Project Cost Management: Everything You Need to Know

Cost management plays a critical role in the success of any project. However, even a minor convenience could affect your budget. In fact, 47% of agile projects are late, have budget overruns, or result in unhappy customers.

So, how do you increase the success rate while staying profitable? The answer is by creating a robust project costing and budgeting plan. 

The two primary ways to determine project costs are manually and with tools. Manual calculations are tedious and prone to errors. On the other hand, project costing management tools https://firstbit.ae/products/erp-dubai/project-costing/ like FirstBit ERP help you automate most tasks, including cost control. Based in Dubai, FirstBit project costing and accounting software allows businesses across the UAE better manage their costs. 

In this article, we will discuss project cost management, how you can create estimates, and the importance of a sound project management system. Let's get started. 

What is Project Cost Management? 

Project cost management is the process of managing the costs of a project from its start to completion. It includes budgeting, scheduling, estimating, cost control, and other related activities.

• Planning: It involves establishing baseline budgets and schedules and tracking expenses as they're incurred.

• Budgeting: In this stage, you predict future expenses for ongoing or new projects with similar requirements.

• Tracking: It involves recording actual expenses and comparing them to the baseline budget.

• Controlling: In this stage, you adjust budgets and optimize resources if actual costs exceed estimates or if something changes during the project's course. 

• Reporting: It enables stakeholders to track progress toward meeting their goals and objectives. It helps them evaluate how well their investment is paying off. 

Why is Project Cost Management Important? 

Projects are often complex and involve multiple tasks and resources. But they must still be completed within a specific timeframe and budget. Cost management ensures that all aspects of a project's finances are controlled, so costs do not exceed budgeted amounts.

The primary objectives of project cost management are to

• Provide information to decision-makers about a project's status, progress, and cost performance.

• Determine problems beforehand so you can take corrective action before they affect the schedule, budget, or quality. 

• Ensure that all necessary resources are allocated effectively and efficiently.

• Reduce uncertainty and risks linked with high-budget projects. 

• Ensure adequate funds are available for each phase of the project lifecycle.

What are the Key Steps In Project Cost Management?

Project costing is not a one-off task you do before starting the project. Instead, it is a continuous process that requires regular monitoring and adjustments (if something changes midway). Here are the four critical steps in the project cost management process. 

1- Project Resource Planning

It involves identifying the right resources for a project and scheduling them for each stage. It also includes analyzing the costs linked with these resources. 

You can use the work breakdown structure (WBS) to simplify this process and improve accuracy. WBS is a detailed analysis of tasks that go into completing a project. This helps you divide the deliverables into manageable jobs and act as a guide for your team. Here are the three components of a work breakdown structure to help you create one. 

• Deliverables: These include the end product of the project. You can divide the result into different stages to assign the work to individual team members. 

• Work components: In this stage, you group similar tasks and define how they work together. 

• Individual tasks: This is the last and most detailed level of WBS. These tasks should have one deliverable and be completed by a single person. 

A clearly defined WBS helps ensure you don't miss even the minute detail of the project. It keeps everyone on the same page while conveying the big picture. 

2- Cost Estimation

It is the process of determining the approximate cost of each resource scheduled for the project. It includes forecasting the cost of completing a project within a defined scope. If the scope changes during the life of a project, you might have to repeat the cost estimation process. Cost estimation can be divided into direct and indirect costs. 

• Direct costs include those necessary or directly involved in completing the project.

• Indirect costs include costs for things that do not contribute to the project's completion but are crucial for the company.

Direct costs include

• Professionals: Employees, freelancers, or outsourced contractors working on the project

• Equipment: Any tools, machines, or software that professionals use to complete the project

• Materials (if any): Physical materials required to complete the project (like raw materials for manufacturing or construction)

• Engineering (if applicable): Research, design work, or installation of equipment necessary to finish the project

• Transportation (if applicable): Freight costs, customs, etc., to bring raw materials or deliver the finished product to the client

Indirect costs include 

• Overhead expenses: Office rent, utilities, client visits, insurance, etc

• General costs: Salaries of executives who oversee multiple projects (including the one you're working on)

You will need to create a cost estimate based on the time duration each resource is required to work for in the project. This will help improve your project costing estimation and mitigate risks. You can also follow one of the techniques to create a more accurate estimate.

