Module 5

Module-5: Managing Project Finances

How to Manage Project Finances- Cost estimating: Work Breakdown Structure,
Cost budgeting: Cost Aggregation, Reserve Analysis, Parametric estimating,
Infrastructure and overheads, Cost control: Change Control, Resource Management.
Apply
Performance Measurement and Analysis- Cost Variance, Earned Value, Schedule 8
CO4
Variance, Cost Performance Index, Schedule Performance Index.

Managing Project Finances:

[Link]
Managing Project Finances

 A well-managed project is completed on time, on spec, and on budget.

How to Manage Project Finances
Project cost management includes three basic processes:
 Cost estimating – Making your best assessment of the costs of the resources needed
to complete a project.
 Cost budgeting – Assigning cost estimates to individual work items and establishing a
baseline for measuring performance.
 Cost control – Controlling changes to the project budget.

By managing these processes, and their inputs and outputs, you can develop an effective
system to ensure that your resource costs remain within the approved budget.
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COST ESTIMATING

 Software cost estimation is the process of predicting the resources and

budget required to develop a software project.
 It involves various techniques and methodologies to assess the effort, time,
and cost involved in different stages of the software development lifecycle
(SDLC).
 In the field of project management, cost estimation is the process of
estimating all of the costs associated with completing a project within scope
and according to its timeline.

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COST ESTIMATING

Cost estimation is the process of quantifying the costs associated with all the
resources required to execute the project.
To perform cost calculations, we need the following information:
 • Resource requirements (output from the previous step)
 •Price of each resource (e.g., staffing cost per hour, vendor hiring costs, server procurement
costs, material rates per unit, etc.)
 • Duration that each resource is required
 • List of assumptions
 • Potential risks
 • Past project costs and industry benchmarks, if any
 • Insight into the company’s financial health and reporting structures
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Software Cost Estimation

 Project scope must be established in advance.

 Software metrics are used as a support from which evaluation is made.
 The project is broken into small pieces which are estimated individually.
 To achieve true cost and schedule estimate, several options arise.
 Acquire one or more automated estimation tools
(Time monitoring tools, Tools for Test Automation, Planning and Estimation Tools, Requirements
Management Tools, Machine Learning-Based Estimation Tools)

Chapter 7 Design and implementation 5

Why is cost estimation important?

 It makes it possible to allocate resources such as labor, tools and supplies in

a way that maximizes effectiveness and reduces waste.
 Cost estimates are used as a starting point for talks and agreements
between parties when negotiating contracts or project requirements.

Chapter 7 Design and implementation 13

Uses of Cost Estimation

 During the planning stage, one needs to choose how many engineers are
required for the project and to develop a schedule.

 In monitoring the project's progress, one needs to assess whether the

project is progressing according to the procedure and take corrective
action, if necessary.

Chapter 7 Design and implementation 14

Uses of Cost Estimation:

 Project planning and budgeting: Cost estimates help determine the

feasibility of a project and allocate resources effectively.
 Client proposals and contracts: Accurate cost estimates are crucial for
providing competitive bids and establishing realistic project expectations with
clients.
 Risk management: By identifying potential cost overruns early, project
managers can take proactive measures to mitigate risks.
 Project tracking and control: Cost estimates serve as benchmarks to monitor
project progress and identify deviations from the plan.
 Decision making: Cost estimates inform decisions about project scope,
features, and technology choices
Chapter 7 Design and implementation 15
Common techniques used in software cost estimation

 Analogy-based estimation: This technique uses historical data from similar

projects to estimate the cost of a new project.
 Parametric estimation: This technique uses statistical models to estimate the
cost of a project based on a set of parameters, such as the size and complexity
of the project.
 Bottom-up estimation: This technique involves breaking down the project into
smaller tasks and estimating the cost of each task individually.

The choice of technique will depend on the specific project and the available data.

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Home Work: Explore

Chapter 7 Design and implementation 17

Work Breakdown Structure

 A work breakdown structure (WBS) is a key project management tool that

helps you break down a large, complex project into smaller, more
manageable tasks. It's essentially a hierarchical outline that visually
represents all the work needed to complete the project, organized from the
final deliverable down to the smallest work packages.
Example:
 Think of it like building a large Lego structure. You wouldn't start by blindly
attaching random pieces; you'd follow the instructions, breaking down the
final model into smaller sections, then subsections, and eventually individual
bricks. A WBS does the same for projects.

