Department of Industrial Engineering Engineering Project Management Presented By Dr. Abed Schokry Chapter 15: Cost Control Learning Outcomes After completing this chapter students should be able to: Define cost management, Discuss cost control requirements, Know how to manage cost, Explain cost management key terms When to implement a cost management system, Describe Earned Value Management concept and how to apply it, Calculate cost and schedule variances, 1
Project Cost Management The processes involved in planning, estimating, budgeting, and controlling costs so that the project can be completed within the approved budget Why Do We Manage Cost? Part of triple constraint, can t manage one without the others (scope, time, and quality) Plots of cost and scope against plan can help spot problems early Cumulative Value Actual Costs (AC) Time Today Earned Value (EV) Planned Value (PV) Is this project over/under budget? Is it ahead of/behind schedule? 2
Cost Management Key Terms PV - Planned Value, estimated value of the planned work EV Earned Value, estimated value of work done AC Actual Cost, what you paid BAC Budget at Completion, the budget for the total job EAC Estimate at Completion, what is the total job expected to cost? ETC Estimate to Complete, forecasted costs to complete job VAC Variance at Completion, how much over/under budget do we expect to be? Cost Management Key Terms Cost variance (CV): CV= EV - AC Schedule variance (SV): SV = EV - PV Cost performance index (CPI). A CPI value less than 1.0 indicates a cost overrun of the estimates. A CPI value greater than 1.0 indicates a cost under run of the estimates. CPI equals the ratio of the EV to the AC. The CPI is the most commonly used cost-efficiency indicator. Formula: CPI = EV/AC Schedule performance index (SPI). The SPI is used, in addition to the schedule status to predict the completion date and is sometimes used in conjunction with the CPI to forecast the project completion estimates. : SPI = EV/PV 3
How Do We Manage Cost? Three processes Cost Estimating Cost Budgeting Cost Control Cost Estimating Cost Budgeting Cost Control Enterprise Environmental Factors Organizational Process Assets Project Scope Statement Work Breakdown Structure WBS Dictionary Project Management Plan Schedule Mgmt Pln Staffing Mgmt Pln Risk Register Inputs Cost Estimating Tools & Techniques Analogous estimating Determine resource cost rates Bottom up estimating Parametric estimating Project management software Vendor bid analysis Reserve analysis Cost of quality Cost Budgeting Cost Control Cost Estimating Outputs Activity Cost Estimates Activity Cost Estimates Supporting Detail Requested Changes Cost Management Plan Updates 4
Estimating Methods Analogous (Top Down) estimating Managers use expert judgment or similar project costs [quick, less accurate] Bottom-Up estimating People doing work estimate based on WBS, rolled up into project estimate [slow, most accurate] Parametric estimating Use mathematical model (i.e. cost per sq ft). [accuracy varies] Two types: Regression analysis based on analysis of multiple data points Learning Curve The first unit costs more than the 100 th, forecasts efficiency gains Estimating Methods Vendor Bid Analysis Estimating using bids + allowances for gaps in bid scope [slow, accuracy depends on gaps] Reserve Analysis Adding contingency to each activity cost estimates as zero duration item [slow, overstates cost] 5
Cost Budgeting Project Scope Statement Work Breakdown Structure WBS Dictionary Activity Cost Estimates Activity Cost Estimates Supporting Detail Project Schedule Resource Calendars Contract Cost Management Plan Inputs Tools & Techniques Cost aggregation Reserve analysis Parametric estimating Funding limit reconciliation Outputs Cost Baseline Project Funding Requirements Cost Management Plan Updates Requested Changes Cost Estimating Cost Budgeting Cost Control Cost Budgeting Budgeting is allocating costs to work packages to establish a cost baseline to measure project performance Remember Contingency items are for unplanned but required changes it is not to cover things such as: Price escalation Scope & Quality Changes Funding Limit Reconciliation Smoothing out the project spend to meet management expectations 6
