Agribusiness Project Management

July 2017
 Session 5
Project Cost Management

Basic principles of cost management.

Project cost management processes.
Cost estimation principles and methods.
Analogous estimation.
Parametric estimation.
Cost estimation accuracy.
Project budget development principles and methods.
Project budget controlling methods.
 What is Cost and Project Cost Management?

Cost is a resource spent to achieve a specific

objective or something given up in exchange.

Costs are usually measured in monetary units,

such as dollars.

Project cost management includes the

processes required to ensure that the project is
completed within an approved budget.
 Project Cost Management Processes

Plan Cost Estimate Determine Control

Management Budget
Costs Costs
 Project Cost Management Processes

1. Plan Cost Management. The process that establishes the

policies, procedures and documentation for planning,
managing, expending and controlling project costs.
2. Estimate Costs. The process of developing an
approximation of the monetary resources needed to
complete project activities.
3. Determine Budget. The process of aggregating the
estimated costs of individual activities or work packages to
establish an authorized cost baseline.
4. Control Costs. The process of monitoring the status of
the project to update the project costs and managing
changes to the cost baseline.
Basic Principles and Terms of Cost Management

Most members of an executive board have a better

understanding and are more interested in financial
terms than in specific industry language, so project
managers must speak their language.
Profits are revenues minus expenses.
Life cycle costing considers the total cost of
ownership, or development plus support costs.
 Basic Principles and Terms of Cost Management

Tangible costs or benefits are those costs or benefits that

an organization can easily measure in dollars.
Intangible costs or benefits are costs or benefits that are
difficult to measure in monetary terms.
Direct costs are costs that can be directly related to
producing the products and services of the project.
Indirect costs are costs that are not directly related to the
products or services of the project, but are indirectly related
to performing the project.
Sunk cost is money that has been spent in the past; when
deciding what projects to invest in or continue, you should not
include sunk costs.
Basic Principles and Terms of Cost Management

Learning curve theory states that when many items are

produced repetitively, the unit cost of those items
decreases in a regular pattern as more units are produced.
Reserves are dollars included in a cost estimate to
mitigate cost risk by allowing for future situations that are
difficult to predict.
Contingency reserves allow for future situations that
may be partially planned for (sometimes called known
unknowns) and are included in the project cost
baseline.
Management reserves allow for future situations that
are unpredictable (sometimes called unknown
unknowns).
Basic Principles and Terms of Cost Management

Variable Costs
Change with the amount of production/work,
e.g. material, supplies, wages
Fixed Costs
Do not change as production change
e.g. set-up cost, rental cost
 Cost Estimation

There are three major cost estimate types that project

managers should rely on:
Rough Order of Magnitude (ROM) Estimate
Budget Estimate
Definitive Estimate
 Types of Cost Estimation

Type of
When Done Why Done How Accurate
Estimate
Very early in the Provides estimate
Rough Order of product life-cycle, of project cost for
Magnitude at the stage of selection project - 25% to + 75%
(ROM) feasibility study. selection
decision.
Early in the Provides high-
Budget project planning level cost
- 10% to + 25%
Estimate stage. estimation.

Later in the Provides refined

Definitive project planning date for project
- 5% to + 10%
Estimate stage. budgeting.
Rough Order of Magnitude (ROM) Estimate

Rough Order of Magnitude (ROM) Estimate is also

known as Ballpark Estimate.
A ROM estimate is based on high-level objectives,
provides a birds-eye view of the project deliverables
and has lots of wiggle room.
Most of ROM estimates, depending on the industry,
have a range of variance from -25% all way to the
+75%.
 Estimating Methods

Analogous (Top Down) estimating Managers use

expert judgment or similar project costs (quick, less
accurate).
Bottom-Up estimating People doing work estimate
based on WBS, rolled up into project estimate (slow,
most accurate).
Parametric estimating Use mathematical model (i.e.
cost per sq. m.) (accuracy varies). Two types:
Regression analysis based on analysis of
multiple data points
Learning Curve The first unit costs more than
the 100th, forecasts efficiency gains.
 Estimating Methods

Vendor Bid Analysis Estimating using bids +

allowances for gaps in bid scope (slow, accuracy
depends on gaps)
Reserve Analysis Adding contingency to each
activity cost estimates as zero duration item (slow,
overstates cost)
 Determine Budget