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Work Breakdown Structure

 A Work Breakdown Structure includes dividing a large and complex project into
simpler, manageable, and independent tasks. The root of this tree (structure) is
labeled by the Project name itself. For constructing a work breakdown structure,
each node is recursively decomposed into smaller sub-activities, until at the leaf
level, the activities become undividable and independent.
It follows a Top-Down approach.
Steps Work Breakdown Structure:
 Step 1: Identify the major activities of the project.
 Step 2: Identify the sub-activities of the major activities.
 Step 3: Repeat till undividable, simple, and independent activities are created.
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Chapter 7 Design and implementation 21
 Construction of Work Breakdown Structure

 Firstly, the project managers and top level management identify the main deliverables of the project.
 After this important step, these main deliverables are broken down into smaller higher-level tasks
and this complete process is done recursively to produce much smaller independent tasks.
 It depends on the project manager and team that up to which level of detail they want to break down
their project.
 Generally the lowest level tasks are the most simplest and independent tasks and take less than two
weeks’ worth of work.
 Hence, there is no rule for up to which level we may build the work breakdown structure of the
project as it totally depends upon the type of project we are working on and the management of the
company.
 The efficiency and success of the whole project majorly depend on the quality of the Work
Breakdown Structure of the project and hence, it implies its importance.

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 Uses of Work Breakdown Structure

 1. Cost estimation: It allows doing a precise cost estimation of each activity.

 2. Time estimation: It allows estimating the time that each activity will take
more precisely.
 3. Easy project management: It allows easy management of the project.
 4. Helps in project organization: It helps in proper organization of the project
by the top management.

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Purpose of a work breakdown structure

In project management, use work breakdown structures for several reasons:

 •To identify the project tasks that make up the critical path of your project
 •To schedule activities that comprise the performance measurement baseline
(PMB)
 •To define the deliverables for your project
 •To plan your resources, timelines, and priorities
 •To get a clearer picture of the risks the project may face as it progresses

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WBS

WBS helps you manage projects more effectively by:

 Breaking down complexity.
 Improving planning and estimation.
 Facilitating communication and collaboration.
 Managing risks and controlling performance.
 If working on any complex project, regardless of size or industry, creating a
WBS is a smart way to increase your chances of success.

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 Purpose of a work breakdown structure (WBS)

 Clarity and Scope Management: It forces you to clearly define the project scope by identifying
all the deliverables and tasks involved. This helps avoid missing anything important and keeps
everyone on the same page.
 Improved Planning and Estimation: By breaking down the project into smaller chunks, it's
easier to estimate the time and resources needed for each task, leading to more accurate project
planning and scheduling.
 Enhanced Communication and Collaboration: The visual format of a WBS makes it easier for
stakeholders and team members to understand the project and their individual roles. This fosters
better communication and collaboration.
 Risk Identification and Mitigation: By looking at all the tasks involved, you can identify
potential risks more easily and develop mitigation strategies.
 Performance Monitoring and Control: The WBS helps you track project progress by
comparing completed tasks against the overall plan, allowing you to identify and address any
deviations early on Chapter 7 Design and implementation 27
Cost budgeting

Cost Aggregation, Reserve Analysis, Parametric Infrastructure and

estimating, overheads

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Cost budgeting

 Budgeting is the process of allocating costs to a certain chunk of the project,

such as individual tasks or modules, for a specific time.
 Budgets include contingency reserves allocated to manage unexpected costs.
 A budget is a financial tool that professionals can use to manage their funds.

 Cost budgeting is the process of creating a financial plan and budget using
cost estimations.
 It is a type of budget that involves totaling all expected costs for a set period.

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Software development budget

 A software development budget is a predetermined amount of money that a

software development company expects to spend on a project from start to
finish.
 The exact amount can vary depending on the complexity of the design, the
number of features offered within the system, and other factors.
 Project managers often use cost budgeting when planning new projects.

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Cost Budget

 To create a cost budget, professionals use data from cost estimates.

 A cost estimate predicts the total costs of each stage during a project.
 A cost budget includes estimates for the following types of costs:

 Direct costs: Direct costs are expenses that relate to physical goods and services used
during production. For example, in a manufacturing company, this could include materials,
production labor and transportation fuel.
 Indirect costs: Indirect costs are the expenses associated with general business
operations. This includes rent, supervisors' salaries and communication services, such as
internet and phone costs.
When creating a cost estimate for a business or a project, financial professionals can total the
indirect and direct costs.
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Why is Project Cost Management Important?

 The importance of cost management is easy to understand.

 To take a simple, real-life example, if you decide to build a house, the first
thing to do is set the budget.
 When you have a sense of how much to spend on the project, the next step
is to divide the high-level budget into expenses for sub-tasks and smaller line
items.

