5.

0 Budgets and Cost Management

5.1 Project Budgeting

Project budgeting is the process of estimating the full cost of the project
from the very beginning until the end. The project budgeting
process involves the following:

 Budget planning: Estimating costs and making a budget

based on a project estimate
 Budget tracking: Keeping track of project expenses during
the project execution phase
 Project budget management: Setting guidelines and
control procedures to guarantee that costs don’t exceed the
project budget

5.2 Estimating Project Cost methods

Project cost estimation is the process that takes direct costs, indirect
costs and other types of project costs into account and calculates a
budget that meets the financial commitment necessary for a successful
project. To do this, project managers and project estimators use a cost
breakdown structure to determine all the costs in a project.
Cost estimation is a process where project managers predict the amount
of money they need to fund their projects. The process entails direct and
indirect costs of the project. These costs may include utilities, materials,
equipment, vendors, and employee compensation.
As managers estimate costs, they may also consider project elements,
including: duration, size, scope and complexity.
There are five main types of costs that make up your total project cost
baseline. Here’s a quick overview of these types of project costs and
how to measure them.

 Direct costs: Direct costs are those that occur in a project

and are attached to specific activities. These are generally
costs that are easier to accurately estimate. They include raw
materials, labor, supplies, etc.
 Indirect costs: Indirect costs in a project are those that are
in support of the project, such as administrative fees. These
can include everything from rent to salaries of the
administrative staff to utilities, etc.
 Fixed costs: Fixed costs, as the name suggests, are those
that don’t change throughout the life cycle of a project.
Some examples of fixed costs include setup costs, rental
costs, insurance premiums, property taxes, etc.
 Variable costs: Variable costs are costs that change due to
the amount of work that’s done in the project and are
variable in nature. These costs can include hourly labor
wages, materials, fuel costs and so on.
 Sunk costs: In project cost estimating, when an investment
has already been incurred and can’t be recovered it’s called
a sunk cost or retrospective cost. Some examples of sunk
costs include marketing, research, installation of new
software, etc.
5.3 What Does a Project Estimator Do?
The project estimator or cost estimator, is tasked with figuring out the
duration of the project in order to deliver it successfully. This includes
determining the resources needed, including labor, materials, etc., which
informs the project budget.

In order to do this, a project estimator must understand the project and

its phases and be able to research the historical data of projects that were
similar and executed in the past. Cost estimators also need to have a firm
grasp of mathematical concepts.

Unlike a project manager, who’s responsible for the delivery and

oversight of the project, a project estimator is focused on the direct and
indirect costs associated with the project. Project estimators work
closely with contractual professionals to develop accurate estimates,
which are presented to project leaders.

5.4 Project Cost Estimation Techniques

All of these factors impact project cost estimation, making it difficult to

come up with precise estimates. Luckily, there are cost estimating
techniques that can help with developing a more accurate cost
estimation.

a. Analogous Estimating

Seek the help of experts who have experience in similar projects, or use
your own historical data. If you have access to relevant historical data,
try analogous estimating, which can show precedents that help define
what your future costs will be in the early stages of the project.
The analogous estimating method combines historical data and expert
judgment to anticipate the costs of a project. Here are its steps:

1. Identify the project's elements, such as size, scope and duration

2. Research similar projects that have used the same elements.
3. Base the cost estimation for the current project on a budget of past
projects.

b. Parametric Estimating

There’s statistical modeling or parametric estimating, another cost

estimation method that also uses historical data of key cost drivers and
then calculates what those costs would be if the duration or another of
the project is changed. The parametric estimating method involves using
historical data to determine the costs of each part of the endeavor. For
example, when planning to build a two-story house, you can review the
historical costs of building a house with the same materials and square
footage, which enables you to design an accurate budget. The parametric
method includes three steps:

1. Identify the number of project units, such as square footage.

2. Identify the cost of each unit
3. Multiply the total number of units by the cost of one unit

c. Bottom-Up Estimating

A more granular approach is bottom-up estimating, which uses estimates

of individual tasks and then adds those up to determine the overall cost
of the project. This cost-estimating method is even more detailed than
parametric estimating and is used in complex projects with many
variables such as software development or construction projects.
For instance, when launching a marketing campaign, you might need
$200 for social media advertisements and $500 for buy-in commercials
on television, which equals a total cost of $700 for the campaign.

d. Top Down Estimate

In the top-down estimating method, you determine the total cost of a
project and separate the cost into smaller categories. For example,
a nonprofit organization is hosting a gala with an approximate cost of
$15,000 overall. The event committee notes that decorations cost
$2,000, food and drinks cost $7,000 and entertainment costs $6,000.
Top-down estimating may be most beneficial at the beginning planning
stages of a project, where you can gain insight into what resources cost
the most.

e. Three-Point Estimate

Another approach is the three-point estimate, which comes up with three

scenarios: most likely, optimistic and pessimistic ranges. These are then
put into an equation to develop an estimation.

1. Optimistic Estimate: This prediction shows the best-case

scenario, where employees complete the project and maintain the
budget
2. Pessimistic estimate: In the worst-case scenario, pessimistic
estimates entail overspending funds on resources
 3. Most likely estimate: A realistic estimate is a median between
optimistic and pessimistic predictions. It refers to the actual effort
employees need to produce to complete the project and its costs

As a project manager, you can calculate the final project cost using
the program evaluation and review technique (PERT) equation:

PERT = [optimistic estimate + pessimistic estimate + (4 x most likely

estimate)] / 6

f. Reserve Analysis

Reserve analysis determines how much contingency reserve must be

allocated. This cost estimation method tries to wrangle uncertainty.

