What Is Cost Management in Project Management

How often do your projects end up exceeding their budget?

Do you feel that planning cost management in project management is a futile exercise as no project ever sticks to its projected costs?

Well, if your answer is a yes, we’re not surprised, considering 24% of project professionals believe that unrealistic budgets hamper projects.

However, we’re also sure that people who agree to this haven’t tried creating a cost management plan that adheres to modern-day project management practices while creating a cost management plan.

Typically, we go through four steps, namely, resource planning, cost estimation, budgeting, and cost control, to bring together the perfect cost management plan.

In this blog, we’ll explore these and try to understand what it takes to manage costs in project management.

So, let’s dive in.

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What is Cost Management in Project Management?

Before we define cost management, first, let us define what is cost in project management?

Cost in project management is the sum total of fixed and variable costs that are incurred during the entire life cycle of a project. It has a key role to play in overall project management as delivering a successful project is a culmination of sticking to the set scope, timeline, and budget.

Now, according to Gartner, “Cost management is the process of planning and controlling the costs associated with running a business. It includes collecting, analyzing, and reporting cost information to more effectively budget, forecast and monitor costs.”

So when we talk about the cost management process in project management, it refers to managing the costs of a project throughout its execution. This process involves planning, estimating, budgeting, and controlling expenses right from the beginning.

It takes into account all probable costs that are bound to be incurred during project execution. Thus, cost management specifies project costs and refers to developing a plan that ensures that costs are kept to a minimum, and the projected plan is followed during project execution. This helps ensure that the project is completed within the defined budget.

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Why is Project Cost Management Crucial for Your Every Project?

Do you have a free hand when it comes to budgeting? Or does your budget estimate have to fall within a ‘reasonable range’?

Most often, stakeholders want the desired project outcome but within the least possible budget that you might hear them refer to as a ‘reasonable range.’ Does that ring a bell? Sounds contradictory, right?

Let’s be honest. To maintain the optimum level of quality, one needs the flexibility to come up with a budget that caters to all the requirements needed to complete the project. But most often, costs are limited for carrying out a project and these costs can escalate without any warning, causing the project budget to go for a toss.

Here is where a cost management plan comes to the rescue!

Simply put, a well-planned project costing enables you to:

• Control budget overruns
• Define clear expectations with stakeholders
• Determine and maintain the profit margin
• Track project costs in real-time
• Enhance overall efficiency
• Boost project quality
• Collect accurate data as a benchmark for future projects

Project cost management is nothing but setting and following a budget baseline while running a business so as to maximize company profits while mitigating possible risks.

Read More: Project Risk Assessment: All You Need to Know About

4 Steps to Cost Management Process in Project Management

There are four steps that lead us to effective cost management within project management. Let’s walk through each of the processes in detail below.

Step 1: Resource Planning

Not sure what is the first step in project cost management?

It is resource planning.

So, can we say that resource planning is the most crucial step in effective project cost management?

Undeniably, yes, considering it is this step that gets the ball rolling.

So, to start with, let’s first define what we are referring to as resources here.

Resources can be anything that we need to carry out our project tasks and activities. These may include people, capital, equipment, and facilities required to complete the project successfully.

Thus, for effective resource planning, you must identify and organize resources for each stage of a project’s life cycle. So start with defining the estimated duration of the project. Only after you have the project timeline set, you can go on to the next step and define which resources are required and when. Also, allocate resources so that they are utilized in the most optimized way possible. Your project cost planning is incomplete without peeping at historical data that will give a better understanding of which and how many resources are capable of performing a particular task.

Early planning for resources will save you from facing a resource constraint later during project execution.

There may be cases during project execution where you might need to adjust these resources due to existing resource availability or changing scope of project. 

Read More: 14 Best Resource Management Software & Tools Of 2022

Step 2: Cost Estimation

Once you are done with action-oriented planning, you must start doing cost estimation and budgeting in project management.

When you predict future expenses, you do so within the project’s defined scope. Also, it requires you to choose between alternatives, comparing where cost can be bought to a minimum while not compromising the quality of the project.

This is where Work Breakdown Structure (WBS) comes into play. It uses bottom-up estimation to ascertain the costs of project tasks and activities right from project initiation to completion. It functions on having foresight for current and future tasks to determine costs that will be incurred during project execution.

Costs can be fixed, variable, direct, or indirect.

• Direct costs are costs that are directly related to the cost object. Also, these are traceable during the project’s life cycle.

For example, equipment costs, direct materials, and staff salaries.