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 Why is cost budgeting important?

Cost budgeting is an important part of planning a new project or business

strategy. A cost budget may have the following benefits:
 Increases efficiency
Financial professionals can use cost budgeting to analyze their project expenses.
This can help them reduce waste and improve efficiency.
 Improves profitability
Using a cost budget can help professionals lower their overall project costs, which
can increase their profitability.
 Helps professionals meet business goals
A cost budget can help financial professionals meet their business goals by
creating a strategy for each project.
Chapter 7 Design and implementation 34
 How to develop a cost budget

 Set budget guidelines

The first step in creating a cost budget is setting your boundaries or guidelines.

 List all costs

After setting your budget guidelines, you may list all your expected costs.

 Identify known costs

After gathering your general list of costs, you can begin inputting the amounts. Review your list of costs and input the costs you
know already. These will be fixed costs, such as rent and supervisor salaries.

 Estimate expected costs

Next, you can estimate your expected costs. This can include variable costs, such as hourly labor wages and materials.

 Set the timeline

After gathering all of your cost information, you may create a timeline. For projects, you can divide each step into smaller stages.

 Analyze and refine

Professionals can use a cost budget to analyze their overall costs and progress throughout the project.

 Compare actual costs

Throughout the project, you can track your actual costs and compare these to the estimates. This can help you determin3e5 areas
where you can reduce costs. Chapter 7 Design and implementation
Cost Aggregation

 Cost aggregation is the process of combining individual cost estimates to get

one all-encompassing figure that represents spending for a project.

Cost aggregation is defined as summing the cost for the individual work package to control the financial account up to
the project level.

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Cost aggregation tools

 Cost aggregation tools are software applications or systems that can help to
perform cost aggregation more efficiently and effectively.
 It can provide features such as data collection, analysis, calculation,
visualization, reporting, or integration that can help to automate, simplify, or
enhance the cost aggregation process.
 It can be used to reduce the errors, inconsistencies, or delays in the cost
aggregation process.

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 Reserve Analysis

 Reserve analysis is a technique that involves adding a contingency reserve or

a management reserve to the total project cost to account for the uncertainties
and risks that may affect the project cost.
 A contingency reserve is a portion of the project budget that is allocated for
known or foreseeable risks that may cause cost overruns, such as scope
changes, quality issues, or resource fluctuations.
 A management reserve is a portion of the project budget that is allocated for
unknown or unforeseeable risks that may cause cost overruns, such as natural
disasters, regulatory changes, or stakeholder conflicts.
 Reserve analysis can be used to increase the confidence and flexibility of the
project cost.
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Reserve Analysis

 Used for estimating activity duration and cost, reserve analysis includes
estimation of additional time to the project schedule (to allow time for
unexpected delay) and additional cost to the project budget (in case of
activity cost overruns).
 The PMBOK defines reserve analysis as "an analytical technique to
determine the essential features and relationships of components in the
project management plan to establish a reserve for the schedule duration,
budget, estimated cost, or funds for a project.“

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 Parametric estimating

 This estimation requires historical information gathered from previous projects.

 This technique is used for both cost and time estimates calculations. But, unlike
analogous estimation technique, parametric estimation requires plugging the
historical data into a formula, spreadsheet, database, or computer program to
come up with an estimate.
 Here you enter your parameters on the historical database which is designed
specially as a system for parametric estimation. It is sometime also referred as
Quantitative based estimating.
 E.g When you need to determine what would be the total cost of construction
when you have cost per square foot or the units of work multiplied by
productivity unit rate to estimate activity duration.
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 Infrastructure and overheads

 Software development infrastructure refers to the tools, processes, and environments used
to create software applications. In general, the term is used interchangeably with "software
development platform.“
 If an IT infrastructure is flexible, reliable and secure, it can help an enterprise meet its goals
and provide a competitive edge in the market. Alternatively, if an IT infrastructure isn't
properly implemented, businesses can face connectivity, productivity and security issues—
like system disruptions and breaches.
 In software engineering, overhead can influence the decision whether or not to include
features in new products, or indeed whether to fix bugs.
 A feature that has a high overhead may not be included – or needs a big financial incentive
to do so. Often, even though software providers are well aware of bugs in their products,
the payoff of fixing them is not worth the reward, because of the overhead.

Chapter 7 Design and implementation

Cost control

Change Control, Resource Management

Chapter 7 Design and implementation 43

Cost control

 Cost control is a continuous process done throughout the project lifecycle.

