BUDGETING A PROJECT Project Management and Leadership 2017D, PhD, PMP

BUDGETING A PROJECT Project Management and Leadership 2017D, PhD, PMP

Predicting and analyzing the prospective financial performance of the project s product is often performed outside of the project. PROJECT COST MANAGEMENT is primarily concerned with the cost of the resources needed to complete project activities.

DECIDING TO INITIATE A PROJECT DECIDE TO: BUY MAKE 80 000 100 000 at P=0.1 90 000 at P=0.3 80 000 at P=0.3 40 000 at P=0.3

DECISION TREE BUY 80K 0.1 MAKE 0.3 73K 0.3 0.3 80K 100K 90K 80K 40K

TIME VALUE OF MONEY OPPORTUNITY money invested (e.g. in a low-risk investment) will earn interest and the total amount available will be greater in the future. INFLATION the same amount of money in the future will not purchase as many goods and services as today. RISK something could go wrong, causing the future payment to be smaller or later than expected (or not happen at all). (mod. MARTLAND 2011, p.162)

2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 100,00 110,00 121,00 133,10 146,41 161,05 177,16 194,87 214,36 235,79 259,37 38,55 42,41 46,65 51,32 56,45 62,09 68,30 75,13 82,64 90,91 100,00

DISCOUNT RATE The rate of return used in a discounted cash flow analysis to determine the present value of future cash flows

NET PRESENT VALUE The sum of the present values (PVs) of incoming and outgoing cash flows over a period of time. https://en.wikipedia.org/wiki/net_present_value Adjusting, or discounting them to get their present value means working out how much money would have to be invested now in order to generate that specific amount at that time in the future. (BUGLEAR 2005, p.267)

INTERNAL RATE OF RETURN (IRR) The discount rate at which the total PV of the cash flows into a business arising from an investment precisely equals the initial outlay. IRR is the discount rate that would result in NPV of zero for the investment. In general, the higher the IRR, the more attractive the project. (BUGLEAR 2005, p.270-272)

HIGHLIGHTS: 1. DECISION TREES ARE USED TO CALCULATE EMV OF A PROJECT 2. MONEY HAS TIME VALUE 3. ESSENTIAL BUSINESS METRICS NPV and IRR ACCOUNT FOR IT

COST MANAGEMENT PROCESSES 1. PLAN COST MANAGEMENT 2. ESTIMATE COSTS 3. DETERMINE BUDGET 4. CONTROL COSTS

HOW TO PLAN Expert judgment Analytical techniques Meetings

COST MANAGEMENT PLAN A component of the PM plan; describes how the project costs will be planned, structured, and controlled It can establish: Units of measure Level of precision Level of accuracy Reporting formats

HOW TO ESTIMATE Expert judgment Analogous estimating Parametric estimating Bottom-up estimating Three-point estimating Vendor bid analysis Group decision-making techniques

OUTPUTS ACTIVITY COST ESTIMATES BASIS OF ESTIMATES (assumptions, constraints, ranges)

A GOOD COST ESTIMATE COMPLETE REASONABLE CREDIBLE ANALYTICALLY DEFENSIBLE (MISLICK & NUSSBAUM 2015, p.292)

HOW TO DETERMINE BUDGET Cost aggregation Reserve analysis Expert judgment Historical relationships Funding limit reconciliation

OUTPUTS COST BASELINE. The approved version of THE TIME-PHASED PROJECT BUDGET, excluding any management reserves, which can only be changed through formal change control procedures and is used as a basis for comparison to actual results; is developed as a summation of the approved budgets for the different schedule activities. PROJECT FUNDING REQUIREMENTS. Total funding requirements and periodic funding requirements (e.g., quarterly, annually) are derived from the cost baseline.

ACTIVITY COST ESTIMATES WORK PACKAGE COST ESTIMATES CONTROL ACCOUNTS COST BASELINE PROJECT BUDGET PROJECT BUDGET COMPONENTS CONTINGENCY RESERVE MANAGEMENT RESERVE ACTIVITY CONTINGENCY RESERVE

COST OVERRUNS (NICHOLAS 2012, p.283)

NOTABLE OVERRUNS The 2012 London Olympics: 2.4B (the bid in 2005) 9.3B (adj. in 2007) 8.9B (in 2010) (Ahiaga-Dagbui & Smith 2014) The City of Boston s Central Artery project (the Big Dig): $2.8B (by 1998) $14.6B (in 2007) (Wikipedia)

REASONS FOR COST ESCALATION Changes in requirements or design Economic and social factors Ego involvement of the estimator Inefficiency, poor communication, and lack of control Project contract Uncertainty and lack of accurate information (NICHOLAS 2012, p.282-286)

Cost estimating, budgeting, and control are sometimes thought to be the exclusive concerns of cost specialists, planners and accountants, but in projects they should be the concern of everyone. Project participants who are closest to the sources of costs engineers, scientists, systems specialists, architects, or others should be involved in the estimating and budgeting process. (NICHOLAS 2012, p.281-282)

HIGHLIGHTS: 4. PROJECT BUDGET CONSISTS OF ACTIVITY ESTIMATES AND 3 BUFFERS 5. COSTS ESCALATE THROUGH A PROJECT