The reserve analysis technique accounts for challenges that may occur
when executing the project. It includes funds for the contingency reserve
and money for expected conflicts, such as technical difficulties or
limited productivity. It also includes the management reserve, which is
funds that cover unexpected conflicts, such as historical weather events
or national health emergencies

g. Cost of Quality

Cost of quality uses money spent during the project to avoid failures and
money applied after the project to address failures. This can help fine-
tune your overall project cost estimation. Plus, comparing bids from
vendors can also help figure out costs.

Project Management Information System

The project management information system (PMIS) technique uses
specialized software to manage the steps of your plan. You can input
your resources and their costs to determine their total price. The
software also organizes your resources into a calendar, showing how
your plan progresses and the necessary resources for each step.

h. Delphi Method

The Delphi method is the process of gathering a panel of experts and

engaging in several rounds of questions about how to make certain
business decisions or solve an organizational problem. Every answer the
experts provide is anonymous. After each round, facilitators review and
sort through all the answers.

They'll locate answers with common themes and ideas and will share
these with the other experts. Once the experts hear and digest the other
panelists' answers, they're given the option to adjust their own answers
according to the group's responses.

The main purpose of the Delphi method is to encourage these experts to

settle on a mutual agreement and to establish a group consensus. Many
industries and organizations may use this method for
business forecasting or structural decisions, like industry predictions,
government planning or financial strategies.

i. Decision Making

The decision-making model considers every team member's opinion,

meaning the employees vote on the cost estimation figure. The team
decides by achieving votes in ways such as:
Unanimous vote: Every team member agrees on the figure. For
instance, if there are five people on the team, all five need to share the
same perspective.

Majority vote: A majority vote, or plurality, encompasses more than

half of the team. For example, if there are 10 members, at least six can
vote the same way

Points allocation: The team assigns 100 points across a particular

subject, which can highlight areas of interest or value. For instance, an
area that receives two points may be insignificant, while an area that
receives 89 points may require more attention

j. Vendor bid analysis

A vendor is an individual or company that supplies goods and services

to businesses or consumers. Vendors buy products or services
from distributors and resell them to others, usually individual
consumers. Their main goals are to monitor customers’ interests and to
have enough goods in stock to meet demand.

Vendor bid analyses may be beneficial for projects requiring vendors'

use exclusively. First, you send a request for proposal (RFP) document
to vendors you're interested in hiring. In the document, the vendors list
the price and quality of their services and share their responses with you.
Then, you compare the prices to estimate how much the entire project
may cost.

k. Expert Judgment
By receiving expert assistance, your team can resolve interpersonal
conflict and select the best estimating method for your endeavors.
Experts examine historical data and explain how an environment can
affect the execution of a project. For example, experts may advise you to
debut a children's movie during the summer since the target audience
may be out of school and attending the movie theater frequently. They
may also suggest combining estimating methods to calculate the most
approximate cost figure.

5.5 How to Estimate Project Costs in 10 Steps

1. Define the cost estimate’s purpose: Determine the purpose

of the cost estimate, the level of detail that is required, who
receives the estimate and the overall scope of the estimate.

2. Develop an estimating plan: Assemble a cost-estimating

team and outline their estimation techniques. Develop a
timeline, and determine who will do the independent cost
estimate. Finally, create the team’s schedule.

3. Define characteristics: Create a baseline description of the

purpose, system and performance characteristics. This
includes any technology implications, system
configurations, schedules, strategies and relations to existing
systems. Don’t forget support, security, risk items, testing
and production, deployment and maintenance and any
similar legacy systems.

4. Determine cost estimating techniques: Define a work

breakdown structure (WBS) and choose an estimating
method that’s best suited for each element in the WBS.
 Cross-check for cost and schedule drivers; then create a
checklist.

5. Identify rules, assumptions and obtain data: Clearly

define what’s included and excluded from the estimate and
identify specific assumptions.

6. Develop a point estimate: Develop a cost model by

estimating each WBS element.

7. Conduct a sensitivity analysis: Test the sensitivity of costs

to changes in estimating input values and key assumptions,
and determine key cost drivers.

8. Conduct risk and uncertainty analysis: Determine the

cost, schedule and technical risks inherent with each item on
the WBS and how to manage them.

9. Document the estimate and present it to

management: Having documentation for each step in the
cost estimate process keeps everyone on the same page with
the cost estimate. Then you can brief the project
stakeholders on cost estimates to get their approval.

10. Update the cost estimate: Any changes to the cost

estimate must be updated and reported. Also, perform a
postmortem where you can document lessons learned.

5.6 Why is cost estimation important

As a project manager, cost estimation is important for planning because
it can help you achieve the following:
Maintaining your budget
When you decide to launch a project, you may design a budget that
dictates how much money you can afford to spend on resources and
equipment. Cost estimation enables you to predict the funds needed and
compare the estimation with your budget. If the estimation exceeds your
budget, you can refine your plan before starting the project.
Prevent overspending
Without a strategic plan, you may overspend on resources. For example,
if you discover halfway through a project that purchasing more
equipment is necessary, you might spend more money than expected. To
help with this challenge, estimating all your costs before you begin a
project is best.
Improve Profit Margins
Several factors can cause project costs to rise throughout a project's life
cycle. These may include poorly scoped work, unexpected events
and inflation. These factors can present a risk to completing the project
within budget and meeting profitability targets. Accurate estimating can
help you determine expected and unexpected costs, protecting a
company's profit margins.
5.7 Managing the Project Cost Baseline
5.7.1 Project Cost Baseline
Cost refers to the planned expenses that a company will incur while
completing a project. Managers often create baseline cost estimates by
dividing their projects into smaller segments and estimating required
resources for each. They may include costs such as labor, materials,
equipment, permitting and any other expenditures that a team may incur.
Besides these costs, a baseline may include a contingency fund to cover
unexpected costs and keep the project under budget. During the course
of a project, teams can use this baseline to see whether they are staying
within their budget and make adjustments accordingly.
A cost baseline is the budget that has been approved for a project,
broken down into a list of salaries, materials, equipment and more. It’s
the sum of the cost estimates for all the tasks on your project schedule.
Once you have a cost baseline, you need to add a management reserve,
which is a portion of the project budget that’s used as a contingency
reserve for management control and unexpected costs. Those two
elements make up your project budget.
5.7.2 Why Are Baselines Important

Setting a cost baseline is important because keeping to your project

budget is important. Going over budget is a sure sign that your project is
heading in the wrong direction. Miss the mark with the budget, and
you’re going to have some unhappy stakeholders.

