The 4-Step Cost Management Process

18 March 2022

Home
Blog
Cost Management
Cost Management Process

In our previous article on Project Cost Management, we looked at what cost management is and what the different types of cost are. In this article, we will review the key elements necessary for implementing cost management into your organization. Together, these concepts build the foundation for effective cost management and set your organization up for success.

In order to implement a project cost management framework, it is necessary to understand the different phases of the cost management process; from defining a cost management plan to delivering reports.

The 4 Steps of the Cost Management Process are:

Cost Management Plan Set-Up
Cost Estimation and Budgeting
Cost Control
Cost Reporting

1. Cost Management Plan Set-Up

The cost management plan is part of the project management plan, which is defined before the project work begins. It is a complete guide which defines how the project, and therefore its costs, should be managed. Having the cost management plan defined provides us with the processes and organization needed to manage project costs.

What is included in the cost management plan? There is no exhaustive list of what should be found in each cost management plan, however the main axes are often identical amongst various projects. For example, we typically recommend sections for defining:

the different types of costs in the project,
the tools used to manage them,
the data structure required to track them,
the different stakeholders impacted, and
the reports used with a cadence for sending them to each stakeholder group.

2. Cost Estimation and Project Budgeting

Now with the cost management plan defined, the next step is to establish the initial cost estimation and project budget. Although, the final budget of a project is never the one provided during project initiation. A first estimate will be made at the start of a project, but the budget will always evolve during the life of the project. Think of your personal life, for example. Haven’t you ever budgeted for a vacation and had to reconsider it when something unexpected happened? If your car breaks down, you’d likely change your spending plans for vacation.

The cost estimate is derived from several elements:

Cost Breakdown Structure – CBS (see definition below)
Resource Planning, which takes into consideration:
- The need for resources for the project (labor or material),
- The cost of each resource, and
- The duration of the activities.

Cost Breakdown Structure (CBS)

The Cost Breakdown Structure (CBS) is a representation of all the project costs broken down into a hierarchy based on work. It is derived from the Work Breakdown Structure (WBS) which is part of the schedule management activities. (See graphic below.)

Resource Planning

Project Resources are the people and the materials needed to complete a project. Resource planning is necessary to determine how much material, how many workers, and for how long both will be needed. The workforce on a project are often the most costly resources, so it is important they are well planned for. Large projects usually have a designated resource manager for this.

Typically, these estimates are handled inside of a fully-costed schedule. Each resource is assigned tasks with specific durations. Since each worker also has a set pay rate, these assignments allow resource managers to build out the resource-based costs into the schedule.

How to Estimate Project Costs for Budgeting

After completing the CBS and Resource Planning, you know where each cost is coming from. Now you can estimate the total cost of your project, although there are many ways to do so. Let’s take a look at the three most common ways:

Matrix Method: All project tasks are defined and referred to on a task/cost matrix to obtain the overall cost.
Bottom-up estimate: Each team estimates how long their tasks will take, and these are rolled up to the project managers. Then, knowing how long the overall project will take, the cost manager can estimate the total cost.
Top-down estimate: The overall project duration is determined by the management team and then broken into tasks to be completed. These tasks will then have an allocated budget to be passed on to the project taskforce.
Analogous estimation: This involves comparing a project with similar ones of the same size to determine the cost of a project that would come close to it.

Often a combination of these are used, and determining which is best depends on the nature of the project: Is the project repeatable? Is it a new initiative? Each method is associated with risk and opportunity management. For example, a very detailed cost estimate is time consuming but will likely have a lower risk of inaccuracy.

Other ways to estimate cost are as follows:

Expert judgment (for those with experience)
The proportional distribution method (percentage distribution over the life cycle of the project)
Estimate based on units of work: based on an estimate of the tasks to be carried out
Parametric Estimation: Uses an algorithm that combines historical data and project-specific parameters
3-point estimate and calculation of PERT (program evaluation review technology): Calculates an average of the optimistic, probable and pessimistic estimates.

Once you’ve estimated your project costs, you’re ready to set your baseline. This will be the reference for what is planned for and approved during the entire project.

3. Cost Control

Now that you have set up the Cost Management Plan and successfully estimated the project budget, it’s time for the bulk of the work – monitoring and controlling project costs.

Cost control allows you to understand how your project costs may differ from your expected budget. Then, you are able to take corrective action. How a team manages and controls costs depends on what they had defined in the Cost Management Plan. In most cases, cost control requires input data provided by the project controls or purchasing teams.

Generally, cost control is also done using a dashboard and requires post-treatment. For a given activity, a dashboard shows clearly the differences between the expenses made (actual costs, actual expenses incurred, budget spent) and the initially planned costs. This is called a deviation. The diagram below shows both “completed” and “forecasted” data.

For each deviation identified, the cost manager must investigate the cause. For example, why was a payment not made, or is there a supplier delay? To answer these questions, you can rely on the cost manager. Once the root cause is known and addressed, the team can adjust the forecasted expenses.

All deviations (overspend or underspend) must be justified. Otherwise, you may see your target budget capped and no longer able to ensure the timely delivery of certain work. If a deviation is significant enough to impact your annual financial goal, the cost manager must identify a corrective plan to reduce the deviation and to realign with the project objectives.

Earned Value Management (EVM) is another key method organizations use to measure project performance, and cost is a crucial element of this. Calculating and monitoring the Cost Performance Index (CPI) is one way to ensure the project stays within budget. EVM is a complex subject, so we recommend diving into more detail on this later.

4. Cost Reporting

Our final step in the cost management process is reporting. The goal of cost reporting is to provide data and insights so the project manager can make the decisions necessary to keep the project on track.

There are many reports that can be edited based on the different cost visualizations. This can be done by visualizing the work done with regard to the budget spent (Earned value management): This makes it possible to analyze the productivity of the project.

We can also run different analyzes depending on the desired time interval or depending on the particular type of activity.

We can therefore summarize the different phases of cost management through this diagram:

While we briefly introduced the cost manager in this article, in our next article we will go into more detail about who is responsible for managing costs and what each of their roles entail.

This article series was written by Aurélien CRÔNIER and Mehdi DARD with contributions from Fanny DA SILVA and the MIGSO-PCUBED Cost Management Community of Practice.