Are you struggling to complete your projects successfully while juggling managing resources, activities, deadlines, and unexpected obstacles? If you add the pressure of planning and tracking expenses and keeping within tight budgets, project management can get quite an overwhelming task to do irrespective of the type and size of the project.
In fact, up to three-fourths of projects end up well beyond the set budget constraints and more than a half of managers consider cost overruns as the main reason for project failure. McKinsey and the University of Oxford found that over 50 % of IT projects exceed their predetermined budgets by an average of 45 % totalling $66 billion annually. Reportedly, the situation is similar in the construction sector, with an average overrun of 28 % for nine out of ten projects.
How can you prevent such unforeseen bloated costs and keep your project on track?
In this article, we’ll discuss the steps and factors that are essential for effective project cost management. We’ll touch upon how implementing project management software can help avoid running above your project and risking your project completion.
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Let’s get started by highlighting the fundamental concepts.
What is project cost management?
This is an important part of project management that focuses on the cost of the resources that the completion of project activities requires. Project cost management is defined as estimating, planning, and controlling all expenses made throughout its life cycle. This process aims to ensure that the project is completed within the preset budget.
Project cost management has the following objectives:
- Calculating the money needed to carry out project tasks in line with the project scope
- Establishing a project budget
- Allocating funding based on cost estimation
- Tracking expenses and collecting data
- Analyzing the data to assess performance and facilitate future decision-making
- Promoting compliance with the approved budget
The accomplishment of these objectives will enable you to keep project costs under control.
Why is project cost management important for small businesses?
You may think project cost management is relevant to large enterprises that deal with multiple large-scale projects. Actually, it’s even more important for small business management. Effective project cost management enables small companies to stay on budget and make the best use of their limited resources.
Let’s highlight some of the benefits it brings to your business. Project cost management
- Establishes project cost balance and provides a cost baseline against which actual costs are measured and controlled.
- Provides well-timed risk analysis and risk management plan.
- Helps keep the budget on track.
- Promotes efficiency through properly allocating budgets so that operations go smoothly.
- Maximizes profits by minimizing overspending.
Thus, effective project cost management can help you increase the chances of successful completion of your project and higher profits.
6 Key factors of project cost management
Project cost management is considered a continuous process that involves the following activities intended to lay down the major functions within project development:
1. Cost management planning
The cost management plan is part of the project management plan. It gives guidelines on how the expenditures will be managed throughout the project.
To build your cost management plan, you’ll need:
- The project charter identifying the preapproved financial resources and the approval requirements
- The schedule management plan setting the procedures for schedule development and monitoring
- The risk management plan establishing the risk identification and management processes
Cost management planning aims at ensuring coordination and efficiency of cost management efforts. It identifies the methods and techniques of estimating, budgeting, tracking, and controlling project costs.
The cost management plan determines the units, accuracy, and methods of measuring performance, earned value management rules, cost thresholds, reporting formats and frequency, etc.
2. Planning project resources
This precedes the actual project work and aims at identifying all resources necessary for its execution. Resources include all employees and contractors as well as the technology, facilities, and materials required to have the project work done.
The process of resource planning is closely connected with the project scope and the work-breakdown structure splitting the project development into smaller and easily manageable tasks.
3. Cost estimation
Cost estimation is where you calculate the costs of all the resources required to accomplish the project work.
This could be in a form of itemized project budget:
but also this could be the process of project cash-flow planning where you place the project cost in time:
The estimates should be revised during the course of the project in line with the data collected. Using dedicated (project) cash flow management tools will bring valuable details of all inbound and outbound cash so that you can adjust cost estimations accordingly. This will naturally lead to an increase in estimation precision.
There are various cost estimating methods:
- Analogous cost estimation, where you calculate costs based on your experience with similar previous projects
- Bottom-up cost estimation, developed by calculating costs for individual work packages and then summing them
- Three-point estimating, where the cost range is an approximation of three estimated values: “Most likely” calculating realistic effort assessment and predicted expenses, “Optimistic” taking the best-case activity scenario, and “Pessimistic” based on the worst-case scenario.