The cost baseline is a bottom-line issue, but it’s also a way to assess cost
variance, cost performance and planned effort versus actual effort.
Without a baseline, you have nothing to measure your spending against
and control costs. Few things are more important than cost management
when managing a project.

5.7.3 Problems caused by not having a project baseline

here are at least six possible problems that may occur when a strong
project baseline is absent:

1. Inadequate resourcing: If you don’t have a planned schedule, you

may not know which resources you will need and when.

2. Schedule delays (due to mistimed procurement, material

delivery, etc.): Without knowing when you need material, it’s
difficult to ensure it’s ordered on time, especially if it’s something
that needs to be ordered weeks or months in advance.

3. Issues with quality management: An unclear scope baseline can

result in substandard quality. For example, if you know paint is
needed but not what color or finish, the outcome may not meet the
customer’s quality standards.
 4. A lack of proper change management: Without baselines in
place, it’s difficult to track and manage changes. You have no
yardstick to measure against, so it can be challenging to know if
your outcome is different than originally expected.

5. The inability to accurately report progress: As with the earlier

example, it’s difficult to tell if you’re running behind schedule if
you don’t have a baseline to compare against.

6. Customer and/or sponsor dissatisfaction: Any of the five

problems above can result in poor project performance, which will
mean unhappy stakeholders, including your customer
and/or sponsor

5.7.4 Managing Baseline

Project cost management is a process for assessing costs before and

during a project. It allows a company to make informed financial
decisions by identifying whether a proposed plan's benefits justify its
projected cost. This tool also enables managers to make decisions
proactively, as an up-to-date budget forecast can help them make
adjustments to their project plan.

So managing cost baseline involves estimating project costs, creating a

budget, tracking actual costs, identifying variances, and taking corrective
actions.

Here are some of the cost baseline management techniques in

project management.
 1. Earned Value Management (EVM):
This technique helps in tracking project progress and cost performance
by measuring what work has been completed (earned value) against
what was planned and what was actually spent.
As a project manager, you’ve likely encountered situations when your
projects sit in the grey area between success and failure. For instance,
your project might have stayed within budget but missed its timeline, or
perhaps it met the deadline at the cost of team burnout. In such
scenarios, the lack of performance tracking against variables like cost
and time often contributes to project failure despite meticulous planning.
So, if you are looking for more definitive goals for project success, you
must use Earned Value Management or EVM.
EVM provides a clear picture of ‘where a project stands’ and ‘how far
the journey is ahead.’ This accuracy helps spot discrepancies, change
plans, correct mistakes, and make timely yet quality delivery possible.
Moreover, it integrates cost and time – two diverse yet crucial factors on
a unified scale and lets you compare the execution against the plan.

This way, earned value management brings you closer to precision in

project planning and accuracy in performance for unmatched process
delivery. It empowers you to define responsibilities without burning out
your team members and provides stakeholders with clarity regarding
progress.

Earned value management is a project management methodology that

integrates schedule, costs, and scope to compare the planned vs. actual
and identify variances. This system helps managers systematically
measure project performance against the baseline.
EVM uses key metrics like Planned Value (PV), Earned Value (EV),
and Actual Cost (AC) to spot discrepancies and rectify them for timely
delivery within budget. It also helps forecast future performances and
outcomes, enabling project managers to adjust accordingly.

Earned value analysis (EVA) is typically used in complex, large-scale

projects with significant budgets and longer timelines.

EVA metrics and Formula

Project managers analyze the project’s schedule and cost performances

with EVM based on the following crucial indicators:

Schedule variance (SV)

Schedule variance is the difference between the actual work done (EV)
and the work planned to be completed (PV). It indicates if the project
is ahead of schedule, on or behind schedule.

SV =

EV – PV
0 variance means the project is on schedule, whereas negative or
positive variance means it is behind and ahead of schedule.

Cost variance (CV)

It is the difference between the value earned and the actual cost. It
shows if the project is within budget or not using the following
formula:

CV =

EV – AC
0 variance means the project is adhering to the approved cost. Negative
and positive variance indicates the project is going over and under the
budget, respectively.

Schedule performance index (SPI)

SPI is the ratio between the earned value and the planned value. It is a
relative measure of the project’s time efficiency using the formula:

SPI =

EV / PV
If the value of SPI is greater or equal to 1, it means the project is on
track, whereas less than 1 indicates a deviation from the scheduled
project budget.

Cost performance index (CPI)

It is the ratio of earned value to actual cost. In other words, the CPI
equals the earned value divided by the actual costs. PMI’s PMBOK®
Guide defines the CPI as a “measure of cost efficiency on a project.”

CPI =

EV / AC
It is a relative measure of the project’s cost efficiency and can estimate
the remaining task’s cost.

To-Complete Performance Index (TCPI)

The to-complete-performance index (TCPI) is a forecast that shows the
efficiency required to complete the remaining work within the
approved budget. The formula used to calculate it is:

TCPI =

(BAC – EV) / (BAC – AC)

A TCPI greater than 1 means the project needs to perform better than
its current cost performance to stay within budget.

