Cost Management - Cost Estimating

The essence of project management is the management of human resources, material assets, and other capital, toward the successful completion of a project's goal. Every decision to initiate a project should be based at least in part on the expectation that an important strategic goal will be accomplished by committing limited financial resources, and that the project will deliver value to the sponsor that exceeds the planned cost by an adequate margin.

Cost management processes, interacting with each other and with processes of other project management areas, create accurate estimates and use objective, quantitative methods, such as Earned Value Management (EVM), discussed later in the book, to help monitor and control costs.

Cost Management Plan

The work involved in the Project Cost Management processes is preceded by a planning effort by the project management team. The Develop Project Management Plan process produces a cost management plan which sets out the format and establishes the criteria for planning, structuring, estimating, budgeting, and controlling project costs.

Cost Management Plan Components

A cost management plan can establish the following:

  • Precision level - Cost estimates for schedule activities will adhere to a rounding of the data to a prescribed precision, for example, hundreds of dollars (00) or thousands of dollars (000), based on the scope of the activities and the magnitude of the project, and may include an amount for contingencies;
  • Units of measure - Each unit of measurement, such as staff hours, staff days, staff weeks, or lump sum, is defined for each resource;
  • Links to organizational procedures - The work breakdown structure (WBS) component used for project cost accounting is called a control account (CA). Each control account is assigned a code or account number that is linked directly to the performing organization's accounting system. If cost estimates for planning packages are included in the control account, then the method for budgeting planning packages is included;
  • Control thresholds - Variance thresholds for costs or other indicators, for example, person-days or volume of product at designated points in time during the project, can be defined to indicate the agreed amount of variation allowed;
  • Earned Value rules - These are the rules the project management team sets for computing earned value, discussed in more detail later in the course:
      1. The formula for determining the estimate to complete are defined
      2. The criteria by which earned value will be recognized according to the                completion status of the work package (0-100, 0-50-100, or other)
      3. The WBS level at which earned value analysis will be carried out
  • Reporting formats - Formats for the various cost reports are defined; and
  • Process descriptions - Descriptions of each of the three Project Cost Management processes are documented.


Defining the Value of a Project Using Total Cost of Ownership (TCO)

Of special interest when considering cost management is the difference between the cost of the project life cycle and the cost of the product life cycle. As an illustration, consider the example of an electric power plant. The product is the gas-powered electric plant. The initial project is to build the plant. After this first project has been completed, the plant is turned over to the operators, who now use the plant to produce electricity over the plant's lifetime. At the end of the economic life of the plant, the plant will be shut down, and the salvageable components disposed of.

The Total Cost of Ownership (TCO) is a financial estimate that reflects not only the cost of the project but also all aspects in the further use and maintenance of the product produced by the project. The decision to initiate a project to create a product, service, or result requires an understanding of the total life cycle cost of the product in order to compare the total costs required to achieve this benefit to the benefits that are expected.

In other words, the value of the project, or in some business and marketing contexts, the value proposition, may be stated as follows:

Annual VALUE = (BENEFITS - TCO - Tax) / (1 + R)T

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