The Long & Short of Project Cost Management

If you are in the business of delivering projects, then project cost management is critical to your success. Without a reliable cost estimate, you won't be able to anticipate how much money your project will require and how long it will take to complete.
Iryna Viter
April 29, 2022

As a project manager, there's nothing worse than having your project go over budget. If you've experienced that, you're not alone: an estimated that over 85% of projects run over their initial budget. That means a lot of profit margins being squeezed - and a lot of stress for the person in charge of cost management!

For every successful project, it’s crucial to understand its costs and manage them well. But, every project's activities and costs are unique, which can make managing each one challenging. In this article, we'll lead you through the complex world of project cost management, and arm you with tips to keep your project costs in check.

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What is project cost management?

By PMBOK's definition, project cost management is the process of planning, estimating, budgeting, financing, managing, and controlling costs to complete the project within the approved budget.

Project cost management aims to avoid any cost overruns on projects, ensure project profitability, and keep profit margins high. As a project manager, it is essential that you calculate project costs during the planning phase for approval before work commences to stay within the cost management plan.

Successful project cost management begins with good estimation practices. It is one of the most important aspects of project management and a primary function of any project manager.

Cost estimation is the process of predicting the cost of resources to complete a project. It is performed by the project manager, usually along with the core team. Cost estimation is an ongoing process that continues as the project moves from definition to completion. It is especially relevant when dealing with fixed-price projects.

This means that you, as the project manager, need to understand the cost of each activity within your project, and how much time it will take to complete each activity.

Why is project cost management important?

Project cost management is an important component of project management. When you start a new project you will have to consider all the resources needed for you to run a successful project and avoid budget overruns.

Why do we need it? When you have this information, you can use it to track costs throughout the project. The cost estimates are used as a baseline for controlling budgeted costs and are compared against actual costs throughout each phase of the project.

Cost management is crucial because it helps you:

  • Monitor and control spending during a project's lifecycle.
  • Identify ways to reduce costs by comparing estimated costs with actual costs and evaluating variances for possible corrective actions.
  • Analyze cost trends to determine whether current spending is sustainable. If there is a wide variation, corrective action may be needed to bring expenditures back in line with expectations.

Here's an example of a project cost management dashboard from Runn:

project cost management

Budget overruns can affect the bottom line, reduce customer satisfaction, and fail meet established goals. But when you manage your project accounting effectively, you can ensure that you deliver the results promised within the approved budget. This may improve future budget allocations for your projects.

The challenges of cost estimation in project management

Cost estimates are rarely accurate because they are based on assumptions, and you can’t predict the future with absolute certainty. However, it is critical to have accurate cost estimates so that you can ensure your project budget is sufficient.

Although project forecasting cost is a critical management skill, it's also one of the most challenging. The challenge is due to the many potential risks that can be hard to detect and the fact that project managers are rarely in control of all the project variables that influence the total costs.

At each stage of a project's timeline, there are four main challenges to predictability:

  • Short-term uncertainties
  • Long-term uncertainties
  • Project complexities and interdependence
  • Stakeholder objectives

Short-term uncertainties

The early stages of a project require some guesswork as you estimate resources and timelines based on preliminary information. You'll have to refine your estimates as more details emerge, but even then, you'll be dealing with assumptions.

Long-term uncertainties

Some uncertainties come after the early stages are completed, even though you have detailed plans. These are unforeseeable at the start of a project but only surface as the project progresses. The unexpected costs associated with these uncertanties can mean you need to find more money, which becomes a critical factor in project success.

Complexity and interdependence

The longer a project goes on, the more complex and interdependent its elements become. This makes it difficult for any manager to keep track of the cost management process affecting budgets and schedules.

Project managers also find that these complexities pose additional challenges for effective communication among project teams. The lack of effective communication ultimately undermines predictability even further, and can impact project performance.

Stakeholder objectives

Timely completion of the main objectives is usually a goal for everyone involved in a project, but so is cost containment. When changes occur during the project life cycle, stakeholder objectives may dictate the path to choose and the costs involved. It can then be a stressful process to manage the specific project to avoid cost and budget overruns.

How to create an accurate cost estimate

The cost of a project is typically broken down into three parts:

  • Direct costs
  • Indirect costs
  • Contingency costs.

Direct costs can be directly tied to the work being done on project-related tasks. They may include material costs, time spent by employees on the project, travel expenses for fieldwork, subcontractors' costs, etc.

Indirect costs are general business costs such as rent, utilities, and equipment crucial in keeping the project operational. It also includes salaries for non-project employees, and insurance.

Contingency costs are extra funds reserved for unforeseen events that have low probability but high impact if they occur. Reserve analysis can help you estimate the contingency you need for your project.

So, once you have estimates for these three aspects, you can add them all up together so that everything is accounted for. Remember to take your time to carefully budget for the project to ensure you cover every aspect. A rushed budget means you will miss something crucial, which will be detrimental to a project's success.

Factors that influence the project budget

The cost may be influenced by factors such as scope, quality, schedule, human resources, risk, and procurement.

Scope

To create an accurate cost estimate, you will first want to review the project scope. This refers to the details of what needs to be done to complete a project. The scope of your project has a lot to do with the final cost so you need to make sure that it’s as detailed as possible.

The more complex the project requirements are, the more they will contribute to the overall project cost. Cost estimates should be broken down into phases so that companies can adequately budget for each phase of work.

For example, if your client has made changes during the planning process which did not feature in your original actual cost estimate, you will want to update it now.

Quality

Quality refers to how well a product or service meets customer expectations. Higher-quality projects typically require more resources than those with lower standards for quality control; therefore, higher quality comes at a higher price tag when it comes to managing projects within your company’s budget.

Understanding your client's expectations for quality before the start of the project is vital, particularly for projects with fixed costs.

Human resources

Human resources professionals in project management are personnel with the skills and abilities necessary for a project to succeed. A work breakdown structure will help simplify the resources you will need to complete each task.

For each project, a qualified person has to be assigned. If a project is complex, it will necessitate additional professionals, which will impact the overall management cost.

You should use a spreadsheet or project accounting software to calculate the labor component of your project cost estimate. On a basic level, this involves multiplying estimated labor hours and hourly wages, but more detailed estimation methods relating to the different costs of different resources will help you get a more accurate total estimated cost.

Schedule

The length of time a project takes also affects its total cost. A project that takes a long time to execute, will need a larger budget to see you through to project completion.

However, a longer schedule sometimes helps with cost control, as it gives you more flexibility with critical tasks and scarce resources. Rather than having to hire a new specialist, for example, you may be able to adjust your resource schedules to that your in-house specialist can work on the project around their other tasks.

Risk

Project managers need to factor in unforeseen occurrences such as that may affect a project. These risks could be uncertain events or conditions affecting a project. Project risks also include scope creep, operation changes, changes in product prices, stretched resources, (time risk as a result of delayed timelines), and miscommunication that causes a lack of clarity.

Techniques for effective project cost management

There are three basic techniques for effective project cost management:

  • Top-down estimating: Project managers estimate costs in the early stages of a project based on the assumption that similar past projects will have similar future costs.
  • Bottom-up estimating: Project managers make an initial estimate based on various factors such as the nature of the work, the duration and resources required to complete the work, and current market rates.
  • Earned Value Management: A more accurate way to estimate costs is by using earned value management (EVM), which allows you to track the actual cost and progress of a project.

While the bottom-up approach is often the simplest when starting out, the other techniques can help you generate a good budget with an accurate estimate of project costs.

Top-down estimating

Companies can use historical data from past projects to estimate costs on current or future projects as a good starting point. Project management software can help in ths process, as you you can look at previous projects with similar deliverables, timelines, team sizes, and objectives for a more accurate budget estimate.

If you don't have any similar projects to use for your estimate, you will need to do more research. One way is to ask people familiar with the type of work that needs to be done on this project if they have any estimates. However, do not blindly accept someone else's numbers without understanding how they were calculated and whether they are accurate.

You can also ask people in your organization who may have worked on similar projects. If all else fails, look at other sources of information such as industry surveys and published case studies.

Earned value management

When you have the total cost estimate for your project expenses, you can create a cost baseline for your project. This is important in helping you carry out detailed planning, which will prevent extra costs.

Earned value management comes into play while the project is underway. It helps you compare your actual costs to your original budget, or cost baseline. This tells you whether you are on track or need to make and adjustment.

Other project cost estimation techniques

Techniques like expert judgment, analogous estimation, and parametric estimation are also very helpful in creating an accurate cost estimate. They rely on input from experts in different fields who have relevant background knowledge and experience working on similar projects before.

Once you have the initial estimate, you can use the inputs about what you know about the project to determine if your initial estimate needs to be adjusted. For example, if you are working on a new product launch and your company has successfully launched several other similar products, it may be possible to use historical information about those projects (analogous estimating) as a starting point for this project's cost estimate. Project accounting tools make it simpler for you to review historical projects and manage the costs of ongoing work.

Final thoughts

When developing a project plan, you should analyze cost performance; while supervising current and future expenses. This will help you avoid cost overruns. Resource planning will help sort out project costs to run your project profitability. Whether you are running small projects or large projects you need a tool that will help you manage your cost budget.

Resource management software like Runn extracts and displays project data for you so you can monitor your project activities. This project also helps in benchmarking future cost management plans and project budgets.

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