Variance at Completion (VAC)

Variance at completion (VAC) estimates the difference between the
budget at completion (BAC) and the estimate at completion (EAC).
The formula used to calculate it is:

VAC =

BAC – EAC
It indicates whether the project is expected to finish under or over the
pre-decided budget.

Here is EVA example

Let’s take the example of a construction firm planning to build a new

office building. The total project budget, or Budget at Completion
(BAC), is $1,000,000, and the planned duration is 12 months. By the
end of Month 6, the firm expected to complete 50% of the work,
meaning the Planned Value (PV) is:
PV = $1,000,000 × 50% = $500,000.
However, upon review, only 40% of the work has been completed.
This gives the Earned Value (EV):
EV = $1,000,000 × 40% = $400,000.
At the same time, the firm has already spent $600,000, which
represents the Actual Cost (AC).
Now, let’s calculate the key metrics to evaluate the project’s
performance. First, the Cost Performance Index (CPI), which
measures cost efficiency, is:
CPI = EV ÷ AC = $400,000 ÷ $600,000 = 0.67.
A CPI of less than 1 indicates that the project is over budget. Next,
the Schedule Performance Index (SPI), which assesses schedule
efficiency, is:
SPI = EV ÷ PV = $400,000 ÷ $500,000 = 0.8.
An SPI of less than 1 shows the project is behind schedule.
Additionally, the Cost Variance (CV), which highlights cost
deviation, is:
CV = EV – AC = $400,000 – $600,000 = -$200,000.
The negative CV confirms overspending. Lastly, the Schedule
Variance (SV), which measures schedule deviation, is:
SV = EV – PV = $400,000 – $500,000 = -$100,000.
This negative SV reveals that the project is also behind schedule.
These calculations demonstrate that the project is over budget and
delayed, providing clear insights to identify inefficiencies and make
necessary adjustments to steer the project back on track.

2. Trend Analysis:
Analyzing cost trends over time can help identify potential cost
overruns or under-runs, allowing for proactive measures.
Trend Analyses are mathematical methods for establishing trends based
on past project history and allowing for adjustment, refinement or
revision to predict future cost. Regression analysis techniques can be
used for predicting cost/schedule trends using data from historical
projects.
 Trend analysis in cost baseline management involves identifying and
analyzing patterns in cost data over time to understand project cost
performance and predict future costs. It helps in detecting deviations
from the budget baseline, anticipating potential overruns, and evaluating
the effectiveness of cost control measures.
Steps in Conducting Trend Analysis:
a. Gather Data:
Collect historical cost data, including actual costs incurred, planned
costs, and any relevant variances.
b. Analyze Data:
Use statistical techniques or graphical representations to identify
patterns and trends in the cost data.
c. Identify Deviations:
Compare actual cost data with the budget baseline to identify any
significant deviations or variances.
d. Analyze Causes:
Investigate the reasons behind identified cost variances and trends, such
as scope creep, resource inefficiencies, or external factors.
e. Take Corrective Action:
Based on the analysis, implement corrective actions to address
identified issues and ensure project cost management within the
budget.

Benefits of Trend Analysis in Cost Baseline Management:

a. Early Warning System:
Identifies potential cost problems early on, allowing for proactive
measures to mitigate risks.
 b. Improved Budget Forecasting:
Provides more accurate budget forecasts based on historical cost
trends.
c. Enhanced Cost Control:
Supports effective cost control measures by providing insights into cost
performance and areas for improvement.
d. Better Decision-Making:
Informs strategic decision-making regarding budget adjustments,
resource allocation, and scope changes.
e. Increased Project Success:
Contributes to overall project success by ensuring that project costs are
managed effectively within the allocated budget.

3. Change Management:
Changes to project scope, requirements, or other factors can
significantly impact costs. Effective change management ensures that
the cost baseline is updated and the impact on costs is properly
assessed.
4. Variance Analysis:
Comparing actual costs to the cost baseline helps identify variances
(differences) between planned and actual costs. These variances are
then analyzed to understand the reasons for the differences and take
corrective actions.
It compares planned performance with actual results, using cost variance
(CV) and schedule variance (SV) to identify deviations in cost,
schedule, and scope. This helps project managers evaluate if the project
 is on track, ahead of schedule, behind schedule, under budget, or over
budget, and take corrective actions beforehand.
5. Cost Performance Reports:
Regular and accurate cost performance reports provide project
managers with a clear picture of the project's financial status and help
them track progress against the cost baseline.

5.8 The Meaning of Variances in Cost and Progress

Variances in standard costing refer to the differences between actual
costs and the predetermined or “standard” costs.
The formula for cost variance is:
Cost variance = budgeted cost of work performed (BCWP) - actual
cost of work performed (ACWP)
Sometimes people will use the term earned value instead of the budgeted
cost of work performed and the term actual cost instead of the actual
cost of work performed. So the formula may look like this:
Cost variance = earned value - planned cost
You can also calculate cost variance as a percentage, which is fairly
common depending on how you want to present the information. In
order to express it as a percentage, you would use this formula:
Cost variance % = (earned value - actual cost) / earned value
Material Variance measures the difference in cost due to changes in
material prices or usage. it is calculated by (Actual Price - Standard
Price) x Actual Quantity.

Labor Variance tracks wage rate or hour differences using the

formula (Actual Rate - Standard Rate) x Actual Hours.

Overhead Variance looks at the difference in fixed or variable overhead

costs, calculated as (Actual Overhead - Standard
Overhead), highlighting operational inefficiencies.

