Within the project management context, begins with estimating. As a practical matter, there are three (3) primary uses for project “cost estimating”:
- To identify and quantify potential (and probable) project “cost factors” (i.e. what will we have to spend money on?).
- To estimate related cost values and create an appropriate, realistic budget (i.e. how and when funding will be spent).
- To track estimated costs (as they become actual expenditures) and monitor any and all resulting variances.
Cost Control is Part of “Managed Change”
Since project cost estimates are just that – estimates, and it is unlikely that related project budget, resulting from these estimates, can be etched in stone. Projects have a pulse, and the circumstances and conditions under which projects occur can, and do change, impacting costs and expenses. To deal with this uncertainty, project managers often apply a “contingency factor” when preparing a project budget. This contingency factor normally consists of a 5 – 10% boost of anticipated project expenses in order to uncover inexperience, as well as the “unknown” or the “unexpected”.
Contingency or “Not to” Contingency. That is the question…..
Depending on the degree of internal experience with a given type of project, contingency reserves may or may not be necessary. In addition, there is a philosophy that says that contingency reserves are dangerous, leading to unwarranted project spending.
- Budget Contingency Pros: The extra funds are in hand when needed, without seeking further approval. Considering that project circumstances can change so frequently, contingencies readily acknowledge this fact, facilitating project completion.
- Budget Contingency Cons: Contingency reserves make it easier to gloss over project costs, making budgets less precise. Contingency reserves encourage cost overruns, by granting easy access to additional funding without a thorough consideration of available alternatives.
To-Do List: (4) Key Steps to “Trackable Costs”
The following listing lays out the four (4) primary steps for project cost estimating and tracking:
Step #1 Make the continency decision.
Contingency budget decisions should be made at the start of the budget estimating process. Will you need a contingency budget, and if so, in what amount, and how will it be used?
Step #2 Identify the cost factors.
While cost factors will vary based on project characteristics and business circumstances, in general, project costs can be viewed from four basic perspectives – labor, capital investments, overhead (to maintain the project environment) and project specific (costs to plan, manage and execute the project):
Step #3 Establish cost factor values.
Project budgets quantify the expected costs associated with a project, and these budgets must be based on a reasonable, realistic estimate of likely project costs and expenses. The estimation of project costs is part science, and part intuition, common sense and experience.
In fact, past projects can be the most valuable indicator of current project expenses. As project costs are estimated, the following factors should be considered:
- The specific cost factors involved depending on the needs of the project.
- The costs of similar projects in the past.
- The opinions and feedback of project participants. When estimating costs, it is important to get a broad spectrum of information, experience and opinion.
Step #4 Track expenditures and variances.
Once the project budget is created and approved, and the project is underway, costs and expenses must be tracked to ensure that budget utilization is as planned and expected (are you spending what you expected to spend based on how the project is proceeding?).
Variances Happen. That’s not good or bad in and of itself. If variances exist (and they will), you must determine whether the variance is “positive” or “negative”, and what it all means. Then you can “react” and act accordingly.
A positive variance indicates that you are under budget, but appearances to the contrary notwithstanding, this are not necessarily a good thing. When project expenses are less than expected, this may be a sign that the project is not proceeding according to plan, and may be behind schedule. In addition, a positive variance may be a sign of ineffective estimating. On the other hand, this under budget condition may be the result of legitimate changes, discounts, or cost saving measures.
A negative variance indicates that the project is over budget. Depending upon whether the negative variance is at a monthly or overall project level, this variance may be the result of serious project problems, such as excessive changes, schedule delays or ineffective budgeting. If the negative variance is on a monthly level, but the overall project is on track, there may not be an immediate cause for concern.