Cost Baseline Project Funding Requirements Performance Reports Work Performance Information Approved Change Requests Project Management Plan Inputs Tools & Techniques Cost change control system Performance measurement analysis Forecasting Project performance reviews Project management software Variance management Cost Control Outputs Cost Estimate Updates Cost Baseline Updates Performance Measurements Forecasted Completion Requested Changes Recommended Corrective Actions Organizational Process Assets Updates Project Management Plan Updates Cost Estimating Cost Budgeting Cost Control Cost Budgeting Budgeting is allocating costs to work packages to establish a cost baseline to measure project performance Remember Contingency items are for unplanned but required changes it is not to cover things such as: Price escalation Scope & Quality Changes Funding Limit Reconciliation Smoothing out the project spend to meet management expectations 7
Cost Baseline Project Funding Requirements Performance Reports Work Performance Information Approved Change Requests Project Management Plan Inputs Tools & Techniques Cost change control system Performance measurement analysis Forecasting Project performance reviews Project management software Variance management Cost Control Outputs Cost Estimate Updates Cost Baseline Updates Performance Measurements Forecasted Completion Requested Changes Recommended Corrective Actions Organizational Process Assets Updates Project Management Plan Updates Cost Estimating Cost Budgeting Cost Control Cost Management Do Project Managers Control Costs, Monitor Costs Or Both? Cost estimating Cost accounting Project cash flow Company cash flow Direct labor costing Overhead rate costing Others, such as incentives, penalties, and profitsharing 8
Cost And Control System PLANNING WORK AUTHORIZATION AND RELEASE DATA COLLECTION AND REPORTING COST ACCOUNTING CUSTOMER AND MANAGEMENT REPORTING PHASE I PHASE II PHASE III PHASE IV PHASE V PLANNING CYCLE OPERATING CYCLE Cost Control Requirements Measure resources consumed Measure status and accomplishments Compare measurements to projections and standards Provide the basis for diagnosis and re-planning Thorough planning of the work to be performed to complete the project Good estimating of time, labor, and costs Clear communication of the scope of required tasks 9
Cost Control Requirements (cont.) A disciplined budget and authorizations of expenditures Timely accounting of physical progress and cost expenditures Periodic re-estimation of time and cost to complete remaining work Frequent, periodic comparison of actual progress and expenditures to schedules and budgets, both at the time of comparison and at project completion When to implement a cost management system Possible cost reductions PROJECT COSTS Cost of change PROJECT LIFE CYCLE PHASES CONCLUSION: A cost management system should be implemented right at the beginning of the life cycle of the project. 10
Partitioning The Budget The Work Authorization Form Work Authorization Form WBS: 31.03.02 Work order no: D1385 Date of original release: 03 Feb 01 Date of revision: 18 March 01 Revision number: C Description Cost Work Work Centers Hours Cost Starts Ends - Test Material 2400 150 R4500 1 Aug 15 Sept - Processing 2610 160 R7500 - Final inspection 2621 140 R3500 - Packaging 2623 46 R 750 - Delivery 2624 R 350 Project office authorization signature: 11
Planning and budgeting WBS Element M G R Org Org Org Work packages Work Package WP ORG Description of task Sched: Start Stop Budget: COST ACCOUNT CHANGE NOTICE (CACN) CACN No. DESCRIPTION OF CHANGE: Revision to Cost Account No. Date REASON FOR CHANGE: Requested Budget Authorized Budget Labor Hours Period of performance Materials From ODCS To BUDGET SOURCE: Funded Contract Change Management Reserve Undistributed Budget Other INITIATED BY: APPROVALS: Program Mgr. Prog. Control 12
Sources Of Additional Funding Funded contract change Management reserve Undistributed budget Other (e.g. profits) Cost data collation and reporting flow chart Actuals Labor ACWP Inventory Accounts BCWP Computer BCWS Monthly Total Program Effort Weekly Labor Reports MCCS Comparison reports To All Execs Variance Report 13
Cost Data Labor Material Other direct charges Overhead Types of Budgets Distributed budget Management budget Undistributed budget Contract changes 14
Variance Analyses Variables for variance analysis Budgeted cost for worked scheduled (bcws) is the budgeted amount of cost for word scheduled to be accomplished plus the amount of level of effort or apportioned effort scheduled to be accomplished in a given time period. Budgeted cost for work performed (bcwp) is the budgeted amount of cost for completed word, plus budgeted for level of effort or apportioned effort activity completed within a given time period. This is sometimes referred to as an earned value. 15