Determine Budget is the process of aggregating the

estimated costs of individual activities or work packages
to establish an authorized cost baseline.
The key benefit of this process is that it determines the
cost baseline against which project performance can be
monitored and controlled.
A project budget includes all the funds authorized to
execute the project. The cost baseline is the approved
version of the time-phased project budget, but excludes
management reserves.
 Cost Aggregation

Project Management
Budget Reserve

Cost Baseline Control Contingency

Accounts Reserve

Activity
Contingency
Reserve
Total amount

Work Pachage
Cost Estimates Activity Cost
Estimates

Project budget component

 Project Budget Spending

120
Project Budget
Management Reserve
100 BAC

80
Funding
60 Requirements
Cost Baseline
40
Expenditures
20

0
0 10 20 30 40 50 60 70 80 90 100
 Cost Budgeting

Cost budgeting involves allocating the project cost

estimate to individual work items over time.

The WBS is a required input for the cost budgeting

process because it defines the work items.

Important goal is to produce a cost baseline:

A time-phased budget that project managers use to

measure and monitor cost performance.
 Cost Control

Project cost control includes:

Monitoring cost performance.

Ensuring that only appropriate project changes are

included in a revised cost baseline.

Informing project stakeholders of authorized

changes to the project that will affect costs.

Many organizations around the globe have problems

with cost control.
 Key Parameters of EVM

Planned Value (PV):

What value of work should have been accomplished to
date?

Earned value (EV):

How much value has been realized to date?

Actual Cost (AC)

How much has actually been spent to date?
 Key Parameters of EVM

Cost Variance (CV):

CV = EV AC
Schedule Variance (SV):
SV = EV PV
Cost Performance Index (CPI)
CPI = EV / AC
Schedule Performance Index (SPI)
SPI = EV / PV
 Earned Value Management

Method to measure project performance against scope,

schedule and cost baseline (performance
measurement baseline)
Interpretation of basic EVM performance measures
Cost Performance Index (CPI)
Schedule Performance Index (SPI)
 Earned Value Management

Method to measure project performance against scope,

schedule and cost baseline (performance
measurement baseline)
Interpretation of basic EVM performance measures
Cost Performance Index (CPI)
Schedule Performance Index (SPI)

Performance Schedule
Measures SV > 0; SPI > 1 SV = 0; SPI = 1 SV < 0; SPI < 1
CV > 0; CPI > 1 Ahead of schedule, On schedule, Behind schedule,
Cost Under budget Under the budget Under the budget
CV = 0; CPI = 1 Ahead of schedule, On schedule, Behind schedule,
On budget On budget On budget
CV < 0; CPI < 1 Ahead of schedule, On schedule, Behind schedule,
Over budget Over budget Over budget
 Earned Value Technique: Example
Project Budget: $400K At the 3 month checkpoint:
Project Schedule: 4 months
Spent: $200K
Work completed: $100K

Terms and Formulas Definition Example

Earned Value (EV) As of today, what is the estimated value (based on

budget prices) of the work actually accomplished? $100K

Actual Cost (AC) As of today, what is the actual cost (actually spent
money) incurred for the work accomplished? $200K

Planned Value (PV) As of today, what is the estimated value (based on

budget prices) of work planned to be done? $300K

Cost Variance (CV) Negative is over budget $100K $200K

= EV - AC Positive is under budget = ($100K)

Schedule Variance (SV) Negative is behind schedule $100K - $300K

= EV - PV Positive is ahead schedule = ($200K)

Cost Performance Index We are getting $__ worth of work out of every $1 $100K/$200K
(CPI) = EV/AC spent. Are funds being used efficiently? = 0.5 i.e. 50%

Schedule Performance We are (only) progressing at __ percent of the rate $100K/$300K

Index (SPI) = EV/PV originally planed = 0.33 i.e. 33%

4/0.33
Revised Total Duration Baseline Duration/Schedule Performance Index
= 12 months
 Earned Value Technique

Terms and Formulas Definition

Budget at completion How much did we BUDGET for the TOTAL project
(BAC) effort?

Estimate at Completion What do we currently expect the TOTAL project

(EAC) = BAC / CPI cost (a forecast)?