Whichever of the estimating methods you choose, note that you should never overlook this step. The accuracy of calculation is crucial for properly identifying the necessary funding. Cost estimation is based on the project schedule and the estimated duration of using the individual resources. This allows for estimating project costs in time.
Comprehensive cost planning takes into account the cost of resources, labour, and deliverables. In addition, market conditions will also influence your estimation. So, you have to consider the resource supply routes and the risks with the responses they require. Anticipate any variables and potential changes, such as price rises due to inflation, natural disasters, or accidents.
Taking such a multitude of factors in mind can be a time-consuming and tedious task. A project management solution can significantly simplify it. What’s more, 48 % of companies using dedicated software report its positive impact on the accuracy of project cost estimates.
4. Budget determination
Determination of project budgets involves aggregating the costs of all activities or work packages to set an authorized cost baseline, which is the approved time-phased funding including contingency reserves, but not management reserves.
Budget determination is a crucial process in project development as it provides the cost baseline against which you can measure and control project performance. Setting the budget can be done once or periodically throughout the project execution.
The determination of your project budget is based on the following project documents and data:
- Cost management plan, identifying how costs have to be structured
- Planning resource management, including labour rates, travel fees, and any additional expenses that need to be covered by the overall budget estimation
- Project scope baseline containing the work breakdown structure (WBS)
- Cost estimation
- Project work schedule indicating planned dates for initiating and completing of the all milestones, activities, and work packages along with control procedures
- Potential risks and the costs of risk responses
Determining the project budget can involve:
- Using expert judgment based on similar projects and extensive industry knowledge of funding principles, requirements, and sources
- Data analysis aimed at determining reserves
- Aggregating cost estimates in line with the WBS, by work packages
- Reviewing the information collected in the course of project development
- Reconciling funding limits with the planned costs.
Adequate budgeting is critical for successful project completion and can be revised periodically based on cost monitoring. An itemized project budget can facilitate easy reviewing, processing, and adapting of the multiple entries and purposes.
Note that with smaller projects, resource planning, cost estimation, and budgeting processes are closely related and can be managed together by a single person.
5. Cost control
This is the continuous process of tracking the actual expenditures throughout project development and comparing it with the estimated figures. It aims at identifying cost variances from the cost baseline (or the budget deficit) and taking corrective actions like adjusting the preset budget or the scope of work to bridge the gap.
Earned value analysis is an essential technique when it comes to controlling costs. To make it clearer, the earned value (EV) is an indication of the work performed expressed as the approved budget. The difference between the EV and the actual value is the cost variance, which is a critical measurement of your project cost performance. The lower the variance, the worse your project is performing. Negative cost variances signal a dramatic difficulty in accomplishing a project successfully.
6. Maintain accountability
Clearly defining the project roles and responsibilities and assigning tasks will let you ensure efficient and smooth operations in line with the work breakdown structure.
A task management solution will enhance visibility and empower you to track project work progress. With every member of your team aware of the task they’re assigned, the budget, and the timeline, your project mission becomes possible.
Work smarter, not harder!
Managing a project is an endeavour requiring time, effort, experience, and expertise in a wide range of subjects – from planning and finances to team management, to accounting. Implementing a business management system offers great potential for small and large businesses alike.
In fact, project management solutions help 66 % of companies that have adopted them to successfully accomplish projects within the originally established budgets. On the other hand, this is achieved by only 47% of businesses without a specialized tool.
So, if you still haven’t made use of the smart capabilities modern technology brings, perhaps your next project is the right time to do so.
💡 Get "systematic" help
As complicated as all these calculations may sound, it all boils down to sorting out the parameters that need to be tracked and setting the effective tools to help you monitor them. A full-fledged business management platform that combines project, task, and team management features, that comes with project budget and project cash-flow functionality, can he very helpful.
Such a solution allows you to track actual budget and costs against the planned ones or brings a true overview of incoming and outgoing cash over time. With these insights, you can decide on the best way to manage cash flows, project budget, and revise the costs and funding estimations for the next stages of your project execution.