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Understanding Project Costs
in a Simple Way

Estimating and controlling project costs can be tricky. And because it is usually hard to keep them within the initial budget, managers need an efficient tool to monitor the costs at any point in time.

To be sure, there are plenty of tools on the market today. Some businesses solve this problem by making use of large-scale software solutions, such as Microsoft Project and the like. Needless to say, this doesn’t work for everyone, so we suggest to look at a cheaper and simpler way to track costs.

Types of Cost

Let’s start with some theory. Project costs are expenses that incur in the course of running a project, and this generic definition covers many types of costs that eventually affect project profitability and resulting output.

It’s useful to define and describe cost types for better understanding of how and when they incur, and what are the ways to influence them. There are many ways of categorizing costs, but mostly categories are focused on the relationship between the cost and the output. So here are the most important of output-centered categories:

  • Direct and indirect costs. Direct costs can be traced to specific objects and are related to the volume of output – for example, cost of material, costs of direct labor (necessary for producing the product), and other manufacturing costs. Indirect costs, on the other hand, are not directly related to output and cannot be traced to specific cost object. However, they are necessary to get work done. For example, rent, taxes, supervisors’ salaries, and depreciation of utilities are indirect costs.
  • Fixed and variable costs. Similar to direct and indirect costs, these two cost types differ by their effect on the production volume. While there’s no relation between fixed costs and the resulting amount of goods or services, variable costs vary with the output. For example, rent or depreciation are fixed costs, while costs of labor and material are variable. Some costs are considered mixed, as they don’t relate directly to the output but affect its amount to certain extent.
  • Product and period costs. As the names of the categories suggest, the first one defines the cost of a product incurred during the entire production cycle. The second describes the cost that incurs in a specific interval – week, month, quarter etc.
  • Opportunity costs. This economic concept, also known as alternative costs, plays an important role in decision-making when preparing strategies, planning work scopes, and defining the scope of the resulting output. It describes the value of the choice that has not been taken – and if there are several choices, the value of the most valuable one. Basically, it is the loss from potential gain from the alternative that hasn’t been chosen.
  • Sunk costs. An important concept for managing and optimizing cost-to-output relation. Sunk costs are the costs that have already been incurred without the ability to recover them. They should not affect rational decision-making about investment, as they cannot be avoided or recovered once spent. However, they affect irrational decisions due to the effect of loss aversion, which is any project manager should be aware of.
  • Prospective costs. This type of costs is hypothetical and only incurs when certain action is taken. Until then, they can be avoided. They influence overall costs of a project and it’s not uncommon that they lead to unintended losses.

It’s also important to understand cost structure applied to specific work parts and activity areas. This is essential for analyzing and optimizing project profitability. Generally speaking, there are four major types of costs:

  • Preplanning costs. These are the costs incurred before the actual launch of the project. They can include hiring new employees and staffing the project team, conducting market research and other preparatory work. Consultancy and insurance fees also fall under this type.
  • Material costs. They include the costs of any materials required to build a product or complete a project. For example, if you were to make a chair, you would need to buy pieces of wood, nails or screws, glue, and paint. In the IT industry, material costs can include buying third-party software, servers, storage space, and so on.
  • Human resources. The largest portion of these expenses are payroll costs for all employees working on the project. Any salary should be taken into account here, regardless of the employee’s role, level, or tenure. Very often, salary calculations are based on employee’s monthly performance, for example the number of hours worked.
  • Operating costs. Any costs incurred to ensure the daily operations of a business are operating costs. For example, the office rent, legal fees or office supplies.

Estimating costs

Estimation is one of the first and the most important steps of cost management. There are various estimation types that are applicable to various project types, stages, and uncertainty degrees. The types vary by their scope and accuracy and can be used depending on the availability of relevant data, specific project step, and specific requirements. Here are three estimation types used in project cost management:

  1. Order of magnitude estimate. A very rough estimation conducted at the first stages of a project. It provides managers and stakeholders with the ballpark figures of the actual project cost, what are key factors that affect overall cost, and how the figure can be influenced. The resulting cost can vary by 50-100 percent from this estimate.
  2. Budget estimate. More accurate than the previous type, budget estimate is focused on creating a preliminary list of project cost components. It can differ from the final figure by 10-25 percent, depending on the specific estimation accuracy requirements.
  3. Definitive estimate. With the accuracy of 5-15 percent, this estimate is prepared after the full project plan is ready, and normally includes not only cost items, but also justifications and clarifying descriptions.

Using a Timesheet for Project Cost Management

Depending on the industry, labor costs can make up to 50% of the overall project cost. Often they are the most challenging to control. Yet there is a convenient way to estimate and manage them: employee timesheet.

Timesheets offer multiple ways to organize the process. What you need at this point is detailed project planning. First, start with defining deadlines and time budget for your project. Keep in mind that it’s easier to plan when you break down the project into smaller tasks or steps, and define estimates for each task.

During this step, you can also specify your estimated costs, or set up an alert to inform you when the task budget reaches a certain threshold. This will help you stay proactive in managing the costs.

Next, decide who will be working on which part of the project and assign the tasks accordingly. Once everything is set up, your staff can start tracking their hours using the timesheet.

Throughout the entire project lifecycle, managers will now have valuable data at hand. If we consider the usage convenience, it certainly pays off to choose a timesheet application with built-in reports. They will provide an insight into the current project cost and your team’s progress. The information on project costs will remain valuable even after the project is completed, since managers will be able to leverage historical data in order to make estimates for future projects.

Summary

Project costs don’t constitute a single lump sum. On the contrary, they are built up of several cost types, with human resource costs making up the bulk of the total sum. A simple way to monitor these expenses is to keep timesheet software.

Timesheets are instrumental in estimating and monitoring payroll costs. With detailed information on spent hours and deadlines, they also provide important benchmarks for evaluating the project progress.

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