With operational complexity in growing businesses today, project management is becoming imperative to the success of operations. Whether you are about to endeavor in a project, develop a new product or service, or are working out increased operations and budgeting, project management can increase efficiency and save your organization time and money.
For a project to succeed in its objectives, it must be completed within the constraints of cost, time, and scope. A project cannot exist without each of these key performance indicators; however, cost management may be the most detrimental and therefore the most important pillar since project cost overruns can impact margins, cause net loss, and inhibit operating cash flow for a business. Although the cost constraint of a project is most necessary, only 57% of projects are finished within their initial budgets according to a PMI report. A project may be likely to finish over budget, but according to the study, 32% of the projects that fail are due to a lost budget. Without cost control, a company may quickly and easily lose money and deter so far from the budget that costs go above the project profit.
To succeed in your project or operational undertakings, understanding the cost containment process can help you complete the project within the approved budget and track areas where costs can be reduced. Cost containment through project management can ultimately determine a positive project outcome and deliver a profit. The process of managing project costs can be carried out in three steps, estimating costs, creating a budget, and controlling costs.
Resource Cost Estimation
Containing the costs of a project begins with determining the resources needed and estimating costs. Cost estimation requires a high-level of understanding and clear communication. Before beginning, you must understand the entirety of the project scope otherwise, an accurate cost estimate will not be accurate. Cost estimation is often expected from stakeholders shortly after idea-generating, but a deep identification of all resources is necessary and is often more readily available closer to the project start date if you can allow for adequate report time. Also, keep in mind that an estimation, is a judgment value and cannot be guaranteed accurate; this is important when it comes to budgeting.
Resource planning includes evaluating the physical materials, people, financial, and information resources required for the scope of a project. Determining resources involves the execution strategy of all the tasks and subtasks that should be organized and scheduled in a work breakdown structure. Then you can identify the skills, the people, the contractors, equipment, materials, or suppliers needed for each component of the project and determine the quantities of each resource for optimization and cost estimation.
To calculate project costs, you need resource estimations including time, expert knowledge, potential risks, data analysis, benchmarks, and insight into your company’s financial health and reporting structures. Data computation should be utilized but calculated along with human intelligence because humans have the unique capability to make decisions based on experiences. Using the bottom-up approach by estimating costs at each task level can help perform an inclusive cost calculation. Managers should consider fixed and variable costs, overhead allocation, inflations, and staffing costs.
Collect industry benchmarks in your market and historical data from previous projects to understand how funds have been spent in the past and among competitors. Forecast costs with accounting methods and mathematic formulas such as parametric modeling or the program evaluation and review technique (PERT). LQD Business Finance, a tech-enabled lender, offers a free EZ Cash Flow Tool to forecast cash inflows and outflows assisting with your cash management and budgeting.
Cost estimation is not only a critical part of cost containment and project management, but it is also a part of the planning stage where resources can be evaluated, and decisions can be made for cost reduction. If there are multiple solutions for a project, cost estimating methodologies can provide a comparative analysis and direction in reducing costs. For instance, lifecycle costing intakes the scope and cost of the end-to-end lifecycle of a project, and can help evaluate future resource requirements, maintenance, or restocking costs. In manufacturing projects, for example, this estimation process can help optimize project costs over time and minimize future service costs and replacement charges.
Another key area for cost optimization when resource planning lies within the people and skills needed for your project. You should strategically hire the right internal employees and know when to outsource project-based work. Outsourcing to experts can be an efficient way to receive quality work that may just be within reach of your employee’s bandwidth while reducing operating costs. Additionally, spending time training employees to be more efficient with their time can increase productivity long-term and ensure that projects are completed on time.
Once there is a clear identification of required resources and estimated costs, the budgeting process can begin by determining contingency estimates and available budget reserves to allocate costs to each part of the project. Budgets are typically designed in accordance with different activities or project phases over time and address cash flow and financial constraints. Strategic budgeting will coordinate accounting elements and propose budgets that are feasible within the scope of work, and profitable to the organization.
As budgets are built off estimations, projects are likely to be completed within +/-10% of the planned budget. If project spending goes too far over the budget, it might cause a marginal profit loss and the potential for the project to become a failure. But on the other hand, overestimated budgets may tie up capital that would be better used elsewhere.
As a precaution to this, cost estimations may become bloated in the budgeting process. Your budget may require a buffer; however, you do not want to count on change management later or allow over budget management decisions to result in fewer savings and performance issues if employees become comfortable with buffered slack. Buffering time and resources into the budget is a highly strategic and calculative process, and apart of the contingency reserve. Developing a budget consists of three parts; the base estimate, a contingency and allowances estimate, and a budget reserve.
Using the project resource cost estimation, budgeting allocates the cost forecasts into cost accounts against which cost performance will be measured and assessed giving the base estimate. Standardizing forecasting and budgets can help you create a higher level of reliability in how the cost is created and budgeted between different phases of the project. Following the base estimate, contingency and allowance budgeting is necessary to ensure that there is an adequate amount of budget established to accommodate risk and unforeseen cost increases. Start a contingency estimate by identifying each possible risk and then assessing the impact and potential overrun to be established in a risk reservoir. Applying a proper method to determining contingency reserves is a process of its own, but an important one depending on the size and complexity of your project scope. Utilizing quantitative risk analysis algorithms through a probabilistic method requires a detailed project and more time but will yield better results than a deterministic method that is based on expert judgment. Unless the project manager is highly experienced, you should not rely on feel to determine risk reserves. A computational analysis of risk will help you provide a highly controlled estimate. In addition to determining a risk reservoir on top of cost estimates, the manager or project owner may want to ensure another level of budgetary compliance for unanticipated events or changes in the project, industry, or economy. This is done by including a budget reserve determined by and accessible only by upper management authority or the project manager.
The budget sets the project limits so that every decision can be guided by that limit helping your organization save and contain costs. Budgeting provides the project with limits and benchmarks that forms the baseline of cost containment.
After the development states, cost control is a critical subset of project management to exercise a strict amount of supervision over project expenditures and performance. Cost control is the process of measuring variances from the estimated cost baseline and taking effective corrective action to achieve minimum costs and avoid cost overruns. An important part of cost control is not only to evaluate actual cost against cost baseline information but also to understand and record what is causing the variance and continuously forecast expected final costs.
Cost Control Management Plan
A cost containment plan should designate project performance measurements, the deviation threshold, what actions must be done, and executive a decision-making queue. To measure cost performance, there is an abundance of methodologies to analyze data, but many have become unnecessarily complex and timely to adopt. Nonetheless, using a quantitative approach to analyze cost variances is highly effective. Tools to use include alternative analysis, variance analysis, trend analysis, reserve analysis, and so on; but the most widely used and standardized tool is the earned value method.
Earned Value Method
To evaluate what your funds are accomplishing, the earned value method calculates the effectiveness of project spending by looking at the cost, time, and task completion within the entire scope simultaneously. It measures the planned value against the earned value and uses the actual cost and time to deliver the cost and schedule variance with a positive or negative number indicating the cost and time performance of the project.
For example, you want to measure the progress of task X that is 25% complete. From the cost estimation, the budget or planned value of this task is $10,000, and it is expected to be 50% complete by now.
Planned value (PV) of task X = $10,000 X 0.5 = $5,000
Earned value (EV) of task X = $10,000 X 0.25 = $2,500
Next, to determine the actual cost (AC) of the work, we look at actual costs spent on task X. So far, $3,000 has been spent on material costs.
Schedule variance = EV – PV $2,500 – $5,000 = -$2,500
Cost variance = EV – AC $2,500 – $3,000 = -$500
Both results returned a negative variance which concludes that not only is the project behind in schedule, but that task X is overspending on the work that is getting completed. This is a simplified example, and calculating the earned value method and its various formulas can become a lot more extensive depending on the number of details available. Since projects range from a few activities to a few hundred subtasks in a work breakdown structure, evaluate which calculations are appropriate to your project and how frequently you should measure them to ensure that the value of your project manager’s time spent measuring will yield informative results.
Measuring cost and project analytics can be a powerful tool in providing insight into areas where cost can be scaled back and where operating costs and be cut.
Once the procedural process of collecting, measuring, and evaluating data is designed in the cost management plan, cost control evolves into a continuous process throughout the project lifecycle. Since cost control is a preventative action, monitoring the forecasted vs. actual cost variance should be done timely and precisely. Having a clear understanding of the control thresholds is also imperative to reacting before the project budget becomes too overspent and jeopardized.
Cost containment includes accounting management techniques in both cost performance analysis and in operational decision-making to control profits. If your project expenditures run into issues with your budget, accounting data analytics relies on several cost control alternatives. If changes need to be made, weigh net effects and project quality effects of proposed areas, and identify which costs have strategic significance and which do not.
On the other hand, as project managers track data and progress, it is important to determine budget conformity and identify areas of improvement for budget allocation and spending. Costs may be able to be reduced for different parts of the project and estimated final costs can be adjusted. Cost containment can help finetune the budgeting process for future projects and further identify areas where cost optimization can be injected.
Contain Your Costs with Project Management
The project management cost containment process is not simplistic; however, it is in-theory the simplest way to ensure that a project is carried out within budget and cost reduction opportunities are realized and managed efficiently. Through a project management procedure, cost containment cycles through the phases of resource cost estimation, budget implementation, and cost control.
Following these project management processes will provide structured insight into where you can optimize your resources in both the planning phase and the post-launch control phase. It will challenge you to accurately estimate your costs and structure an optimal budget with expertise and computations. And it will prompt you to set a deviation control plan and measure project performance with proactive quantitative methods that enable you to make quick decisions and corrections.
This cost containment process is the most secure way to ensure that your project finishes within the planned scope, time, and budget and ultimately delivers a successful and profitable project leading your business to financial success.