If you are in the business of delivering projects, then project cost management is critical to your success. Without a reliable cost estimate, you won't be able to anticipate how much money your project will require and how long it will take to complete.
As a project manager, watching your project go over budget can be a major cause of stress. And if you've experienced that stress first-hand, you're certainly not alone. It's a very common issue.
In fact, according to recent research by the PMI, up to 50% of projects run over budget. That means a lot of profit margins being squeezed - and a lot of concern for the person in charge of cost management.
For every successful project, it’s crucial to understand its costs and manage them well. But every project's activities and costs are unique, which can make managing each one challenging.
In this article, we'll lead you through the complex world of project cost management, and arm you with tips to keep your project costs in check.
By the PMI's definition, project cost management is the process of planning, estimating, budgeting, financing, managing, and controlling costs to complete the project within the approved budget.
Project cost management aims to avoid any cost overruns on projects, ensure project profitability, and keep profit margins high. As a project manager, it is essential that you calculate project costs during the planning phase for approval before work commences to stay within the cost management plan.
Successful project cost management begins with good estimation practices. It is one of the most important aspects of project management and a primary function of any project manager.
Cost estimation is the process of predicting the cost of resources to complete a project. It is performed by the project manager, usually along with the core team. Cost estimation is an ongoing process that continues as the project moves from definition to completion. It is especially relevant when dealing with fixed-price projects.
This means that you, as the project manager, need to understand the cost of each activity within your project, and how much time it will take to complete each activity.
Project cost management is an important component of project management. When you start a new project you will have to consider all the resources needed for you to run a successful project and avoid budget overruns.
Why do we need it? When you have this information, you can use it to track costs throughout the project. The cost estimates are used as a baseline for controlling budgeted costs and are compared against actual costs throughout each phase of the project.
Cost management is crucial because it helps you:
Here's an example of a project cost management dashboard from Runn. It gives a quick recap of the resources assigned to the project and the costs their work will accrue. On top of that, you can see a line chart which illustrates how the project budget will change and where it’s standing compared to previously made estimates.
Budget overruns can affect the bottom line, reduce customer satisfaction, and fail meet established goals. But when you manage your project accounting effectively, you can ensure that you deliver the results promised within the approved budget. This may improve future budget allocations for your projects.
Cost estimates are rarely accurate because they are based on assumptions, and you can’t predict the future with absolute certainty. However, it is critical to have accurate cost estimates so that you can ensure your project budget is sufficient.
Although project forecasting cost is a critical management skill, it's also one of the most challenging. The challenge is due to the many potential risks that can be hard to detect and the fact that project managers are rarely in control of all the project variables that influence the total costs.
At each stage of a project's timeline, there are four main challenges to predictability:
The early stages of a project require some guesswork as you estimate resources and timelines based on preliminary information. You'll have to refine your estimates as more details emerge - but even then, you'll be dealing with assumptions.
Some uncertainties come after the early stages are completed, even though you have detailed plans. These are unforeseeable at the start of a project but only surface as the project progresses. The unexpected costs associated with these uncertainties can mean you need to find more money, which becomes a critical factor in project success.
The longer a project goes on, the more complex and interdependent its elements become. This makes it difficult for any manager to keep track of the cost management process affecting budgets and schedules.
Project managers also find that these complexities pose additional challenges for effective communication among project teams. The lack of effective communication ultimately undermines predictability even further, and can impact project performance.
Timely completion of the main objectives is usually a goal for everyone involved in a project, but so is cost containment. When changes occur during the project life cycle, stakeholder objectives may dictate the path to choose and the costs involved. It can then be a stressful process to manage the specific project to avoid cost and budget overruns.
Depending on your line of business, changes in market conditions can have a detrimental impact on project cost estimation. Here you need to consider different variables like labor rates, material costs, resource availability, and the potential economic changes sitting around the corner. Your project cost predictability can easily be impacted by things like inflation, supplier issues, and demand fluctuation.
If your business is dependent on contractors, suppliers, and third-party vendors they are likely to bring certain project overrun risks into the picture simply because of the unpredictability factor. This unpredictability can come from things like price changes or service delivery timelines, all of which will have an impact on your project budget.
The cost of a project is typically broken down into three parts:
Direct costs can be directly tied to the work being done on project-related tasks. They may include material costs, time spent by employees on the project, travel expenses for fieldwork, subcontractors' costs, and so on.
