When managing the project budget, the PM should collect as much information as possible about costs. This includes any software, hardware, or service purchases. It will include purchase orders, including P.O. numbers and their amount. It will also include contracts with suppliers and vendors, and the date on which those contractors were paid. It also needs to include the cost of labor, materials, and overhead for each activity and segment outlined in the work breakdown structure. This process may include building, testing, and marketing the final deliverables. All of this will help the project manager to determine the actual expenses incurred during the project and whether the project is staying on budget.
Cost Estimation
Knowing the project costs is very important for creating a successful project that doesn’t go over budget. Calculating the costs, in terms of the overhead, labor, schedule, licensing, vendor contracts, and so on, is often complicated in large complex projects. If this is not done correctly, the cost estimates and budget may be wildly incorrect, which could lead to project failure.
Depending on how many business departments may be involved, a project may be divided into cost centers. This means that each department has a budget. And any project activity related to that department will need to be assigned to that cost center.
Cost Estimation Techniques
Some of the cost estimation techniques a project manager could apply to an IT project include the following:
- The bottom-up technique calculates the sum of the costs associated with the production of each deliverable starting at the lowest level of detail.
- The unit technique breaks the project into units of work, estimates the cost-per-unit, and factors in the cost of maintenance per hour of operation.
- Linear regression technique, in the simplest terms, compares the cost drivers (independent variables) with the dependent costs (dependent variables) to forecast future costs. Good regression analysis usually requires more statistical analysis than what is provided here.
- The parametric technique combines the unit technique (breaking the project down into units of work) with linear regression to establish a cost-per-unit. This technique may factor in historical data, deterministic or probabilistic methods, and a wide variety of parameters to create a more accurate analysis of costs. This technique may be used in larger, more complex, projects that have many variables where precise calculations are required to avoid going significantly over or under budget.
- The top-down technique sets an initial budget, or target price, and attempts to structure the project in such a way as to not exceed that budget. This technique is more feasible when a team has completed similar projects, has good historical data, and is highly confident about the costs involved.
Earned Value Analysis
Earned value analysis provides the PM with a way to understand a project’s progress at a given point in time. It compares the planned work with the actual work to determine whether the project is meeting its targets. Alternatively, PMs have the option of using earned value management systems (EVMS) that help to automate this methodology. Some calculations involved with earned value analysis include:
Earned value consists of the budgeted cost of work performed (BCWP), which helps determine the value of work performed compared to the budget.
EV = (Completed Work / Total Work) × Budget
According to the following example, the project has an earned value of $20.
- Completed Work: 0.5 hours
- Total Work: 30 hours
- Budget: $40 × 30 hours = $1,200
EV = (0.5 / 30) × $1,200 = $20
The planned value consists of the budgeted cost of work scheduled (BCWS), which helps to determine the amount of the budget used up to this point.
PV = (Planned Work at this point in time / Total Work) × Budget
The actual value consists of the actual cost of work performed (ACWP), which helps to determine the actual project expenditures up to this point.
AC = (Cost Per Hour) × (Completed Hours of Work)
The schedule variance reveals whether the project is ahead or behind schedule. To calculate the schedule variance, the present value is subtracted from the earned value:
SV = EV - PV
Reveals if the project is under or over budget:
CV = EV - AC
Measures the efficiency of time utilization. This ratio is calculated by dividing the budgeted cost of work performed (BCWP) by the budgeted cost of work scheduled (BCWS). Greater than 1 is good:
SPI = EV / PV
Assesses the cost efficiency. This ratio is calculated by dividing the budgeted cost of work performed (BCWP) by the actual cost of work performed (ACWP). Greater than 1 is good:
CPI = EV / AC
The remaining funds left for the project:
Remaining Budget = Budget - AC
Measures how quickly the project is spending resources:
Burn Rate = Total Costs / Total Time Passed
Predicts the final cost of the project based on current performance:
BAC = (Revised Budget) / CPI
Forecasts the amount of additional funds needed:
ETC = EAC - AC
Indicates the efficiency required to finish the project within budget:
TCPI = (Budget - EV) / (Budget - AC)
The SPI is used to calculate the new time schedule:
New Time Schedule = (Revised Time-Table) / SPI