to timing
of individual work items to establish a baseline for measuring
performance;
• Cost control: controlling changes to the project budget;

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Project Cost Management Cycle
 Project Cost Management Processes

• Plan Cost Management is the process of defining how the

project costs will be estimated, budgeted, managed,
monitored, and controlled.
• The key benefit of this process is that it provides guidance and
direction on how the project costs will be managed throughout
the project.
• This process is performed once or at predefined points in the
project.
• The inputs, tools and techniques, and outputs of this process are
depicted in the data flow diagram of the process (see next slide).

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Plan Cost Management Process

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 Plan Cost Management Outputs
• Units of measure. Each unit used in measurements (such as staff hours, staff
days, or weeks for time measures; meters, liters, tons, kilometers, or cubic yards
for quantity measures; or lump sum in currency form) is defined for each
resource;
• Level of precision. This is the degree to which cost estimates will be rounded up
or down (e.g., US$995.59 to US$1,000), based on the scope of the activities and
magnitude of the project.
• Level of accuracy. The acceptable range (e.g., ±10%) used in determining
realistic cost estimates is specified, and may include an amount for
contingencies.
• ………………
• ………………
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 Estimate Cost Process
• Estimate Costs is the process of developing an
approximation of the cost of resources needed to complete
project work.
• The key benefit of this process is that it determines the
monetary resources required for the project.
• This process is performed periodically throughout the
project as needed.
• The inputs, tools and techniques, and outputs of this
process are depicted in next slide
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Estimate Cost Process

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 Method Statement
• Definition:
• A work method statement is predominately used in construction to
describe a document that gives specific description of how a specific
work related task is to be performed. It will generally indicate the task
description, how it will be performed, resources required, time
required and possibly estimated resource costs.
• Sample format - internet search

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 Cost Estimating
• An important output of project cost management is a cost
estimate.
• There are several types of cost estimates and tools and
techniques to help create them.
• It is also important to develop a cost management plan that
describes how cost variances will be managed on the project.
• Cost estimate can be broken down into cost breakdown
structure (CBS)
• (similar to Work Breakdown Structure - WBS)

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 Generic Cost Estimation Methods

• Expert Judgment – use of knowledge gained from past project

management experience. Expert judgment, in conjunction with
objective estimation techniques, provides valuable information
about the organizational environment and information from prior
comparable projects.
• Three-Point Estimates – use of three estimates to determine a
range for an activity’s cost: the best-case estimate, the most likely
estimate, and the worst-case estimate.
• Previous Tender Analysis – determination of what the project
should cost based on a review of vendor bids/proposals. This
technique may be used in conjunction with other cost estimation
techniques to ensure that cost estimates are comprehensive.
 Analogous Estimating / Top-down Estimating:
Using the actual cost of a previous, similar project as the
basis for estimating the cost of the current project. It is less
costly but less accurate. (Rough-cost Estimate)
 Parametric Modeling:
• Using project characteristics (parameters) in a mathematical
model to predict project costs.
• Est. Cost, C = f(x1, x2, x3, x4,……xn) where xi are project physical
parameters.
• For example, a road project cost is a function of design speed,
pavement type, terrain, geographical location, length, etc.
• A pipeline project is a function of pipe size, type of fluid,
terrain, length, depth of excavation, fluid pressure, etc.
 Parametric estimation model
• Development of a parametric model:
– Collect data on many similar projects;
– Obtain a list of key project parameters for all projects;
– Develop an equation of cost as a function of other project
parameters through regression analysis;
 Regression analysis
• Note: Regression analysis is a powerful
statistical method that allows you to
examine the relationship between two or
more variables of interest. While there are
many types of regression analysis, at their
core they all examine the influence of one
or more independent variables on a
dependent variable.
• Example of regression plot with one
independent variable; i.e cost capacity
function
 Bottom-up Estimating:
• Estimating the cost of individual work items, then summarizing
or rolling up the individual estimates to get a project cost
(Detailed Estimate)
• i.e detailed cost breakdown structure.
 Project Cost Estimate vs Phases

 At the conceptual stage – cost estimate is very crude – used for

deciding whether or not to proceed;
 Need to perform sensitivity analysis;
 At preliminary design stage – cost estimate is refined – but still with
significant variance;
 Variance reduces at final design, tender stage and during construction
stage;
 Final cost is ONLY known precisely when the project is completed.