• Indirect costs are costs that are not directly related to the cost object. Besides, these are non-traceable during the project’s life cycle.

For example, office supplies, insurance, and accounting expenses.

• Fixed costs are costs that are bound to occur, no matter how many projects an organization has accomplished in a specific period.

For example, rent, lease, taxes, and salaries.

• Variable costs are costs that do not change in the exact direct proportion to the number of projects accomplished.

For example, overtime expenses, inputs to production, and wages.

The estimates that you make in this phase of cost management become the baseline that you refer to during project execution to compare the estimated costs to actual costs i.e. to evaluate the performance of the project.

Let us look at the different approaches to estimating costs for creating a budget.

A. Bottom-up Estimation

It refers to estimating project costs at a granular level. Costs are estimated starting from the lowest level of project execution to the highest. These costs are then summed up to arrive at an approximate total cost for the project.

B. Top-down Estimation

In this, the total budget is evaluated as a whole. This budget figure is then separated into smaller numbers and distributed to each phase of the project, depending on the estimated requirement of that particular phase.

C. Analogous Estimation

Analogous estimation refers to previous projects of similar nature to arrive at the estimated budget of the current project. For this, it is important that you have ready data available for previous projects that can be referred back to when needed.

D. Parametric Estimation

Parametric estimation involves using algorithms or calculations to arrive at the estimated budget. For this, it is crucial that you have the project variables clearly established to enable an accurate estimation of the budget.

E. Three-point Estimation

This methodology requires arriving at three estimates, namely, optimistic estimate, pessimistic estimate, and most likely estimate. Once these estimates are confirmed, you then apply a formula for this triangular distribution which is E=(O+M+P)/3, where,

E – Expected project cost

O – Optimistic estimate

M – Most likely estimate

P – Pessimistic estimate

The advantages of estimating accurate costs are:

• Accurate project planning
• Improved resource utilization
• Improved business profitability
• Positive client relationship

Note: As the project progresses, there will be some costs that will change or be added. Ensure that you regularly review your estimates and make the required changes as and when necessary.

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Step 3: Budgeting

Now that you have arrived at the expected project cost, it’s time to create a budget for your project.

Cost budgeting involves analyzing the detailed estimate of the costs that are expected to be incurred in project execution. Also, it is continuously updated to incorporate any changes during project execution.

Putting together a budget is not as easy as it looks now that you have the estimates sorted. If you under-call the budget, you may end up falling short of resources and missing the deadline. On the other hand, if you over-call the budget, chances are that it may not get the approvals for project initiation. Thus, building an accurate project budget is paramount for the smooth journey of a project, right from the beginning.

A project budget is instrumental in the decision-making process. It helps direct efforts such that project activities are carried out in the most efficient manner, adhering to the project budget all along.

Moreover, a project budget is a means through which stakeholders are communicated how much money is needed, and when, to fulfill the project requirements. It is crucial to secure funding from the stakeholders.

Here are a few techniques that you can use to create the perfect project budget in no time.

• Cost aggregation: This involves estimating the costs for each project task and activity right from the beginning. These individual costs are then summed up to arrive at the project budget baseline.

• Historical data: In this, you extract data related to incurred costs in previously delivered similar projects and create a budget for the existing project taking those costs into account.

• Reserve analysis: For this, you analyze and predict unforeseen costs for a project. You then create an estimated reserve that may come into use in case of an uncertain event during project execution.

• Funding limit reconciliation: This technique requires you to compare the planned expenditures of a project against the available fund limit. In case of discrepancies, you may have to re-schedule or re-create the project plan.

Step 4: Cost Control

So, you’re through with creating the dynamic document, the project budget, right? But, is that where your role as a project manager ends?

Certainly not!

Project cost control is the next big process that you need to gear up for.

As the project moves forward, there are a few deviations that you are bound to face. Here, project cost tracking comes at the forefront of cost management. In this, you are required to track and monitor whether the project is sticking to its budget or not. If not, you must anticipate changes timely and act immediately. For this, you should control the costs if they begin to exceed the estimation and revise your project budget accordingly.

Let’s look at a few techniques of cost control below.

• Forecasting: This involves making predictions or assumptions related to the possible project cost of a project. This helps manage risks by evaluating them timely and minimizing their impact on project delivery. Key metrics to track for effective cost forecasting include project duration, resource availability, and reserves for unforeseen events.

• Variance analysis: This refers to estimating the variability between planned and actual project costs to determine whether the project was delivered within the set budget or not. For this, you first determine the project baseline and compare it to actual costs incurred throughout the project’s life cycle.