5.81 Negative vs Positive Variances

Cost variances are negative, positive or zero. A negative cost variance
happens when you overspend and go above your budget. A positive cost
variance happens when you underspend and stay below your budget. A
zero cost variance is when the amount you spend matches your budget
exactly. Negative cost variances can indicate a business is overspending
and whether the business has enough excess funds to cover its
overspending. Positive cost variance can indicate both effective and
unsuccessful activities, and zero cost variances are ideal.
 There are two typical reasons for the cost variance fluctuating positively
or negatively rather than resulting in zero. One reason for differences in
cost variance can be due to overestimations or underestimations about a
specific outcome. Another reason cost variance can fluctuate can come
from external factors outside of your organization's control, like market
transitions. Several causes of unexpected cost variances can include:
5.8.2 Why is identifying variances necessary?
 Track Progress Against Budgeted Costs: Variances help
organizations compare actual performance with budgeted costs,
offering insights into financial health.
 Identify Areas for Improvement: Analyzing variances highlights
inefficiencies or areas where processes can be optimized for better
performance.
 Informed Decision-Making: By understanding variances,
organizations can make decisions to optimize operations, reduce costs,
and improve efficiency.
 Regular Review of Standard Costs: Periodic review and updates of
standard costs ensure they remain aligned with market conditions and
changes in production processes.
 Corrective Action for Variance Management: Promptly addressing
variances helps maintain budget adherence and ensures the
organization remains on track to meet financial goals.

Cost variance example 1

Your computer is having a problem, so you take it to a repair shop.
The tech rep inspects your computer and gives you a quote of $500 to
fix the problem. You go back to the repair shop after a few days to
pick up your computer and find out that instead of repairing one of the
parts, they had to replace it with a new one. So, your bill ended up
being $600, an extra $100 more than you thought it would be. In this
scenario, the earned value is $500 and the actual cost is $600.

You would calculate the cost variance like this:

Cost variance = $500 - $600

Cost variance = -$100

If you want to express the cost variance as a percentage, you would

calculate it like this:

Cost variance % = ($500 - $600) / $500

Cost variance % = -$100 / $500

Cost variance % = -20%

Cost variance example 2

You are a project manager and have 12 months to complete a project
with a budget of $50,000. After six months, you have spent $30,000,
however, only 40% of the project is complete. You use the
cost variance formula to figure out if you are over or under budget at
this point in time. The actual cost is $30,000 and the earned value is
40% of $50,000 or $20,000.
You would calculate the cost variance like this:

Cost variance = $20,000 - $30,000

Cost variance = -$10,000

So at this point with 40% of the project completed, you are over
budget by $10,000.

5.9 Diagnosing Causes of Cost Variances and Remedial Measures

Here are 5 ways of identifying and correcting variances.
a. Understand the types of cost variances
There are two main types of cost variances: favorable and unfavorable.
A favorable cost variance means that the actual cost is lower than the
planned cost, which implies a saving or a higher profit. An unfavorable
cost variance means that the actual cost is higher than the planned cost,
which implies a loss or a lower profit. Depending on the nature and
scope of your project, activity, or process, you may need to analyze
different types of cost variances, such as material, labor, overhead, or
sales variances.

b. Use a standard costing system

A standard costing system is a method of estimating the expected costs
of a project, activity, or process based on predetermined standards or
benchmarks. It allows you to compare the actual costs with the standard
costs and calculate the variances. A standard costing system can help
you identify the sources and causes of cost variances, as well as measure
the efficiency and effectiveness of your operations. However, you need
to ensure that your standard costs are realistic, updated, and aligned with
your goals.

c.. Apply variance analysis techniques

Variance analysis is the process of investigating and explaining the
reasons for cost variances, which can help you determine the impact on
financial performance and take corrective actions if needed. Common
techniques include variance decomposition, which breaks down total
cost variance into smaller components, such as price, quantity, mix, or
yield variances. Variance reconciliation adjusts for the effects of cost
variances to understand how they affect income statement and balance
sheet. Variance trend analysis tracks and compares cost variances over
time or across different periods, projects, activities, or processes to
identify patterns and evaluate corrective actions.

d. Implement corrective actions

Once you have identified and analyzed the cost variances, you need to
implement corrective actions to address them. Depending on the nature
and magnitude of the cost variances, you may need to revise your
budget, optimize your resources, improve your processes, negotiate with
your suppliers or customers, or change your pricing strategy. You should
also monitor and evaluate the outcomes of your corrective actions and
make adjustments as needed.
e. Communicate and report the cost variances
The final strategy for identifying and correcting cost variances is to
communicate and report them to the relevant stakeholders, such as
managers, employees, clients, or investors. You should provide clear and
accurate information about the cost variances, their causes, their
impacts, and your corrective actions. You should also use appropriate
formats and tools, such as charts, graphs, tables, or dashboards, to
present the cost variances in a visual and understandable way.
Communicating and reporting the cost variances can help you gain
feedback, support, and accountability for your cost management efforts.

