The cost management knowledge area is a set of processes within the Project Management Body of Knowledge (PMBOK) as defined by the Project Management Institute.
It is needed to complete a project within the project’s approved budget. It includes determining the budget required to complete the project as well as monitoring and controlling the costs to meet the budget.
When a project is set to begin, a work breakdown structure (WBS) is created as a breakdown of the project requirements, objectives, and deliverables. A thorough WBS makes for easier cost management.
After the project scope is clearly defined and all the project activities have been determined, each deliverable and activity has an associated cost. Since project resources will perform activities, they will add some costs to projects, such as expenses and salary. Projects will also require equipment, tools, and materials to complete, and those will need to be budgeted, too.
Cost management primarily deals with the costs of resources that are needed to complete the project. After the budget is determined, cost management continues to measure and monitor cost performance to ensure the project meets the agreed upon budget.
Cost management consists of four processes. Three of the processes belong to the planning group, and the other belongs to the monitoring and controlling group. Cost management is important to the company bottom line because constantly going over budget will not only eat profit margins, but could also damage client relationships due to extra costs and project delays.
When procurement professionals take the time to master cost management, they can help ensure their organization remains competitive beyond cost, but also in preparation to anticipate and proactively address customer needs.
The Cost Management Process
The four cost management processes are:
- Plan cost management
- Estimate costs
- Determine budget
- Control costs
Plan Cost Management Process
During this process, the project manager and other members of the project team will work together to create a plan to determine the budget, estimate costs, and manage costs over the course of the project from start to finish.
The cost management plan is the primary output for the plan cost management process. It details how to manage the project costs and budget. Three key areas of this stage are life cycle costing, total cost of ownership, and value engineering.
Life Cycle Costing
Life cycle costing is a process that involves compiling all the costs that the owner or producer of an asset will incur over the asset’s lifespan. Consider how often you replace your cell phone. Generally, you replace or upgrade every two years because that’s the technological product’s life cycle. That’s why it’s important to consider the total cost of ownership on all products or services that are purchased over the course of the project.
Total Cost of Ownership
For instance, when purchasing a vehicle, you have the cost of the vehicle itself, but that’s only a portion of the total cost of ownership. Other costs to consider include: taxes and insurance, tag and title fees, fuel, and regular maintenance to extend its lifetime. Some vehicles, particularly those that require specialized parts or service, will have a higher total cost of ownership.
Using the total cost of ownership analysis allows a business to find the lowest total lifetime cost for purchasing and operating goods and services. Though it isn’t necessary to subject all purchases to a total cost of ownership analysis, it is crucial to do it for any purchase that will bring rather significant operating and maintenance costs over a long usable life. The total cost of ownership analysis is commonly used when it comes to purchasing things such as: vehicles, property, computer systems and software, machines and other equipment.
Value engineering is doing the same work in a more affordable way. For example, if you’re planning a construction project and find that you’ll need a bulldozer for about two months, it makes more sense to rent the bulldozer rather than buy one – unless of course you’ll continue to use the bulldozer in a number of other projects in the future. In that case, it may make more sense to purchase it.
However, when you consider the cost of renting the bulldozer means you’re not responsible for the necessary maintenance and upkeep, it is often more budget-friendly option to rent it. The total cost of ownership for a single bulldozer could mean you have to have multiple high dollar projects that require plenty of bulldozer use before the purchase pays for itself.
To determine which is the better option, define the lifetime costs and the cost components. Bring in the relevant stakeholders, the people who requested the purchase, and a financial controller. Meet with them to create the possible scenarios, then compare those with various financial ratios such as return on investment, payback period, and so on. Choose the best fitting scenario and implement it.
Estimate Costs Process
During this phase, you’ll estimate costs for each project activity, including the tools, materials, and equipment needed to accomplish every activity. Then, based on these cost estimates, you’ll be able to estimate the overall project budget.
Searching for cost information means the buyer determines the cost of components they need – from the materials, machines, and labor that’s used to manufacture their final projects. In cost calculation, the direct cost is determined by combining material and labor costs. There’s also indirect cost, or overhead, that are costs not directly related to the manufacturing process, such as staff resources, office space, taxes, etc.
Projects will have different types of costs. You’ll have fixed costs, which are things like office rent. This cost remains the same regardless of how many project resources you’ll need. You’ll also have variable costs, which are things like personnel expenses and material costs. These costs will vary depending on the number of people or the amount of materials.
Making sure you have all the inputs is critical because all cost estimations is based on the inputs and missing an input, or having inaccurate estimates for any of the inputs can throw off the entire budget. Depending on how accurate you need everything to be, you must plan accordingly. This may mean spending more time gathering quotes from suppliers and service vendors.
As you select suppliers for everything you need to complete project activities, it’s important to make sure the agreed price is fair. It’s important to calculate cost to determine whether the price is right, and where it is necessary to focus efforts to reduce extra costs.
A lot of companies have increased their outsourcing, so they heavily depend on the cost and performance of their suppliers. By effectively managing those costs, buyers can contribute more to company profits.
Determine Budget Process
In this phase of cost management, after all the estimates are complete, the cost estimations are combined to determine the overall project budget. The project budget is comprised of several components. In addition to all the activity cost estimate, contingency reserves are added to pad the budget to accommodate risks that may occur during the project.
Control Costs Process
This is the final process in the cost management knowledge area. This is designed to control the project expenses as the project moves forward, and seeks to complete the project within the determined budget.
Progress reporting is a vital part of cost management because it is based on the previous expenses and the project schedule. To make sure everything stays in line with the original plan, it is important to regularly evaluate whether or not the remaining project activities will be completed within the remaining budget and timeline. The progress needs to be reported to all the relevant stakeholders. If deviations from the original plan are expected, this provides the chance to take corrective action to get the project back on track to meet the estimated budget.
During the project planning phase, all project team members should agree on how often these progress reports will be compiled and presented to stakeholders as part of the project management plan (PMP). Progress reporting aims to keep everyone accountable.
Earned Value Management
Earned value management is a critical part of cost management because these calculations determine whether you are under budget, on b