Variables for variance analysis (cont.) Actual cost for work performed (acwp) is the amount reported as actually expended in completing the work accomplished within a given time period. Cost variance = bcwp acwp Schedule/performance variance = bcwp - bcws Variances The cost variance compares deviations only from the budget and does not provide a measure of comparison between work scheduled and work accomplished. The scheduling variance provides a comparison between planned and actual performance but does not include costs. 16
Measurements Measurable efforts: discrete increments of work with a definable schedule for accomplishment, whose completion produces tangible results. Level of effort: work that does not lend itself to subdivision into discrete scheduled increments of work, such as project support and project control. Cost variance calculation CV = BCWP - ACWP A negative variance indicates a cost overrun 17
Schedule variance calculation SV = BCWP - BCWS A negative variance indicates A behind schedule condition Variance percent's SCHEDULE VARIANCE % = (SVP) SV BCWS X 100 COST VARIANCE % = (CVP) CV BCWP X 100 18
Project Variance Analysis Variance upper boundary Projected cost $ Actual cost variance Variance lower boundary R&D Qualification Development Phase i PHASE II Phase iii TIME Management Reserve Contracted cost Actual cost Management Reserve $ Released budget TIME 19
Information Requirements Budgeted cost for work scheduled (BCWS) Budgeted cost for work performed (BCWP) Actual cost for work performed (ACWP) Estimated cost at completion Budgeted cost at completion Cost and schedule variances/explanations Traceability Variance Analysis Questions What is the problem causing the variance? What is the impact on time, cost, and performance? What is the impact on other efforts, if any? What corrective action is planned or under way? What are the expected results of the corrective action? 20
Variance reporting Variance reporting is accomplished at each reporting interval. However, the variance threshold reports are exception reports and occur only when the variances exceed the upper and lower boundaries of the project variances envelope. Reporting intervals Depends on the type of organization and characteristics of the projects. Project-driven organization - weekly. Non-project-driven organization - monthly 21
The 50/50 rule Half of the budget for each element is recorded at the time that the work is scheduled to begin and the other half at the time the work is scheduled to be completed. For a project with a large number of elements the amount of distortion from such a procedure is minimal. Analysis Budgeted cost for work Scheduled (BCWS) Performed (BCWP) Budget - 6 8 14 12 Cost account budget = 100 (thousands) 10 12 Work packages BCWS = 38 BCWP = 49 SCHED. VARIANCE = +11 50-50 rule used for work in process J F M A M J J A S O N D 8 12 10 8 22
Using The 50-50 Rule 4,000 10,000 TIME LINE 12,000 4,000 LEGEND COMPLETED NOT COMPLETED BCWS = 34,000 BCWP = 33,000 BAC = 52,000 6,000 6,000 10,000 TIME Earned Value Status Reporting Time line Cumulative cost, $ ACWP BCWS BCWP CV SV Time 23
Estimate at completion (EAC) EAC = ACWP BCWP X Budget at completion (BAC) The estimate at completion is the best estimate of the total cost at the completion of the project. The EAC is a periodic evaluation of the status of the project - usually on a monthly basis or until a significant change has been identified. Progress reporting Progress reporting needs to answer four fundamental questions: 1. Where are we today (time and cost)? 2. Where will we end up (time and cost)? 3. What are the present and future risks? 4. Are there any special problems that need to be addressed and what can management do to help? 24
Estimate at completion (EAC) 2. EAC = (360/340) X 579,000 = $613,059 Overrun = 613,059-579,000 = $34,059 3. COST SUMMARY Costs are running approximately 5.9% over budget due to higher salaried labor. 4. SCHEDULE SUMMARY The 24.4% behind schedule condition is due to subtasks 4 and 6 which have not yet begun due to lack of raw materials and the 50/50 method for booking costs. Overtime will get us back on schedule but at an additional cost of 2.5% of direct labor costs. Milestone report Milestone/ Scheduled Projected Actual Subtask Completion Completion Completion 1 4/1/97 4/1/97 2 5/1/97 5/1/97 3 5/1/97 4/23/97 4 7/1/97 7/1/97 5 6/1/97 6/1/97 6 8/1/97 8/1/97 7 9/1/97 9/1/97 8 10/1/97 10/1/97 25
Activity report Reporting Status Reporting Is More Than Just A Computer Printout. Intranet Status Reporting Reporting Favorable Status Reporting Unfavorable Status 26