The emphasis here is as much on timely and clear reporting as measuring.
 It is the process of measuring cost variances from the baseline and taking
appropriate action, such as increasing the budget allocated or reducing the
scope of work, to correct that gap.
 Cost control is crucial for project success, and change control and resource
management are both crucial tools for achieving it.

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Change Control

Change control is a formal process for managing modifications to the project

scope, schedule, or budget. It helps ensure that changes are necessary,
feasible, and within your planned resource allocation. Here's how it impacts
cost control:
 Prevents scope creep: Uncontrolled changes can quickly inflate costs.
Change control requires justification and approval before implementation,
mitigating unplanned expenses.
 Maintains budget integrity: By evaluating the cost impact of proposed
changes, you can adjust them or reject them to stay within budget.
 Improves decision-making: The formal process promotes informed decisions
about changes based on their value and cost implications.
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How do you control finance costs?

Cost control techniques are typically broken down into 5 steps which include:
 Planning your budget.
 Monitoring expenses.
 Using change control systems.
 Time management.
 Tracking earned value

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 Resource Management

Resource management involves effectively allocating and utilizing your team,

tools, and materials throughout the project.
It affects cost control in several ways:
 Optimizes resource utilization: By assigning the right people to tasks and
avoiding overstaffing, you minimize labor costs and ensure efficient resource
usage.
 Reduces waste: Proper management helps avoid material waste, duplicate
efforts, and unnecessary tool purchases, keeping costs under control.
 Improves team productivity: When team members are clear about their roles
and responsibilities, they work more efficiently, optimizing resource time and
cost.
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Project Cost Management

Chapter 7 Design and implementation 50

Performance Measurement and Analysis

Schedule
Cost Variance, Earned Value,
Variance,

Cost Schedule
Performance Performance
Index, Index
Chapter 7 Design and implementation 51
 Cost Variance

 Cost Variance (CV) is also known as budget variance as it deals with the budget of
the software development.
 It is the difference of the actual cost and the budgeted cost or in other words it is
difference between what was expected to be spent and what was actually spent.
 The difference between the earned value and the actual cost is known as Cost
Variance.
CV = EV - AC
 Interpretation of Cost Variance (CV):
1. If CV is negative, the task is over budget.
2. If CV is zero, the task is on budget.
3. If CV is positive, the task is under budget.
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 Schedule Variance

 Schedule variance is basically used to indicate whether a project is running ahead or

behind.
 It is the difference of Budgeted Cost of Work Performed (BCWP) and Budgeted Cost
of Work Scheduled (BCWS).
 Schedule variance is computed by calculating the difference between Earned Value
and Planned Value.
SV = EV - PV
 Interpretation of Schedule variance:
 1. If SV is negative, the project is behind schedule.
 2. If SV is zero, the project is right on schedule.
 3. If SV is positive, the project is ahead of schedule.
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 Earned Value, Actual Cost and Planned Value

Earned Value (EV) represents the monetary value of the completed work based on the project
• Earned Value (EV): schedule and budget.
Imagine you planned a task for $100 and finished 70% of it. The earned value would be $70.
 It is also known as Budgeted Cost of Work Performed (BCWP). The amount of
the task that is actually completed is called Earned Value. It is calculated from
the project budg et.
EV = Percent Complete * Task (actual) Budget
• Actual Cost (AC): Actual Cost (AC) is the total amount of money spent on the project, regardless of how much
work is completed.
 It is also known as Actual Cost of Work Performed (ACWP). Actual Cost is the
amount that has been spent on the task.
• Planned Value (PV):
PV = Planned Completion * Task (actual) Budget
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 Co-relation of SV and CV

 SV and CV are positive:

The project is ahead of schedule and it is under budget.
 SV is positive and CV is negative:
The project is ahead of schedule and it is over budget. In other words, we can say that the
tasks performed are over budget but more of them have been performed before scheduled.
 SV is negative and CV is positive:
The project is behind schedule and it is under budget.
In other words, we can say that the tasks performed were efficient but more of them should
have been performed earlier.
 SV and CV are negative:
The project is behind schedule and it is over budget.
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 Example:

Given a budgeted cost of a project at Rs. 9, 00, 000. It is to be completed in 9 months.

After a month, you have completed 10 percent of the project at a total expense of Rs.
1, 00, 000. The planned completion should have been 15 percent. Calculate Cost
Variance and Schedule Variance.
Solution:
 Planned Value = Planned Completion (%) * Actual Budget
= 15% * Rs. 9, 00, 000
= Rs. 1, 35, 000
 Earned Value = