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Project Management Tutorial: Cost Planning in Project Management

December 4, 2019


If you are working as a project manager, program
manager or PMO you will likely to get involved the annual budget data gathering exercise.
This mean you will need to pull together cost for ongoing and planned projects. Therefore,
fundamental knowledge of cost planning is critical for every project manager.
In the lecture we will discuss the basics of cost planning. You will learn
* what types of cost you need to consider for cost estimating, budgeting or proposal
bidding * how to use an iterative approach for more
accurate cost estimates * how learning curves impacts costs
Why is cost planning knowledge important? Because you won’t get a project kicked-off
or approved without looking at costs. Most organizations require project managers to
develop a business case. The business case includes the costs and benefits of project
and help decision makers to compare and prioritize it with other projects. If don’t determine
project costs as part of the project charter, chances are that your project won’t get
approved. Also you can’t manage project costs if you can’t compare incurring costs
against a project budget. Therefore, cost planning is critical. In this lecture we will talk about different
aspects of cost planning. I will walk you over a checklist of cost types
frequently incurred in projects. Then, we will review different cost estimate
appraches, including level 0, 1 and 2. After that, will review the concept of the
learning curve. Slide 1:
Cost planning includes cost estimates, bids, or budgets.
Cost planning starts with itemizing cost types in a spreadsheet. Cost types are broken down
into * direct costs
* indirect costs and * contingency costs
Direct costs are directly attributable to the cost object. A cost object can a project
or product. For example, a cost object could be a CRM implementation project or a cost
object be a website or a car. In manufacturing or other non-construction
industries the portion of operating costs that is directly assignable to a specific
product or process is a direct cost. Direct costs are those for activities or services
that benefit specific projects, for example salaries for project staff and materials required
for a particular project equipment or cost for subcontractors. Because these activities
are easily traced to projects, their costs are usually charged to projects on an item-by-item
basis. Indirect costs are not directly attributable
to a cost object, e.g. a project or product. Indirect costs have to be allocated to a cost
object on some basis. Examples of direct costs include supervisor salaries, insurance, training,
taxes, or maintenance. Indirect costs are those for activities or services that benefit
more than one project. Their precise benefits to a specific project are often difficult
to trace. For example, it may be difficult to determine precisely how the activities
of a director of an organization benefit a specific project. Of course, if the director
adds no value to organization whatsoever the cost allocation exercise becomes really easy
🙂 Contingency costs “refers to costs that will
probably occur based on past experience, but with some uncertainty regarding the amount.
These uncertainties are risks to the project. Some refer to these risks as “known-unknowns”
because the estimator is aware of them, and based on past experience, can even estimate
their probable costs. The estimated costs of the known-unknowns is referred to by cost
estimators as cost contingency. Examples of contingency cost items include
Inflation allowance, currency exchange variations and cost for other risk factors. Slide 2:
Estimating costs is difficult. What are techniques to make cost estimating easier?
Most project managers use an iterative approach to estimate costs. Initial project cost estimate
have a low accuracy while estimates later in the project, as more information is known,
are have higher accuracy. First you start with a Level 0 that is a Top
Down rough order of magnitude estimate, e.g. “a project in the initiation phase could
have a rough order of magnitude (ROM) estimate in the range of +/-50% of the actual costs.
This can be done within a day and will be based on similar projects and expert judgement.
Next, as more information is known, you will be able to develop a Top Down level 1 estimate
in the range of +/-25% of the actual costs. This can be done within a few days and will
also be based on similar projects and expert judgement.
Later in the project, as more information is known, you a bottom up Level 2 estimate
narrows costs to a range of +/-10% of the actual costs. This estimate can be done within
a few weeks as it requires itemizing costs based on cost types as we just discussed.
Due to the iterative nature of projects, the more we discover about the project, the more
accurate our estimate will be. Spend only as much time estimating as needed
to make the business decision at hand. Remember that estimating takes time and time
is money. Refining our data as we progressively elaborate
our project plan produces a more definitive estimate. Slide 3:
There are two types of cost estimating – Top-down and bottom up Top-down looks at the project or a large activity,
as a whole without breaking it down. Bottom-up requires to break down the project
into activities, estimate the cost of each, and roll up the individual activities to get
a project total. For Top-down you can use analogous or parametric
estimating which we discussed in an earlier lecture. Just to recap:
Analogous estimating uses similar past projects to estimate the duration or cost of your current
project, thus the root of the word: analogy. For example, if it cost $3,000 to develop
a mobile app a few months ago and you are responsible for developing a new similar mobile
app, you estimate it to cost $3000. You can use it to categorize and prioritize