Here is a practical example

A manufacturing company produces electronic gadgets. The standard
cost for materials is $10 per gadget, and the standard labor cost is $5
per gadget. In a particular month, the company produces 5,000
gadgets. The actual costs were $52,000 for materials and $26,000 for
labor.
Step 1: Set Clear Objectives
Objective: Reduce production costs by optimising material and labor
expenses.
Action: Analyse material and labor variances to identify cost-saving
opportunities.
Step 2: Develop Standard Costs and Budgets
Standard Costs: $10/gadget for materials, $5/gadget for labor.
Budget for the Month: Materials = 5,000 gadgets * $10 = $50,000;
Labor = 5,000 gadgets * $5 = $25,000.
Step 3: Implement Tracking and Measurement Systems
System Implementation: Use accounting software to track actual costs
versus standard costs.
Data Collection: Collect data on actual spending and production
output.
Step 4: Conduct Regular Variance Analysis
Material Variance Calculation: Actual - Standard = $52,000 - $50,000
= $2,000 unfavorable.
Labor Variance Calculation: Actual - Standard = $26,000 - $25,000 =
$1,000 unfavorable.
Step 5: Investigate Variances
Material Variance Analysis: Explore reasons like price increases or
excess usage.
Labor Variance Analysis: Investigate causes such as overtime or
inefficiencies.
Step 6: Take Corrective Actions
Material Cost Actions: Negotiate prices, reduce waste, and switch
suppliers.
Labor Cost Actions: Improve scheduling, enhance training, and revise
work processes.
Step 7: Revise Plans and Standards
Revising Standards: Adjust standards if new suppliers are found or if
efficiency improvements are implemented.
Communicating Changes: Ensure all departments are aware of the new
standards.
Step 8: Continuous Monitoring and Improvement
Ongoing Monitoring: Regularly review the cost reports.
Seeking Improvements: Continuously look for further cost-saving
opportunities.
Step 9: Feedback and Learning
Encouraging Feedback: Seek input from production staff on potential
improvements.
Learning from Variance Analysis: Adjust strategies based on feedback
and results.
Step 10: Alignment with Long-Term Goals
Strategic Alignment: Ensure cost reductions align with long-term
profitability and quality goals.
5.10 TCO Calculation Methodology (Practical)

The total cost of ownership (TCO) refers to how much it costs to

purchase, own and operate an asset. Finance experts in a wide variety of
industries calculate the total cost of ownership of assets to learn about
their value compared to the expense of purchasing, using and
maintaining them. Learning about the total cost of ownership can help
you calculate how much it costs to invest in a particular asset so you can
determine whether its value is worth the expense.
The calculation allows the finance expert to evaluate how expensive the
asset is to own throughout its entire lifecycle. By performing this
calculation, individuals can compare the expense of buying and owning
an asset with the value it provides. This allows them to decide whether
the asset is worth the expense of having.
5.10.1 How to Calculate TCO
You can calculate the total cost of ownership by considering the
following factors:
Purchase price: the purchase price is how much it costs to make the
initial asset purchase.
Operation expenses: some assets may involve expenses to operate,
such as purchasing fuel or paying for electricity to power a piece of
equipment.
Maintenance and repair costs: the total cost of ownership factors how
much it costs to maintain and repair an asset across its lifespan.
Upgrade expenses: companies may want to upgrade assets like
software, which can incur expenses to include in the total cost of
ownership.
Documentation costs: finance experts consider the expense of acquiring
and maintaining necessary documents like licences to own and operate
certain types of equipment.
Cost of training: if the asset requires special training for those who
operate it, finance experts consider training expenses as part of the total
cost of ownership.
5.10.2 TOC Example
Example 1:
A school district wants to provide laptop computers to its students. It
considers the initial purchase price of a bulk order from several vendors
to get the best deal. To look at the most accurate price comparison and
total cost of ownership, the school district includes an analysis of the
initial device cost, installation, teacher and student training, security
costs, software elements, ongoing technical support and future system
updates. It gains valuable insight into the long-term benefits and costs
of the purchase when applying total ownership cost calculations.
Example 2:
A restaurant owner wants to expand their business by offering food
delivery. They've researched the price of a vehicle but they also consider
more than the cost of the car. The total cost of ownership factors in the
financing, insurance, registration, taxes and fees, depreciation and
potential costs of vehicle repairs, plus fuel and wages paid to a delivery
driver. The restaurant owner analyses the total cost of ownership and
 determines that the amount of extra business generated by a delivery
option can increase revenue and cover the investment of a delivery
vehicle and driver.
Example 3:
A paper company is choosing between two corporate social
responsibility (CSR) initiatives:
Reforestation project:

 Acquisition cost: $20,000 for affiliation

 Operational costs: $45,000 per year
 Total cost: $65,000
 Additional benefits: the company estimates goodwill, branding
advantages, and industry grants valued at $15,000, effectively reducing
the total cost to $50,000

Medical Research initiative

 Acquisition cost: $20,000 for affiliation

 Operational costs: $45,000 per year
 Total cost: $65,000
 Additional benefits: no significant additional benefits estimated

