IT Project Management

10. COST ESTIMATION & BUDGETING

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 Lecture outline
• Introduction
• Importance of Project Cost Management
• What is Cost and Project Cost Management
• Project cost management
• Cost Estimating: Inputs
• Cost Estimating: Tools and Techniques
• Project Cost Management Processes
 The Importance of Project Cost Management

• Estimating activity costs involves developing an approximation of

the costs of the resources needed to complete project activities.
• can forecast the resources necessary for each step of a
project and ensure that projects stay on track
• In approximating costs.
• the estimator considers the possible causes of variation of
the cost estimate, including risks.
• Cost estimating includes identifying and considering various costing
alternatives
• Activity cost estimates is a quantitative assessment of the
likely costs of the resources required to complete work
package activitie
The Importance of Project Cost Management

• IT projects have a poor track record for meeting

budget goals.
• A cost overrun is the additional percentage or
dollar amount by which actual costs exceed
estimates.
 The Importance of Project Cost Management

• Estimating activity costs involves developing an

approximation of the costs of the resources needed to
complete project activities.
• In approximating costs.
• the estimator considers the possible causes of variation
of the cost estimate, including risks.
• Cost estimating includes identifying and considering various
costing alternatives
• Activity cost estimates is a quantitative assessment of
the likely costs of the resources required to complete
work package activitie
What is Cost and Project Cost Management?

• Cost is a resource sacrificed or foregone to

achieve a specific objective or something given
up in exchange.
– Costs are usually measured in monetary units like
dollars.
• Project cost management includes the processes
required to ensure that the project is completed
within an approved budget.
 Cost Estimating: Inputs
1. Project Charter.
• describes the business needs, cases, and requirements for the
project
• include constraints, assumptions, and requirements
• Constraints
• mandatory milestone deadline
• required delivery dates
• available skilled resources, and organizational policies
• Assumptions
• are factors that, for cost estimating purposes
• be considered to be true, real, or certain
 Cost Estimating: Inputs

2. Project Scope Statements.

• describes the current project boundaries
• It provides important information about project needs and
strategies that must be considered during project cost
planning
• provides constraints and assumptions related to project
scope
3.Project Management Plan
• change control management plan, and overall contracts
management plan
• guidance and direction for cost management planning
 Cost Estimating: Inputs

4. Work Breakdown Structure and Dictionary.

• provides the relationship among all the elements of the
project and the project deliverables.
5. Time Management Plan
• A significant factor in calculating the project cost is the kind,
quantity, and length of time that will be required to use
resources to perform the activity
• Estimating activity resources
• determining the availability and quantities required of
people, equipment and materials needed to perform
project activities.
• Activity duration estimates will affect cost estimates
 Cost Estimating: Inputs

6. Staffing Management Plan

• Project staffing attributes and personnel rates
• necessary components for developing the project cost
estimate, are used to develop cost estimates.
• when the project experiences a negative risk event,
• it will nearly always increase cost and delay the schedule.
7. Environmental and Organizational Factors
• The cost estimate planning process must consider
• the conditions of the marketplace
• what materiel, products, goods, and services are available in the
marketplace, from whom, and under what terms and conditions
8 . Organizational Process Assets
• Cost estimating templates
• Commercial databases
 Cost Estimating: Tools and Techniques
1. Analogous Cost Estimation
• the actual cost of a previous similar activity as the basis for estimating the cost of the current
activity
• used to estimate costs when there is a limited amount of detailed information about the project
• form of expert judgment

2. Resource Cost Rates

• The cost estimate planning process must consider
• the conditions of the marketplace
• what materiel, products, goods, and services are available in the marketplace, from
whom, and under what terms and conditions

3. Bottom-up Cost Estimating

• estimating the cost of individual work packages or individual
activities
• smaller scope activities increase the accuracy of the activity
cost estimates
 Cost Estimating: Tools and Techniques
4. Computerized Tools
• project management software spreadsheets
and simulation and statistical tools
5. Other Cost Estimating Methods
• include vendor bid analysis and an analysis
of what the project should cost
6. Contingency Activities
• contingency allowances for cost and time in
many activity estimates
Project Cost Management Processes
1. Planning cost management:
– determining the policies, procedures, and documentation that will
be used for planning, executing, and controlling project cost.
2. Estimating costs:
– developing an approximation or estimate of the costs of the
resources needed to complete a project.
3. Determining the budget:
– allocating the overall cost estimate to individual work items to
establish a baseline for measuring performance.
4. Controlling costs:
– controlling changes to the project budget.
Project Cost Management Summary
Basic Principles of Cost Management
• Most members of an executive board better understand
and are more interested in financial terms than IT terms,
so IT project managers must speak their language.
– Profits are revenues minus expenditures.
– Profit margin is the ratio of revenues to profits.
– Life cycle costing considers the total cost of ownership, or
development plus support costs, for a project.
– Cash flow analysis determines the estimated annual costs and
benefits for a project and the resulting annual cash flow.
Types of Costs and Benefits
• Tangible costs or benefits:
– are those costs or benefits that an organization can easily
measure in dollars.
• Intangible costs or benefits:
– are costs or benefits that are difficult to measure in monetary
terms.
• Direct costs:
– are costs that can be directly related to producing the products
and services of the project.
• Indirect costs:
– are costs that are not directly related to the products or services
of the project, but are indirectly related to performing the project.
More Basic Principles of Cost Management