Indirect costs are general business costs such as rent, utilities, and equipment crucial in keeping the project operational. It also includes salaries for non-project employees, and insurance.
Contingency costs are extra funds reserved for unforeseen events that have low probability but high impact if they occur. Reserve analysis can help you estimate the contingency you need for your project.
So, once you have estimates for these three aspects, you can add them all up together so that everything is accounted for. Remember to take your time to carefully budget for the project to ensure you cover every aspect. A rushed budget means you will miss something crucial, which will be detrimental to a project's success.
When you’re dealing with a certain project type for the first time, chances are high there will be some costs you will simply overlook due to lack of experience or factors out of your control. Here are the ones that tend to be that snake in the grass:
The cost may be influenced by factors such as scope, quality, schedule, human resources, risk, and procurement.
To create an accurate cost estimate, you will first want to review the project scope. This refers to the details of what needs to be done to complete a project. The scope of your project has a lot to do with the final cost so you need to make sure that it’s as detailed as possible.
The more complex the project requirements are, the more they will contribute to the overall project cost. Cost estimates should be broken down into phases so that companies can adequately budget for each phase of work.
For example, if your client has made changes during the planning process which did not feature in your original actual cost estimate, you will want to update it now.
Quality refers to how well a product or service meets customer expectations. Higher-quality projects typically require more resources than those with lower standards for quality control; therefore, higher quality comes at a higher price tag when it comes to managing projects within your company’s budget.
Understanding your client's expectations for quality before the start of the project is vital, particularly for projects with fixed costs.
Human resources professionals in project management are personnel with the skills and abilities necessary for a project to succeed. A work breakdown structure will help simplify the resources you will need to complete each task.
For each project, a qualified person has to be assigned. If a project is complex, it will necessitate additional professionals, which will impact the overall management cost.
You should use a spreadsheet or project accounting software to calculate the labor component of your project cost estimate. On a basic level, this involves multiplying estimated labor hours and hourly wages, but more detailed estimation methods relating to the different costs of different resources will help you get a more accurate total estimated cost.
The length of time a project takes also affects its total cost. A project that takes a long time to execute, will need a larger budget to see you through to project completion.
However, a longer schedule sometimes helps with cost control, as it gives you more flexibility with critical tasks and scarce resources. Rather than having to hire a new specialist, for example, you may be able to adjust your resource schedules to that your in-house specialist can work on the project around their other tasks.
Project managers need to factor in unforeseen occurrences such as that may affect a project. These risks could be uncertain events or conditions affecting a project. Project risks also include scope creep, operation changes, changes in product prices, stretched resources, (time risk as a result of delayed timelines), and miscommunication that causes a lack of clarity.
There are three basic techniques for effective project cost management:
While the bottom-up approach is often the simplest when starting out, the other techniques can help you generate a good budget with an accurate estimate of project costs.
Techniques like expert judgement, analogous estimation, and parametric estimation are also very helpful in creating an accurate cost estimate. They rely on input from experts in different fields who have relevant background knowledge and experience working on similar projects before.
Once you have the initial estimate, you can use the inputs about what you know about the project to determine if your initial estimate needs to be adjusted. For example, if you are working on a new product launch and your company has successfully launched several other similar products, it may be possible to use historical information about those projects (analogous estimating) as a starting point for this project's cost estimate.
Project accounting tools make it simpler for you to review historical projects and manage the costs of ongoing work.
Now that we've reviewed the techniques used to manage project costs, let's go through how you can put the theory into practice:
Costs and availability of the resources or the team that’ll work on a project make up a leading factor in project cost management.
While it may seem straightforward to estimate the cost of people involved in a project, challenge arises when different team members charge differently.
For example, a client requests for a specific senior team member to work on their project. In this case, you’ll need to factor in costs based on the employee’s seniority level.
Effective resource planning is the key to nailing this step. Always have an employee inventory ready so you can review employees’ skills, charges, and availability.
At the same time, using a resource calendar helps you assign and schedule work by looking at an employee’s availability and how good a fit they are for a specific project.
The skills inventory pulls together all the information around your resources’ expertise, skills, and seniority. It helps you analyze and assess your existing talent pool and make informed decisions when it comes to hiring more people. You can use this database to easily spot resource and skills gaps as well as to get a realistic idea of what you can expect from your existing teams.