projects. If a project is similar to other efforts previously accomplished, analogous
estimating may assist in “sizing” the project into a small, medium, or large category. Used when there is limited information regarding
your current project, an analogous estimate is considered “top-down” and is generally
not as accurate as other estimating techniques. Because the project manager’s, and possibly
the team’s, experience and judgment are applied to the estimating process, it is considered
a combination of historical information and expert judgment. Parametric estimating uses mathematical model
to determine estimates. It’s a more accurate technique for estimating cost and duration,
uses the relationship between variables to calculate the cost or duration.
Essentially, a parametric estimate is determined by identifying the unit cost or duration and
the number of units required for the project or activity. The measurement must be scalable
in order to be accurate. For example, if it took me two hours to create
an e-learning training lecture last week and this week I’m creating 4 e-learning lectures,
I could estimate that it will take eight hours for 4 e-learning lectures.
However, if the first one hour was spent video camera equipment and preparing it, the estimate
would need to be scaled appropriately: 1 hour for setting up video camera equipment and
then four hours to create training lectures, for a total of five hours. What are the similarities between analogous
and parametric estimating: Can be used for both duration and cost estimating
Essentially a combination of historical information (leveraging past projects/activities) and
expert judgment What are the differences between analogous
and parametric estimating? Analogous is considered top-down and is less
accurate than parametric. Analogous estimating uses an “analogy” – comparing a past
similar project to your current project. Parametric is more accurate, specifically
when the underlying data is scalable. Parametric uses a relationship between variables (a unit
cost/duration and the number of units) to develop the estimate. When estimating activities is important to
distinguish between work effort and duration E.g. the work effort to get the approval or
document sign-off completed could be 20 min, however, the duration to obtain an approval
take be 1 week due to other priorities of the approvers. For Bottom-up estimates you can break down
a project into activities, estimate the cost of each, and roll up the individual activities
to get a project total. Bottom-up estimates is more accurate technique
for estimating costs than Top-Down. It’s typically based on Parametric estimating uses
the relationship between variables to calculate the cost or duration. For example, to develop
a web application an engineer may need 120 hours at $50 per hour totaling $6,000 development
costs. Slide 4:
One important consideration in cost planning is the learning curve.
The concept of Learning curves that cost per unit decreases with experience as skills and
processes improve over time. For example, an experienced programmer will typically produce
more and/or better code than and experienced programmer. While an experienced programmer
will require a higher per hour rate than experienced programmer, total costs may cheaper as the
higher per hour rate is offset by more or better output, thus decreasing the cost per
unit. Let’s look at another example. A person
decides to replace some garage doors. He has never done this type of work before,
so he is not sure how long it will take to complete the work.
After obtaining the necessary tools and material and several hours of reading instructions
and some trial and error, the old door is removed and the new door is installed.
The entire job required 8 hours of effort. He decides to replace the second door the
next day. The experience gained during the first installation
results in completion of the second installation in 4 hours. This is a substantial improvement.
He decides to replace a third door and it requires about 3½ hours of effort.
The rate of improvement has decreased considerably from door #2 to door #3.
It may be possible to improve the duration slightly through additional repetition, but
eventually the rate of improvement will no longer be significant.
The information learned from this type of experience can be used to estimate similar
jobs. Typically, learning curves produce a cost
and time savings of 10 to 30 percent each time a company’s experience at producing
a product doubles. The learning curve concept can be applied
to individual team members and their experience, knowledge, and skill with assigned project
tasks as well. Let recap the key take aways.
Cost planning starts with itemizing cost types in a spreadsheet. Cost types are broken down
into * direct costs
* indirect costs and * contingency costs
There are two types of cost estimating – Top-down and bottom up.
Top-down looks at the project or a large activity, as a whole without breaking it down.
Bottom-up requires to break down the project into activities, estimate the cost of each,
and roll up the individual activities to get a project total.
Most project managers use an iterative approach to estimate costs. Initial project cost estimate
have a low accuracy called level 0 while estimates later in the project, as more information
is known, are have higher accuracy. These estimates are called level 1 or level 2 estimates.
An important consideration in cost planning is the learning curve. The concept of Learning
curves that cost per unit decreases with experience as skills and processes improve over time.
This concludes our lesson on different aspects of cost planning.

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3 Comments

  • Reply araie mohamed April 11, 2016 at 2:03 am

    great …thank you

  • Reply Mehedi hasan March 16, 2017 at 6:51 pm

    good

  • Reply Zulkifli Mohammed May 30, 2019 at 5:22 pm

    awesome

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