Whatever the size and the nature of a project are, its management is always a challenge. Project leaders and managers must coordinate a variety of resources and activities, keep their eyes on approaching deadlines, foresee hidden performance obstacles and anticipate the unexpected.
Such a task is surely not for faint-hearted.
While difficulties on the way towards project completion are many, cost management is by far the most significant of them, and a large number of companies fail to do it right. Cost overruns are extraordinarily common in every single sector of performance, every industry and every part of the world. They can reach enormous magnitudes in both short-term and long-term projects, seriously damaging their financial health and reducing chances for success.
Nevertheless, a comprehensive and systematic approach to cost management is a definite remedy to this problem. Focusing on aligning project needs with available resources, supervising current and future expenses, and analyzing cost performance, this practice can assist you a great deal in avoiding the risk of cost overrun.
In this article, we will define what project cost management is, discuss its role in project planning and overview its major components to help you see why you must invest in cost management yourself.
What Is Project Cost Management?
Cost management in projects encompasses the whole of the activities aimed to plan, estimate and monitor spending across the project’s life cycle, starting from its strategic outlining and ending with the assessment of outcomes.
The main objectives of project cost management are to
- calculate how much money is needed to perform tasks and duties involved in the project,
- develop a project budget and allocate funds as per the results of cost estimation,
- track down how much is spent on project-related activities and encourage compliance with the created budget,
- gather statistical data regarding actual project expenses to inform future decision-making.
With the accomplishment of all these objectives, you will increase your chance of taking project costs under control, which will help you reduce the risk of loss and maximize profit.
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Role of Cost Management in Project Management
Cost management is an integral part of project management in general, and its contribution to the project’s success is more than vital. To understand why, let’s identify the primary purpose of project management and explore the issue of project constraints in some detail.
Project Planning and the Triple Constraint
As such, the primary strive of project management is to attain formulated project goals within a specific timeframe, scope and budget. These three restrictive parameters are illustrated within the Triple Constraint Model as interdependent: a change in one of them inevitably entails changes in two others. For instance, when the project’s scope is enlarged, the number of efforts and resources needed to complete it increases. As a result, the deadline and the cost of that project become altered as well.
The origins of the Triple Constraint are unknown, yet the model has been used by managers across the globe for over half a century and has become a practice standard. As basic as it is, the triangle schematically depicts the foundational project boundaries that serve as metrics during resource planning.
In the present-day world of business, it is particularly important to remember the interdependence among project scope, timeframes and costs. The modern environment is rapidly evolving and extremely competitive. It makes managers compromise at every step and choose between affordability and quality, speed and effectiveness, stakeholder satisfaction and profitability. The list goes on.
Thus, you must always be aware of the fact that a decision to complete the project in a shorter-term will entail the necessity to reduce the volume of project-related tasks or invest more money in skilled personnel and technology. Otherwise, you will likely fail to meet the deadline or the quality of your work will badly suffer.
Overall, the Triple Constraint Model is here to remind you of that.
Why Cost Planning is Especially Important?
While all the three parameters included in the Triple Constraint are undoubtedly important to take into account, statistical data show that cost is the most critical factor in defining project failures and success.
According to the McKinsey-Oxford study on performance in the IT sector, cost overruns in software projects can reach 66% on average, and in projects that are not related to software – 43%. However, IT companies are not the only ones to bear financial risks after going over their project budgets. A recent review of evidence from international construction industries revealed that an average cost overrun in medium-sized projects is as high as 32.5%, whereas in megaprojects, the number may reach 88%.
These statistics indicate that regardless of all the advancements in the practice and theory of project cost management throughout the last decades, many projects still suffer the consequences of inadequate expenditure prediction and control. Partially, project cost overruns may be attributed to the lack of a clear strategic plan and managers’ inability to consider potential risks and environmental changes. However, underestimation of project expenses should be validly named the leading reason why businesses go far above their budgeted expectations.
In contrast to teams with a thoughtless attitude to cost management, a serious and careful approach to this essential practice can take you and your project a long way.