WBS Organization BCWS BCWP ACWP Budget SCHED VAR COST VAR Data accumulation Cost Problems Poor estimating techniques and/or standards, resulting in unrealistic budgets Out-of-sequence starting and completion of activities and events Inadequate work breakdown structure No management policy on reporting and control practices Poor work definition at the lower levels of the organization Management reducing budgets or bids to be competitive or to eliminate fat 27
Cost Problems (Cont.) Inadequate formal planning that results in unnoticed, or often uncontrolled, increases in scope of effort Poor comparison of actual and planned costs Comparison of actual and planned costs at the wrong level of management Unforeseen technical problems Schedule delays that require overtime or idle time costing Material escalation factors that are unrealistic Problem Areas in Cost Control Organization: - Inadequate Work Breakdown Structure - Poor work definition at working levels - Lack of formal system procedures Planning and budgeting: - Inadequate forward planning - Over-allocation of budget - Poor integration of budget, schedule, work authorization 28
Problem Areas in Cost Control (cont.) Accounting: - Inability to account for cost of material on applied basis Analysis: - Determination of status not based on work package completion - Comparison of actual vs. planned costs at improper level Revisions: - Failure to maintain valid measurement baseline Cost Problems Per Phase Proposal Phase Failure to understand customer requirements Unrealistic appraisal of in-house capabilities Underestimating time requirements Planning phase Omissions Inaccuracy of the work breakdown structure Misinterpretation of information Use of wrong estimating techniques Failure to identify and concentrate on major cost elements Failure to assess and provide for risks 29
Cost Problems Per Phase Negotiation phase Forcing a speedy compromise Procurement ceiling costs Negotiation team that must win this one Contractual phase Contractual discrepancies SOW different from RFP requirements Proposal team different from project team Cost Problems Per Phase Design phase Accepting customer requests without management approval Problems in customer communications channels and data items Problems in design review meetings Production phase Excessive material costs Specifications that are not acceptable Manufacturing and engineering disagreement 30
Earned Value Progress is compared against the baseline to determine whether project is ahead of or behind plan Percent complete can be difficult to measure, some managers use rules 50/50 Rule Assumed 50% complete when task started, final 50% at completion 20/80 Rule 20% at start 0/100 Rule No credit until complete Planned Value (PV) Budgeted Cost Earned Value (EV) Actual work completed Actual Cost (AC) Costs incurred Estimate to Complete (ETC) What s Left Estimate at Completion (EAC) What final cost will be Earned Value Graph Planned Value (PV) Variance at Completion (VAC) Target Cost & Schedule Schedule Variance (Time) Earned Value (EV) 31
Earned Value Formulas NAME FORMULA NOTES Cost Variance (CV) EV-AC Negative = Over budget Positive = Under budget Schedule Variance (SV) Cost Performance Index (CPI) Schedule Perform Index (SPI) Estimate to Complete (ETC) Variance at Completion (VAC) Estimate at Completion (EAC) EV-PV EV/AC EV/PV EAC-AC BAC-EAC See following slide Negative = Behind Schedule Positive = Ahead of Schedule How much are we getting for every dollar we spend? Progress as % against plan How much more do we have to spend? At the end of the day, how close will we be to plan? Earned Value Formulas NAME FORMULA NOTES Estimate at Completion (EAC) BAC/CPI AC+ATC AC+BAC-EV AC+(BAC-EV)/CPI Use if no variances from BAC have occurred Use when original estimate was bad. Actuals + New estimate Use when current variances are not expected to be there in the future Use when current variances are expected to continue 32
Tricks for Earned Value EV is always first Variance = EV minus something Index = EV divided by something If the formula relates to cost use AC If the formula relates to schedule use PV Interpreting results: negative is bad and positive is good Interpreting results: greater than one is good, less than one is bad Project Start PV Current Status BAC AC ETC EAC Terms to Remember Present Value Net Present Value (NPV) Internal Rate of Return (IRR) Payback Period Benefit Cost Ratio = BCR>1, Payback is greater than the cost Opportunity Cost Sunk Cost Working Capital Straight Line Depreciation Accelerated Depreciation Double Declining Balance Sum of Years Digits Value Analysis (Value Engineering) You won t be calculating most of these numbers on the test, just remember the concepts for general questions 33
End of Chapter 15 34