Controlling Project Costs


Control Costs

Controlling project costs is all about monitoring expenditures, preparing cost forecasts, comparing realized costs against cost baseline and managing changes to it.

This is a project management activity where actual cost of work performed is measured. It is then compared against the allocated budget for the work to understand whether team has spent more, or less than the budget. In case team has spent more than the budget, then forecasts are calculated to understand how much more budget would be required to complete the work within schedule. In case the budget needs to be increased, project manager goes to the sponsor making a case for more budget.

Any resultant changes to cost baseline are managed using Perform Integrated Change Control process.

Controlling project costs is a two-step process –

  1. Calculate variance against baseline
  2. Plan corrective or preventive actions

Earned Value Method (EVM) calculation method helps you with #1 above.

Acronyms

It would be useful at this stage to just read through the list of acronyms used in the tools and techniques of this process.

  • EV – Earned Value. Also referred to as Budgeted Cost of Work Performed (BCWP).
  • AC – Actual Cost. Also referred to as Actual Cost of Work Performed (ACWP).
  • PV – Planned Value.
  • PMB – Total PV is sometime referred to as Performance Measurement Baseline.
  • SV – Schedule Variance.
  • CV – Cost Variance.
  • SPI – Schedule Performance Index.
  • CPI – Cost Performance Index.
  • BAC – Budget At Completion.
  • EAC – Estimate At Completion.
  • ETC – Estimate To Complete.
  • TCPI – To-Complete Performance Index.
  • TAB – Total Allocated Budget.

Exam tip> Understand the alternate acronyms used in the list above. Exam questions may refer to any of them. For instance, instead of Actual Cost, the question may refer to Actual Cost of Work Performed or just ACWP.

What do you need to control project costs?

You need to refer to Cost management plan, and the Cost baseline – which is the yardstick to compare actual cost measurements against, so we know the variance and do something to fix them.

Project funding requirements is about figuring out amount and frequency of time at which budgeted money should be released. This would depend on projected expenditure plan, which is made based on when certain resources come into play during project execution.

For instance, for a new e-commerce product you may need an exhaustive security audit when version 1.0 of the product is released. You will need a funding release around this time.

Then you will need to know the state of project. Information such as which activities (or WBS components) have been taken up, how many are completed, how many are delayed, what is the cost incurred on the work performed, so on.

If your organization has certain cost control related policies, procedures, tools, reporting methods so on, you need to know them as well.

How do you do it?

Earned Value Management (EVM)

This is the most common methodology used to check project progress. It integrates project schedule, cost and scope and gives pretty good indication of project’s state against integrated baseline.

EVM is applicable to any industry and domain. You may refer to the EVM guide used by the US Department of Defense here.

We will cover entire EVM calculations in the next lesson. It will be useful for you to complete next lesson and come back and continue from here.

Forecasting

Forecasting is a means of identifying efforts required to meet project objectives based on the trend shown by project progress so far.

Estimate at Completion (EAC)

Ideally this should be same as Budget at Completion (BAC), which is calculated first during initial planning exercise. However, practically EAC will be different from BAC.

How do you decide whether Budget at Completion is still valid for the project?

A good indication is if the value of CPIs you calculate for successive periods of time start getting farther below 1.0. It is better to calculate EAC the moment you get a CPI < 1.0, to know what it takes to complete the project work. In simpler words, if the project is over budget you need to calculate EAC.

EAC can be calculated manually based on project management team’s knowledge of how project has progressed, using bottom-up ETC.

Estimate at Completion = Actual Cost + Bottom-up Estimate To Complete

EAC = AC + Bottom-up ETC

The downside of bottom-up ETC calculation is that it is best done by people who are actually doing the project work. Which means that team should stop their work and involve in this calculation exercise. This upsets momentum of their work and if they are already working under hard-pressed schedule this will further aggravate the situation.

There are few ways to calculate Estimate at Completion based on the data you already know.

Case 1: You know that remaining work will be performed at the planned rate (or ‘budgeted rate’)

This means that your project has carried out the work as per the schedule and cost planned for activities, and will continue at the same rate.

EAC = AC + (BAC – EV)

Case 2: You feel that future work will continue at the present Cost Performance Index (CPI)

EAC = BAC/CPI

Case 3: You are reasonably confident that future work can be conducted at the present cost and schedule indicators 

EAC = AC + { [BAC – EV] / [CPI x SPI] }

Let us understand these with few examples:

Example 1:

John’s house construction project entered fourth quarter, his actual money spent is at $150,000, and earned value is $153,000. For this much work he had planned approximately $155,000. During initial planning period his total project budget was $300,000. What will be his Estimate at Completion?