While both initiatives have identical upfront and operational costs

totalling $65,000, the reforestation project offers additional benefits
that reduce its effective total cost to $50,000. By conducting a total cost
of ownership (TCO) analysis that includes these indirect benefits, the
company determines that the reforestation project is the more cost-
effective and valuable CSR initiative.
5.10.3 How does TCO work?
The total cost of ownership works by examining the long-term cost of an
investment. It's a thorough calculation that includes the price of
acquiring the asset, along with all the direct and indirect expenses that it
incurs across its lifespan.
It's typical for individuals or business leaders to use this calculation
before investing in a major asset, such as a large piece of equipment or a
software programme. The total cost of ownership may also help business
leaders determine the return on investment from making a major
purchase.
Performing this calculation helps business leaders understand whether
an investment is worth the expense. Unlike other types of calculations,
finding the total cost of ownership is comprehensive because it factors
all potential costs of owning an asset, like the potential cost of repairs
and upgrades.
Since finance experts can't predict the exact expense of owning an asset
across its lifespan, calculating the total cost of ownership can provide an
estimate based on averages, which leaders can use to make business
decisions. Individuals may also use this calculation before making a
major purchase, like a car or house.
Almost every industry can benefit from using the total cost of ownership
to assess the potential expense of an asset across its lifespan. Business
leaders can use this calculation to make effective decisions about their
investments. Here are some industries that are likely to use the total cost
of ownership with consideration for how the calculation may apply:
Technology: it's common for experts in the information technology
industry to use the total cost of ownership to make decisions about
implementing new software systems or devices for a company. For
example, they may determine how much it would cost to install a new
financial modelling software for all members of the finance team, with
consideration for how much updating the system and training members
in it would cost.
Manufacturing: in the manufacturing industry, it's typical to calculate
the total cost of ownership for producing, transporting and storing
products. A manufacturing company may consider the cost of owning
warehouses to store its products compared to the cost of renting
warehouse space.
Capital investing: in capital investing, experts may use the total cost of
ownership when performing a cost analysis for a potential investment.
Investors account for factors like the potential return on investment they
may earn and the economic conditions that may affect the investment.
Government: both national and local government bodies may use the
total cost of ownership to manage their budgets and choose public
projects in which to invest. For example, the local government may plan
a project to improve the school system by calculating the total cost of
ownership of investing in the expansion of school buildings.
Engineering and construction: since it's typical to use heavy
equipment and expensive materials in the engineering and construction
industries, business leaders in these fields may use the total cost of
ownership to predict expenses. They may use this calculation to
determine whether it's more cost-effective to own equipment or to rent
it.
5.10.4 Tips for Calculating TCO
When calculating the total cost of ownership, here are some tips and
factors to consider.
Identify hidden costs. One of the most challenging aspects of
calculating the total cost of ownership is identifying hidden expenses.
Consider expenses like training costs, software licence fees, insurance
expenses and the cost of management.
Consider labour expenses. Recognising how investing in a new piece
of equipment, software or system can affect labour costs is important for
determining whether the investment is worth it. Calculate the labour
costs of operating the new system or equipment and compare it to the
labour cost of maintaining your current system over time to determine
whether the new investment is cost-effective.
Account for interest when financing. Your investment may involve
paying interest depending on your form of payment. When calculating
the total cost of ownership, consider how much interest you're likely to
pay over time if you purchased the investment using credit or a loan.
Factor in expense changes over time. Consider how ownership
expenses may change over time. For example, normal wear and tear may
increase your yearly expenses for repairing and maintaining a piece of
equipment, so anticipate how much more you're likely to spend each
year on equipment upkeep.
5.11Benefits Realization Tracking
Benefits realisation tracking in project management is a process that
ensures a project's planned benefits are actually delivered and realized. It
involves monitoring, measuring, and evaluating the project's outcomes
to confirm they align with the intended strategic goals and business
case. This tracking helps to identify potential issues early on, allowing
for corrective actions and maximizing the project's value.
Benefits realisation management is an organisational method for
determining the worth of proposed projects and programmes. This
method facilitates the management of a company's investment of time
and resources to pursue change and positive outcomes. Typically, it
involves identifying, defining, planning, tracking and realising business
benefits. When applied to a specific project, BRM entails the initiation,
organisation, execution, control and support of changes in an
organisation via management strategies to realise the pre-defined
benefits of a project.
5.11.1 Three stages of Benefits Realisation Management
a. Identify the benefits
The first phase of BRM involves the identification of the expected
benefits. Consider collaborating with the team to determine the expected
value of a particular initiative. This can help you determine if a proposed
project is feasible and if its outcomes can contribute to the organisation's
bigger goals. Then, you can share your projections with the project's
stakeholders to help ensure that the project's intended outcomes match
the organisational goals and mission.
During the identification of the benefits of a proposed project, you can
consider asking yourself and the team the following questions:
 Can you clearly define the benefits?
 Do you know how to measure the benefits?
 When can you deliver the benefits?
 Do the project's expected outcomes coincide with the business's
strategic goals?
b. Execute the benefits
After identifying a project's benefits, you can proceed to the next
phase, which focuses on executing those benefits. This requires
establishing practices and completing each task to achieve the desired
outcomes. Consider employing management techniques to minimise
risks to future benefits and maximise the possibility of achieving
additional benefits. A crucial component of this stage is the
development of a benefits realisation plan, which typically comprises:
 List of the desired project outcomes
 Changes required to achieve a project's results
 Key performance indicators for progress measurement
 Required roles and responsibilities to realise the benefits
 Strategy for communicating progress to stakeholders
 Procedures for identifying opportunities to produce new benefits
When executing the benefits of a project, you can ask yourself a series
of questions to determine whether you have completed this stage. For
instance, you may consider whether you have effectively conveyed the
project's benefits to its stakeholders. You can also ask whether the
project team knows how the outcomes contribute to business benefits.
Another critical factor to consider is to identify who gets the
responsibility to update the project's benefits to reflect new information
and shifting business conditions.
c. Sustain the benefits
Benefits maintenance is the last phase of BRM. This step focuses on
ensuring that the results of a project or programme continue to
contribute value to the organisation. You can complete this step by
evaluating the performance of the deliverables of a project. Consider
collaborating with the team to identify improvement opportunities for
future projects. As you near the completion of the last phase of benefits
realisation, you can consider the following questions to ensure BRM
efficiency:
 Are you providing the benefits within the specified timeline?
 Has the team optimised the benefits to their maximum capacity?
 Have the project's stakeholders approved the benefits?
 Did the team deliver the project results and capabilities to the
business owners?
 Who is responsible for measuring the realised benefits to the
business plans?
5.11.2 Ways to Visualize BRM
a. Benefits dependency map
A benefits dependency map demonstrates how a project relates to an
organisation's strategic goals. There are five sections, each with its own
function. Here are the sections you can include in a benefits dependency
map:
Objective: This section describes the project's measurable ultimate goal
that supports an organisation's mission.
 Final benefit: It discusses the reasons a stakeholder may invest in a
project and the desired outcomes.
Intermediate benefits: Here, you can discuss the benefits that
contribute to the final project goal.
Business changes or outputs: It refers to the required changes for a
project to occur or the deliverables from a project that may help you
achieve a company's bigger goals.
Enabler: This section describes the systems or processes that enable a
team to realise the benefits of a project.