Here is what that skills inventory looks like in Runn.
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Cost estimating involves factoring in the total costs of all resources working on a project including the people, equipment/tools such as software, and the working space.
By accurately estimating your costs, you can develop budgets, allocate resources efficiently, and set realistic financial expectations.
Accurate cost estimates are also essential for improving your project profitability, as it highlights ahead of time where potential cost overrun is a risk, enabling you to make proactive adjustments to scope, timelines, or resources to keep the project on track to make money rather than go over budget.
As we discussed earlier, there are several different approaches to estimating project costs - we recommend that you consider which method best suits your circumstances.
For instance, analogous estimating might be perfectly suitable when there is plenty of historical project data to look at, and if the upcoming project is not expected to be substantially different to past projects. If the project you are working on is novel or different in any significant way, however, bottom-up estimating might be a better approach.
Next, sum up all the costs that’ll go into the project to create a project budget. This should include all direct, indirect, and variable costs.
You should also factor in contingency reserves in case of risks surfacing in a project’s lifespan and project revisions — even redoing parts of it.
The budget that you set here is going to be your baseline budget. Project managers need to proactively track it to prevent cost overruns. In fact, by tracking the baseline project and how the actual costs compare with the estimated budget, you can communicate project scope changes in time and save yourself from potential losses.
Lastly, it’s important you put in place guidelines and procedures to minimize the odds of cost overruns.
Three proven tactics to control project costs include:
Learn more: Achieve Better Profitability with Cost Control ➡️
Project forecasting can never guarantee 100% accuracy but it will certainly reduce the number of risks you could run into and the impact they could have on your project success.
There are lots of things project managers can do to predict how their project budget might change and if you have a reliable project management tool on the table, those options multiply and get automated.
For example, one of the things you could do is run the Monte Carlo simulation. This simulation will ask you to input specific values like project costs or durations and simulate different scenarios to predict potential outcomes and risks.
With Runn, you can do scenario planning to see how your project budget might change overtime. The tool allows you to toggle tentative projects on and off so you can see how various scenarios will change your project budget, team workload and capacity, resource utilization, etc.
This will vary depending on the size of the project and the type of the business. In some cases, you will have a person dedicated to running the financials or at least participating in certain budgeting decisions. In most cases, however, it is the project manager who gets to take care of all project costs.
When planning the project, they need to calculate the total cost, plan out the budget, track project progress, and take measures if it runs over budget. In the end, your goal is to increase potential profits and you can only do it with the help of advanced project planning (where project cost management is a constituent part).
There are lots of tools that help you keep project costs under control. They help you approach the project from different angles and optimize your spendings to achieve optimal outcomes.
Ideally, you’d need to look for an all-in-one solution that brings resource management, project management, and budget management together. But if you want to break those down here are the different aspects to consider.
This type of software helps you track project progress against the budget so you can avoid overpricing and protect your margin. The features you’d need the most would be tracking custom hourly rates and tailoring financial fields.
Time tracking tools are usually fairly intuitive and easy to get started with. They help you estimate resource costs and get your teams to log their time spent on projects. You can then use this information to further allocate resources and make project adjustments.
However, time tracking tools alone won’t get you far. Although simple in nature, they generally cater to the needs of smaller teams and can’t help you do advanced scenario planning or project forecasting.
If you have to provide regular cost-related reports to relevant stakeholders, you might need to look for a reporting tool that can give a high-level project portfolio overview and helps you create digestible analytics dashboards.
Runn is that all-in-one solution that centralizes all data, eliminates cumbersome, manual processes, and gives you accurate estimations of what your project journey is going to be like. Here’s how Runn is going to help you do cost management and save project budget:
Effective project cost management is not just about tracking expenses. In reality, it requires a strategic approach which requires you to look into resource allocation, project outlook, and do continuous forecasting to see if the project is going as expected.
Projects become increasingly complex, while budgets are getting tighter — all of this stands to prove that the importance of professional cost management cannot be overstated.
In the end, successful cost management comes down to balancing financial constraints with project goals, ensuring that every dollar spent contributes to achieving the desired results.
But resource management software like Runn does much of the hard work for you, extracting and displaying project data for you so you can monitor your project activities, and establish benchmarks for future cost management plans and project budgets. Discover a better way to manage project costs; try Runn for free today.