•  Analogous estimating: It uses previous, similar projects as a reference to inform the estimate. You should consider if anything affected the project scope or budget during its lifecycle and adjust accordingly. 

• Parametric modeling: It involves using statistical methods like Regression Analysis or Learning Curve models to inform project estimates.

• Bottom-up estimating: It calculates the cost based on known quantities, such as raw materials cost and duration of human resources working on the project.  

3- Cost Budget

Budgeting involves allocating funds to individual tasks or modules. A sound project budget helps optimize project schedules and resource allocation decisions. You can use the following techniques to create a project budget. 

• Cost aggregation: Combine costs from individual tasks and work components and apply them to the cost baseline.

• Historical data: Determine the budget of new projects from similar, closed ones. 

• Reserve analysis: Create a buffer to stay protected against cost overruns. The degree of protection depends on the risk and scope of the project. 

4- Cost Control

Project managers must monitor project costs and look for scope creep. This includes analyzing when costs vary from estimates, or the scope widens. You must also inform stakeholders of discrepancies in project costing and estimation. To effectively control costs, managers must be aware of

• Original budget

• Approved budget

• Forecasted costs

• Actual costs

To control costs, you can also use variance analysis and the to-complete performance index (TCPI). Variance analysis helps determine the difference between the budget and actual costs. On the other hand, TCPI is a projection of cost performance that your project must achieve on the remaining work. 

Challenges of Project Cost Management

One of the biggest challenges in project cost management is inaccurate estimates. This can happen for various reasons, such as poor planning, lack of experience, or unexpected changes in scope. However, when estimates are not precise, it can lead to the project going over budget and increase financial problems.

Another challenge that can arise during project cost management is unexpected costs. This can happen when unforeseen circumstances arise, such as supplier problems or delays. When unexpected expenses occur, it can lead to the project going over budget and cause financial problems for the project manager and the organization.

Scope creep is yet another common challenge in project costing and budgeting. It is the tendency for a project's scope to increase gradually over time. This can happen for various reasons, including changes in project requirements or adding new features. Thus, you need to include a buffer in your project's budget. 

Do You Need a Project Costing System?

A project costing system helps you plan, organize, manage and track your projects. It gives you a single place to store all the information you need to ensure your projects are successful and avoid overspending. For instance, if you're working on an eCommerce website, you can integrate ERP with your eCommerce website to automate tedious tasks. 

The main features of a project costing system are

• Planning: These help you plan your project and break it down into smaller parts. This will include tasks, milestones, and resources.

• Cash flow management: It helps monitor how much money is coming in versus how much is going out for salaries, materials, or other costs associated with your project's lifecycle. 

• Task Management: It allows you to add tasks, assign them to team members and track their progress over time.

• Time tracking: It lets you see how much time people spend on each task and how much time is left to complete it.

• Budgeting: It helps you manage budgets for different project phases. You can track and manage materials, labor, and other costs.

• Cost monitoring and control: It allows you to track project costs at every stage. This empowers you to take corrective action before the project goes out of budget. 

• Reporting and analytics: It gives you a clear view of how much work you've done and what's left to do. You can also generate custom reports for stakeholders and keep them updated. 

These features can help you plan your projects, create project costing and budgeting, control expenses, and generate reports from one place. In addition, managers handling multiple projects can use it to ensure all their projects stay on track and within budget. 

Final Thoughts

Project cost management is an integral part of project management. It helps you keep track of spending, identify areas where expenses have exceeded budgets and take corrective actions if necessary. Although it could be challenging, the right project costing tool can make things easier by bringing all the data together!