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 Table 1 Types of Cost Estimates (for large projects)
Type of Estimate When Done Why Done How Accurate

Rough Order of Very early in the project Provides rough figure –25%, +75%
Magnitude (ROM) life cycle, often 3–5 of cost for selection
years before project decisions
completion

Budgetary Early, 1–2 years out Puts actual figure in –10%, +25%
the budget plans

Definitive Later in the project, < Provides details for –5%, +10%
1 year out tendering, estimate
actual costs

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 Simple Cost Breakdown Structure
Project Cost
M

Task 1 Cost A Task 2 cost B Task 3 Cost C

Sub Task 1.1 Sub Task 1.2 Sub Task 1.3

Work Package 1.1.1 Work Package 1.1.2 Work Package 1.1.3

Cost A.1.1 Cost A.1.2 Cost A1.3

Work Package 1.1.1.1 Work Package 1.1.1.2 Work Package 1.1.1.3

Cost A.1.1.1 Cost A.1.1.2 Cost A.1.1.3
 Factors Influencing the Quality of Estimates

Planning Horizon

Other (Non-project) Project

Factors Duration

Quality of
Organization Estimates People
Culture

Project Structure and

Reliability of Input Data
Organization

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• Project Management Estimating Software – use of project
management cost estimating software applications, computerized
spreadsheets, simulation, and statistical tools. Such tools can
allow for rapid consideration of multiple cost estimate
alternatives.
 Figure 1 Computer Based Cost Estimate Concept

Computerized
design

Analysis of
Cost Estimate
Items & Costs

Cost Data Base

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Spreadsheets
 Construction cost estimating software
• https://www.capterra.com/construction-estimating-software/
 Typical Challenges with Construction Cost Estimates

• Developing an estimate for a large project is a complex task

requiring a significant amount of effort. Remember that
estimates are done at various stages of the project
• Many people doing estimates have little experience doing them.
Try to provide training and mentoring

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• People have a bias toward underestimation. Review
estimates and ask important questions to make sure
estimates are not biased
• Management wants a number for a bid, not necessarily a real
estimate. Project managers must negotiate with project
sponsors to create realistic cost estimates

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 Reserve Analysis based on Risk Analysis
• Determination of contingency reserves to account for cost
uncertainty.
• Determine priority risks;
• Quantify the impact of priority risks;
• Determine the contingency reserve to cater for priority risks;
• Funding for those risk responses comes from funds set aside in
the contingency reserves. The contingency reserves are added to
the cost estimates to create the cost baseline, against which the
performance of the project is measured. Ref. Project Risk
management
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 Cost Budgeting
• Cost budget involves allocating the project cost estimate
to individual work items and providing a cost baseline;
• A project budget provides information on the expected
expenditure per project planning period;
• A typical cumulative cost curve presents the expected
cumulative project budget.

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Early and Late Start Project Budgets
 Cost Control

 Project cost control includes

– monitoring cost performance
– ensuring that only appropriate project changes are included in
a revised cost baseline
– informing project stakeholders of authorized changes to the
project that will affect costs
 Earned value analysis is an important tool for cost control

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 Earned Value Analysis (EVA)
• EVA is a project performance measurement technique that
integrates scope, time, and cost data
• Given a baseline (original plan plus approved changes), you can
determine how well the project is meeting its goals
• Actual data and information must be must be entered and analysed
periodically to use EVA.

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Traditional vs Earned value management

• Differences in data available for traditional vs

earned value management;
• Traditional method compares what was budgeted
(planned) vs what was actually spent;

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Traditional Cost Management

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Earned Value Management

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 Earned Value Analysis Terms
• Budgeted cost of work scheduled (BCWS), also called the BUDGET, is
that portion of the approved total cost estimate planned to be spent on an
activity during a given period
• Actual cost of work performed (ACWP), also called ACTUAL COST, are
the total direct and indirect costs incurred in accomplishing work on an
activity during a given period
• Budgeted cost of work performed (BCWP), also called EARNED
VALUE, is the percentage of work actually completed multiplied by the
planned cost (or BCWS)

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 Table 10-2 Earned Value Calculations for One Activity After Week One

Week 1 Week 2 Total % Complete Earned Value

Activity after Week 1
after Week 1
(BCWP)

Site Establishment 10,000 0 10,000 75% 7,500

Weekly Plan 10,000 0 10,000

Weekly Actual 15,000 5,000 20,000

Cost Variance -7,500

Schedule Variance -2,500

Cost Performance 50%

Index

Schedule Performance 75%

Index 52
 Table 3 Earned Value Formulas
Term Formula

Earned Value Budgeted Cost of Work Performed (BCWP) =

budgeted cost to date X % complete

Cost Variance CV=BCWP-ACWP (actual cost of work performed)

Schedule Variance SV=BCWP-BCWS (budgeted cost of work scheduled)

Cost Performance Index CPI=BCWP/ACWP

Schedule Performance Index SPI = BCWP/BCWS

To estimate what it will cost to complete a project or how long it will take based
on performance to date, divide the budgeted cost or time by the appropriate
index.