• Learning curve theory

– states that when many items are produced repetitively, the
unit cost of those items decreases in a regular pattern as more
units are produced.
• Reserves
– are dollars included in a cost estimate to mitigate cost risk by
allowing for future situations that are difficult to predict.
– Contingency reserves – allow for future situations that may be
partially planned for (sometimes called known unknowns) and
are included in the project cost baseline.
– Management reserves – allow for future situations that are
unpredictable (sometimes called unknown unknowns)
Planning Cost Management
• The project team uses expert judgment, analytical
techniques, and meetings to develop the cost
management plan.
• A cost management plan includes:
– Level of accuracy and units of measure
– Organizational procedure links
– Control thresholds
– Rules of performance measurement
– Reporting formats
– Process descriptions
Estimating Costs
• Project managers must take cost estimates
seriously if they want to complete projects
within budget constraints.
• It’s important to know
– the types of cost estimates,
– how to prepare cost estimates, and
– typical problems associated with IT cost estimates.
Estimating Costs
Types of Cost Estimates
Estimating Costs
Types of Cost Estimates
• The number and type of cost estimates vary by
application area.
• Estimates are usually done at various stages of
a project and should become more accurate as
time progresses.
• A large percentage of total project costs are
often labor costs.
Cost Estimation Tools and Techniques
• Basic tools and techniques for cost estimates:
– Analogous or top-down estimates:
• use the actual cost of a previous, similar project as the basis for
estimating the cost of the current project.
– Bottom-up estimates:
• involve estimating individual work items or activities and
summing them to get a project total.
– Parametric modeling:
• uses project characteristics (parameters) in a mathematical
model to estimate project costs.
Typical Problems with IT Cost Estimates

• Estimates are done too quickly

• People lack estimating experience
• Human beings are biased toward
underestimation
• Management desires accuracy
Sample Project Cost Estimate
Determining the Budget
• Cost budgeting involves allocating the project cost
estimate to individual work items over time.
• The WBS is a required input to the cost budgeting
process since it defines the work items.
• Important goal is to produce a cost baseline
– a time-phased budget that project managers use to
measure and monitor cost performance.
Controlling Costs
• 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
• Many organizations around the globe have
problems with cost control.
Earned Value Management (EVM)
• EVM 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.
– You must enter actual information periodically to use
EVM.
– More and more organizations around the world are
using EVM to help control project costs.
Earned Value Management Terms
• The planned value (PV),
– formerly called the 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 (AC),
– formerly called actual cost of work performed (ACWP), is the total of direct
and indirect costs incurred in accomplishing work on an activity during a
given period
• The earned value (EV),
– formerly called the budgeted cost of work performed (BCWP), is an
estimate of the value of the physical work actually completed
– EV is based on the original planned costs for the project or activity and the
rate at which the team is completing work on the project or activity to date
Earned Value Management Terms
• Estimate to Complete (ETC) is the cost estimate for work
remaining and is used in forecasting the project cost at
completion.
– ETC = (total PV - EV to date)
– the CV and SV, can be converted to efficiency indicators to reflect
the cost and schedule performance of any project.
– CPI [CPI = EV/AC] ,is the most commonly used cost-efficiency
indicator
– Because , if a CPI value less than 1.0 indicates a cost overrun of
the estimates
– greater than 1.0 indicates a cost under run of the estimates
– (EAC), [EAC=ETC + AC] where the ETC represents work remaining
and considers the resource(s) performance to date
Earned Value Management Terms
• Earned Value less Planned Value is the Schedule Variance (SV).
• Earned Value less Actual Costs is the Cost Variance (CV) for the
projec
• Schedule Variance will ultimately = 0 when the project is
completed because all of the planned values will have been
earned.
• An Estimate at Completion (EAC) is a forecast of most likely
total project costs based on project performance and risk
quantification
• EAC = AC + BAC – EV
Rate of Performance
• Rate of performance (RP)
– is the ratio of actual work completed to the percentage of
work planned to have been completed at any given time
during the life of the project or activity.
• For example, suppose the server installation was
halfway completed by the end of week 1.
– The rate of performance would be 50% because by the end
of week 1, the planned schedule reflects that the task
should be 100 percent complete and only 50 percent of that
work has been completed.
Earned Value Formulas
Earned Value Formulas
• Negative numbers for cost and schedule variance indicate
problems in those areas.
– CPI and SPI less than 100% indicate problems
– Problems mean the project is costing more than planned (over
budget) or taking longer than planned (behind schedule)
• The CPI can be used to calculate the estimate at completion
(EAC)—an estimate of what it will cost to complete the
project based on performance to date.
• The budget at completion (BAC) is the original total budget
for the project.
Earned Value Formulas
Earned Value Formulas