Project Cost Management: 4 Main Processes
The process of successful project cost management is conducted systematically and usually involves 4 steps:
- resource planning,
- cost estimation,
- budgeting,
- and spending control.
In this section, we will overview each of them separately and identify their main outcomes / values.
Resource Planning
Resource planning is an initial stage in project cost management and is closely interrelated with the process of project planning as such. To comprehend which resources are required to start and complete the project, you must know it from the inside out: its short-term objectives, long-term goals and the environment where it is going to be realized. In other words, resource planning is impossible without a well-defined project strategy and a distinct idea of how to implement it.
Based on this, the list of practices involved in resource planning is as follows:
- analysis of the project’s plan and strategy, as well as all relevant internal and external environmental factors;
- estimation of the amount of required resources (e.g., talents, equipment, intellectual property, etc.);
- specification of work activities / procedures based on the knowledge of project scope and timeframes;
- identification of current resource deficits and needs by using the results of the environmental analysis;
- creation of an evidence-based proposal for resource acquisition and allocation.
As an outcome of performing these practices, you will come up with a clear picture of the activities and resources needed to complete the project. You will also see what these resources and activities are, how much you already have and how much you still must acquire. After that, you may proceed towards a more detailed calculation of project-related expenses.
Cost Estimation
Cost estimation implies the assessment of the total amount of money necessary to perform the project. Information obtained at the stage of resource planning will help you a great deal while sorting out project costs: since you already know the quantity and types of required resources, the primary task will be to identify their prices as accurately as possible. Then, just sum up the numbers to see how much the project will cost you as a whole.
Since underestimation and failure to foresee environmental changes increase the risk of cost overrun, you may consider carrying out a risk-based cost analysis as well. For example, evaluate potential loss due to a delay in the supply of essential production materials, some technical issues or even a discharge of a very important employee. Choose anything that makes sense in your situation and add the predicted cost of the event to other estimation results.
Whereas regular cost estimation will allow you to see if the planned project activities are financially feasible to perform and, afterward, optimize them accordingly, risk-based cost assessment will also entice you to secure a backup amount in your project budget. This money will later serve as a cushion against unpredictable and costly events.
Budgeting
At the third phase in project cost management, you will develop a budget – a summary of all expenditures and/or revenues involved in the project. As such, this important document has a purpose to conclude the cost calculation and resource planning efforts. It
- states the final cost estimates,
- clarifies how much money you will have at different stages in the project’s life cycle,
- and indicates how much funds could be and should be allocated to certain project activities.
In the end, a well-developed project budget will lay the foundation for cost control that your team must perform to avoid excess spending and get more profit.
Cost Control
Cost control is the practice of identifying, monitoring and evaluating project costs with an aim to reduce expenses and maximize revenues of a business. It is carried out by contrasting the actual financial performance of the project with expectations stated in the budget.
In an ideal situation, your team should always comply with budget estimates. However, since cost overruns are frequent and are difficult to control 100% of the time, it is important to ensure that all expenses are properly recorded and, consequently, subjected to a thorough analysis.
By comparing data on actual project costs with those stated in the budget, managers can detect flaws in their approach to project cost management and disclose factors that were left without appropriate attention but require consideration. In this way, it becomes possible to enhance the accuracy and quality of cost management and improve the financial performance of future projects.
To sum up the above, here is a list of major procedures involved in cost control:
- encouragement of compliance with budget estimates,
- cost tracking by using robust reporting tools or project cost breakdown structures,
- cost evaluation throughout the project’s life cycle by comparing actual expenses with the predicted ones,
- assessment of the project’s financial performance upon its completion as a means to inform future decision-making and improve the practice of project cost management.
Conclusion
Although cost control is never painless, by approaching it systematically and attentively, you will increase the chance of the project’s success to a substantial degree.
Remember about the triple constraint when developing the project plan, follow the 4-step cost management process explained in this article and adapt it to your business needs and project ideas to gain even better results. The more experience and expertise in cost management you will get along the way, the easier it will become for you to complete any project within the budget and on time.