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 Rules of Thumb for EVA Numbers

• Negative numbers for cost and schedule variance indicate

problems in those areas. The project is costing more than
planned or taking longer than planned
• CPI and SPI less than 100% indicate problems

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 Figure 2 Earned Value Calculations for a One-Year Project After Five
Months

Excel file
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 Figure 3. Earned Value Chart for Project After Five Months
100,000

90,000

80,000

70,000

60,000

50,000
$

40,000
If BCWP line is below others, things
30,000 could be better!
20,000

10,000

-
1 2 3 4 5 6 7 8 9 10 11 12
Month

BCWS or Cumulative Plan ACWP or Cumulative Actual BCWP or Cumulative EV

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 Managing deviations
 Evaluate cost uncertainty and risk up-front
 Establish a reserve and develop risk mitigation plans
 Monitor cost and schedule performance for deviations;
 Accurately record changes to the baseline;
 Bring expected costs within acceptable limits.

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 Using Software to Assist in Cost Management

• Spreadsheets are a common tool for resource planning, cost

estimating, cost budgeting, and cost control
• Many companies use more sophisticated and centralized
financial applications software for cost information
• Project management software has many cost-related
features

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 Construction Contract Cashflow Forecasting -
Example
• The following example of the calculation of the cash flow for a
small construction project is based on a similar example to show
how, based on initial value data, the maximum amount of cash
required to complete the work may be calculated.
• For simplicity and ease of understanding, a number of
assumptions have been made when undertaking the
calculations. The data used to represent the calculations of cost
and value are purely illustrative and not representative of the
true costs and value of actual construction work.
 Data Required
• a graph of contract value against time;
• a graph of contract cost against time;
• the measurement and certification interval;
• the delay in payment between certification and the contractor
receiving the cash;
• the retention conditions and repayment arrangements;
• the project costs broken down into labour, plant, materials and
subcontractor categories and
• the terms of payment for the cost of the resources used.
 Example
• In this example, it is assumed that the total value of the
construction work is Bill. 54.0 TZS. (This value is calculated
from the bid rates and quantities in the Bill of Quantities
document.)
• The value of the work for each month of the project is shown
in Table 1 together with the profit margin covering all
overheads is shown as a percent of value for each month of the
project. (It is assumed that the profit margin varies with the
type of construction work.)
Projected Project Earned Value
 The measurement and certification interval
• These data are known from the contract documents. In this
example, it is assumed that a measurement and certification are
made monthly and certificates are issued within one month of
valuation of works.
• The delay in payment between certification and the contractor
receiving the cash
• In this example, it is assumed that there is a delay of payment of 1
month from agreed certification to the contractor receiving
payment.
 The retention conditions and repayment arrangements

• Retention is at a rate of 5% up to a maximum of 3.0 Billion

• Half of the total retention is to be released on practical
completion and half 12 months later.
The project costs broken down into labour, plant, materials and
subcontractor categories

• In practice, the activity costs will probably comprise labour,

plant, materials and subcontractor costs.
• It is important to know the build up of these costs because the
payment terms for each type of resource may vary.
• In this example, it has been assumed that all costs are
subcontractor costs.
The terms of payment for the cost of the resources used

• In this example, it is assumed that the main contractor meets

all subcontractor costs in the month in which these costs are
incurred.
• In practice, payment conditions vary significantly. Some
payments are made in advance, some when the services/good,
are procured and others much later. All these need to be
considered to reflect the reality.
 Tasks:
• Find the payment schedule;
• Calculate the monthly financial requirements;
• What is the maximum amount of cash required in this project?
• What is the cost of financing if borrowing is possible at about 18% per
annum?
• How will an advance payment of 15% affect the cash flow?
• What would the effect if there is a further delay of one month in payment
without advance payment?
• What measures would a Contractor take to reduce the adverse
consequences of the unfriendly cash flows?
• Thank you.