Estimate to Complete From this point on, how much MORE do we expect
(ETC) = EAC - AC it to cost to finish the project (a forecast)?

Variance at Completion As of today, how much over or under budget do we

(VAC) = BAC EAC expect to be at the end of the project?

EAC is an important forecasting value.

 Earned Value: Graphical Representation

how much we
actually spent by now

PV - how much was

planned to spend
Cost

for the works that

had to be
completed by today

EV budget cost of the work

completed by today

Time
Today
 Earned Value: Graphical Representation
Projection of
schedule delay
at completion
Estimate at
Completion
EAC (EAC)
Projection of
cost variance
BAC at completion
(VAC)
AC

Budget at
COST

Cost Completion
Variance (BAC)
(CV)
PV
Schedule
Variance
ACTUAL (SV)
EV
PLAN

EARN
VALUE

TIME
TODAY
(Reporting
day)
Project is over budget & behind schedule
 To-Complete Performance Index (TCPI)

Helps the team determine the efficiency that must be

achieved on the remaining work for a project to meet a
specified endpoint, such as BAC.

Work Remaining (BAC EV)

TCPI
Funds Remaining (BAC AC)

TCPI value above 1 indicates utilization of the project

team for the remainder of the project can be stringent.
TCPI value below 1 indicates utilization of the project team
for the remainder of the project should be lenient.
 Estimate To Complete (ETC)

Estimate To Complete (ETC) is the estimated cost

required to complete the remainder of the project.

Estimate To Complete (ETC) is calculated and applied

when the past estimating assumptions become invalid and
a need for fresh estimates arises.

ETC is used to compute the Estimation at Completion

(EAC).
 Estimate At Completion (EAC)

Estimate At Completion (EAC) is the estimated cost of the project at

the end of the project.
There are several methods to calculate EAC applicable to different
cases:
Variances are typical - This method is used when the variances
happened at the current stage are not expected to occur in the
future.
Past estimating assumptions are not valid - This method is
used when the past estimating assumptions are not valid and
fresh estimates are applied to the project.
Variances will be present in the future - This method is used
when the assumption is that the current variances will be continue
to be present in the future.
No variances from BAC have occurred or you will continue on
the same rate of spending.
 Estimate At Completion (EAC)

Variances are typical - This method is used when the

variances happened at the current stage are not
expected to occur in the future.

Formula:
EAC = AC + ( BAC - EV )
 Estimate At Completion (EAC)

Past estimating assumptions are not valid -

This method is used when the past estimating
assumptions are not valid and fresh estimates are
applied to the project.

Formula:
EAC = AC + ETC
 Estimate At Completion (EAC)

Variances will be present in the future - This method is

used when the assumption is that the current variances
will be continue to be present in the future.

Formula:
EAC = AC + ( BAC- EV ) / (CPI cum * SPI cum )
 Estimate At Completion (EAC)

No essential variances from BAC have occurred or

you will continue on the same rate of spending.

Formula:
EAC = BAC/ CPI cum
 Variance At Completion (VAC)

Variance At completion (VAC) is the variance on the total

budget at the end of the project.
This is the difference between what the project was
originally expected (baselined) to cost, versus what the it
is now expected to cost.

VAC = BAC - EAC

 Exercise

You have a project to build a box. The box is six sided. Each side is to
take one day to build and is budgeted for $1000 per side. The sides are
planned to be completed one after the other. Today is the end of day
three.
Using the following project status chart, calculate PV, EV, AC, BAC,
CV, CPI, SV, SPI, EAC, ETC, VAC.
Describe your interpretation based on the calculation!
Task Progress Cost spent
Side 1 ||||||||||||||||||||||||||||||||||||||||100% $1,200

Side 2 ||||||||||||||||||||||||||||||||||||||||100% $1,000

Side 3 ||||||||||||||||||||||||||||||75% $750

Side 4 ||||||||||||||||||||50% $500

Side 5 0% $0

Side 6 0% $0
 Exercise Solution

Parameter Calculation Result

PV
EV
AC
BAC
CV
CPI
SV
SPI
EAC
ETC
VAC

Is the project below or over budget?

Is the project late or ahead schedule?
How much more money we need?