• Performance review: As a project manager, it is crucial that you estimate the project costs, its schedule, the scope, and the quality of the project. This equips you to analyze overall project performance and take corrective action to mitigate their deviation from set standards, ensuring more accurate cost estimates for future projects.

• Earned value management: In this, you take the help of a few formulae to measure the progress of your project against its planned expenditure. It involves evaluating the project cost, schedule, and budget among other metrics. A few indicators to include are schedule variance, cost variance, etc.

• To-complete performance index: This comparative earned value management metric helps achieve project goals as per the set target. It clearly indicates the target cost performance index that must be achieved so as to accomplish a project within the defined project cost. This helps you stay on track, ensuring the future efficiency of a project.

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Effective Tips for Cost Management in Project Management

Managing project tasks is not an easy task. While you may be trying to direct your efforts to control one cost, you may find that the cost for another task or activity is mushrooming right below your nose. The strategy is to keep a tab on each activity or resource cost right from the beginning, not letting any cost explode to a point that leads to project failure.

Now that you have a fair idea about what cost management is and what steps you should take to curate a cost management plan, here are a few tips that you should follow to create an effective cost management plan for projects.

Take a look.

1. Track Your Project Budget in Real-Time

Merely setting a project budget is never enough. Tracking the budget is the next important step that follows. Set regular intervals at which you will analyze and ascertain whether the project is moving on the right path. Compare the forecasted costs to actual expenses. Do they match? Or are they exceeding the set budget? If they are exceeding the defined budget, be prepared to react immediately and take steps to contain the costs. 

For this, it is essential that you have a plan laid out beforehand to handle discrepancies between the projected and actual project costs. This will save you from unnecessarily wasting more time in charting a plan to contain exceeding costs.

2. Protect Against Inflation

You might have your costs sorted until the completion of your project, however, not taking inflation into account is bound to affect your project costs. There are chances that your project might demand to reschedule or get postponed for the next six months. For tackling such scenarios, having a plan that incorporates inflation will help. So, observe the existing pricing trends and plan your project costs accordingly. Look for tips and tricks to understand inflation and how you can prevent it from knocking down your project budget.

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3. Account for Uncertain Events

Well, uncertainty behaves in ways we cannot fathom at the beginning of a project. There are some events that we have no control over such as natural disasters, equipment failure, or fire. These can occur in a split second and cause harm to your projects that may even be irreversible.

These uncertain events hamper the project schedule, resulting in quality issues or delayed deadlines. Thus, plan in advance and adjust your budget to incorporate losses from uncertain events that are not in our control.

4. Plan for Contingency Reserves

The budget set aside under contingency reserves involves future project costs that have been identified. This amount will be utilized when an unforeseen expense occurs. This expense can be due to the requirement of more raw materials for project completion or the requirement of more resources to complete the project faster. 

As the project moves forward, it demands things that may not have been visible before as project requirements. Or, as the project evolves, the project requirements evolve, and thus, this is where contingency planning comes into effect.

5. Perform Integrated Change Control

Performing an integrated change control process means reviewing all change requests during project execution. For this, required changes are identified and promptly responded to such that minimum work is required to manage the changes to project deliverables.

 As a project manager, you must practice change management as modern-day project management is incomplete without integrating change management robustly and on time. If not performed well, poor change control can impact the project deliverables, leading to project failure and harming long-term business reputation.

Do You Need a Software for Managing Cost in Project Management?

Leveraging the power of a project management tool for managing costs helps you stay on the right path to completing your project within the set timeline. Such a tool is ProProfs project that helps streamline processes and deliver projects more efficiently per pre-determined metrics. You can create project workflows, prioritize tasks, and manage resource workload easily with it.

With advanced reports, you can effortlessly analyze incurred project costs and compare them with planned project costs instantly. Moreover, the project views of ProProfs project allow you to track project costs in real-time and stick to the defined budget more effectively. All in all, it helps track every detail of a project on the go.

Improve Project Profitability With a Solid Cost Management Process

Cost management in project management is essential to stay on track and achieve things within the pre-defined parameters. Sound cost management helps plan and overturn potential risks for increased business profits.

To simplify project planning and tracking, ProProfs is an excellent tool that helps track budgets with interactive project visualization. With it, you can schedule projects, collaborate in real-time, track milestones, and much more. Moreover, you can get rich insights into project progress and team performance on the go. Overall, it is a great tool to track tasks, milestones, and budgets anywhere and anytime.