b. Benefits dependency network

 Like a benefits dependency map, a benefits dependency network aims to
maximise digital investment returns. This method comprises six sections
that facilitate the visualisation of your BRM strategies. Here are the six
sections you can include in a benefits dependency network:
Business drivers: This refers to a company's high-level drivers for
change
Objectives: It includes a few sentences on your benefits dependency
network that define the project's focus
Expected benefits: This section outlines the benefits of implementing
organisational changes for specific individuals, groups or the entire
company
Enabling changes: Use this section to discuss the modifications
necessary to achieve the project's objectives
Sustaining changes: It typically explains the modifications important to
sustain organisational changes
IS or IT enablers: This section refers to any information systems or
technologies necessary to support organisational changes and realise a
project's deliverables
c. Results Chain
A results chain is another way to visualise a benefits realisation plan. It
is simpler than the previous two, with only four components. Here are
the four components you can include on a results chain:
Outcome: This section describes the desired outcomes of your project
Initiative: It addresses any actions and activities that contribute to the
project's outcome. You can also outline any required modifications or
financial investments
Contribution: This section expands on the initiative element by
providing measurable descriptions of how an initiative contributes to the
project's outcome
Assumption: The last section of a results chain defines the elements that
you assume can happen or that you may have available so you can
achieve the desired project outcome

5.11.3 Factors to consider during BRM framework development

Here are some factors that are important to consider during BRM
framework development:
a. Visibility
This is a crucial component of BRM. While putting in enough effort to
ensure visibility, it is also essential to prevent visibility from becoming
available only to the leadership. For every maximum benefits realisation
value, each stakeholder requires at least a basic understanding of their
tasks. Transparency is another essential element to be present
concerning each aspect.
BRM provides consistent visibility, which helps to avoid oversupply. As
a result, stakeholders are often unaware, while project leaders may
properly know each modification, obstacle, requirement and
accomplishment. Leaders can prioritise constant visibility by
communicating information based on relevancy and importance to
achieve a sense of harmony.
b. Realise the project’s maximum potential
BRM ensures the team realises its full potential while working on a
project. It does not leave any long-term obstacles or challenges. It also
confirms that the team completes every step to ensure the project's
success.
 c. Match the project’s and organisation’s goals
When projects become excessively complex, they may still result in
benefits, but they may rarely match the organisation's objectives and
established framework to realise the benefits. To prevent this, you can
try to ensure that BRM controls the design of each project step. A
common misconception is that alignment with the project and
organisation's objectives shows that each success benchmark measures
individual tasks, whereas BRM exceeds this. It involves the goal
translation, enabling stakeholders to comprehend that the other
objectives also contribute to the overall goals.
d. Stakeholder Engagement
Stakeholders' engagement and communication are common components
of almost every project. BRM enables the leadership to unite individuals
and team members easily to pursue shared values. To accomplish this
without limiting the creative freedom or the extent of their abilities by
consistently communicating and participating is paramount.
e. Budget Control
Another important aspect of BRM is budget management. At first, it can
be a complex component, but it can quickly become a simple tool for
generating even more benefits by implementing the right and most
effective framework in place. Being on a budget is also important for the
successful delivery of benefits.
5.11.4 Importance Benefits Realisation
Benefits realisation is important, as it enables businesses to take on
projects and efficiently deliver the expected benefits. Following are the
importance of benefits realization:
 Avoidance of delays
 Implementation of every assured advantage
 Prevention of basic and significant mistakes
  Sustainable use of resources
 Effective change management

5.12 Monitoring & Controlling Project costs

Project cost control is one component of project cost management, and it
involves tracking how a project's spending varies from baseline
expectations throughout the life of the project and creating corrective
plans if necessary. The project manager is usually responsible for the
project's cost controls, including operating monitoring software and
investigating any cost differences. Good project cost control requires a
detailed knowledge of the project's planning and execution, since the
project manager must be able to identify when the project exceeds the
projections and understand why.
5.12.1 Why are project cost controls important?
Project cost controls are important because they can help keep a project
within its budget, which is an important element of a successful project.
Cost controls make it possible for the earlier cost management steps to
be effective and accurate throughout the project. When a company
consistently completes projects under budget, they can earn a larger
profit, build their brand and reputation for trustworthiness and more
accurately budget for future projects.
5.12.3 What are the steps of project cost control?
Here are the four main processes of project cost control:
a. Measure differences from baseline
First, the project manager understands the baseline budget expectations
by reviewing the original budget and any departmental or stage
breakdowns. Then, they implement tracking procedures to see how the
project's spending compares to the projected costs, and if it is different,
they measure how great the difference is. Tools like specialized software
and spreadsheets can help project managers with this tracking process.
It's important that the project manager make sure their information is as
accurate as possible in this stage so that cost forecasts are accurate in the
next step.
b. Forecast final costs
Once the project manager understands the differences from the original
budget, they use this information to project what the project's final cost
will be if spending continues along current lines. If the project was over
budget in a stage that is now complete, the project manager calculates
any costs added during that time or later delays that event may cause. If
the project is over budget for a process that is still going on, the project
manager calculates how much more over budget that ongoing process
will add to final costs.
c. Determine possible corrective actions
Once the project manager has all this information, they can look at their
plan for the project and see what potential corrective actions could bring
the project back within budget specifications. Depending on the project,
this may involve adjusting the schedule, the staffing or the project
timeline to reduce costs.
d. Implement and evaluate corrective actions
Next, the project manager implements these corrective actions by
negotiating with teammates, vendors or contractors. They may also
communicate with the client to explain the changes and the reasoning
behind them. The project manager then uses the new data and the budget
tracking practices to evaluate whether the corrective actions were
effective. If not, the project manager creates and implements new
corrective actions until they get the desired results.