Answer: $297,000

This is how it is calculated –

John’s SPI = EV/PV; 153,000/155,000 = 0.9871

CPI = EV/AC; 153,000/150,000 = 1.02

Both indicators are hovering around 1.0, which means John is ahead of schedule and good on budget. He is reasonably confident of maintaining same rate going forward.

EAC = AC + (BAC – EV);

150,000 + (300,000 – 153,000) = $297,000

Note: you just need the last formula to calculate the answer. SPI and CPI are calculated just for cost and schedule health check.

SPI, CPI and other EVM formulae are explained in the next lesson, you may want to go through them before proceeding here.

Example 2:

John’s house construction project now entered fifth quarter, and he found his CPI that was consistently around 1.0, this time at a much better 1.03. During initial planning period his total project budget was found to be at $300,000. What will be his Estimate at Completion?

Answer: $291,262

John is quite happy to discover that his project is scheduled to complete within the initial Budget at Completion!

This is how it is calculated –

EAC = BAC / CPI;

EAC = 300,000/1.03 = $291,262

Example 3:

John’s house project entered sixth quarter now and his earned value has come to $225,000, while his actual spending is at $220,588. During initial planning period his total project budget was at $300,000. Now his CPI is working out to 1.02 and SPI at 0.95, what will be his Estimate at Completion?

Answer: $297,987

John is proving to be a competent project manager. He is close to completing the project and his EAC is still within initial BAC! He sure is happy to get his bonus once project is over!

This is how it is calculated –

EAC = AC + { [BAC – EV] / [CPI x SPI] };

EAC = 220,588 + { [300,000 – 225,000] / [1.02 x 0.95] } = $297,987

Estimate to Complete (ETC)

ETC is the estimate of work required to complete remaining activities on the project.

When EAC is known ETC is calculated as,

ETC = EAC – AC

This is because estimate to complete work is the difference between estimate at completion and actual cost of work performed.

Variance at Completion (VAC)

Based on the above, if you want to calculate variance at completion, you simply deduce EAC from BAC!

VAC = BAC – EAC

If this variance is negative it means that at the end of project expenditure will overshoot initial budget.

To-Complete Performance Index

The Budget at Completion (BAC) is planned initially and then the Estimate at Completion (EAC) is calculated during execution phase (when it is clear that BAC cannot be achieved). These are two cost-related goals a project must hit (remember that EAC replaces BAC). And to achieve this goal there is To-Complete Performance Index (TCPI). TCPI is the CPI you need to achieve in order to complete remaining work within the remaining authorized budget.

Put simply, To-Completer Performance Index is calculated by dividing Remaining Work by Remaining Budget.

TCPI = Remaining Work / Remaining Budget

Remember!

Unlike the CPI, higher the value for TCPI more budget control mechanisms are to be applied. These are two opposites.

Remaining Work is calculated by deducting project value earned so far from calculated Budget at completion. This would be (BAC – EV).

Remaining Budget is calculated by deducting actual cost spent so far on the product from the Budget at completion. This would be (BAC – AC) or (EAC – AC) – as the case may be. This makes two distinct cases to calculate TCPI.

Case 1: If you find that project is under budget then you will use Budget at Completion –

 TCPI = (BAC – EV) / (BAC – AC)

 Case 2: If the project is over budget, you need to calculate Estimate at Completion (remember that EAC should be approved through change control process) and use the following formula for TCPI –

 TCPI = (BAC – EV) / (EAC – AC)

Consider an example –

John’s house construction project enters final phase and his CPI is > 1 (project is within budget). Project has spent thus far $260,000 and earned value achieved is about $255,000. Total project budget was planned to be $300,000. What is the TCPI to ensure that project completes within the Budget At Completion?

Answer: 1.1

TCPI = remaining work/remaining budget;

TCPI = (BAC – EV) / (BAC – AC);

(300,000 – 255,000) / (300,000 – 260,000) = 1.1

What do you produce during cost control exercise?

You will calculate values and metrics such as PV, EV, AC, SI, SPI, CI, CPI, TCPI, EAC, ETC – these are documented and shared with appropriate stakeholders.

Forecasts – EAC (Estimate At Completion) calculated either manually (using bottom-up approach) or using formulas is the forecast. These are shared with the stakeholders.

EAC becomes a formal figure only when change control board authorizes it. Authorization is given after project manager or project management team takes EAC as a change request through Integrated Change Control process and formalizes it.

Change requests – whenever some work is monitored it is bound to produce change requests as deviations are discovered. EAC, among others, can be the single most prominent change request in this process.

Summary

Controlling Project Costs is one of those few project management activities that must be executed throughout the project execution phase. If you are doing it for the first time, you may find it a bit tedious. However, the advantage you get is the early warnings of whether the project is slipping. This may help you save cost, effort, customer escalation, or may even save the day. You may find it almost a necessity to run EVM calculations and TCPI every Monday (or whatever frequency you decide on) for your peace of mind.

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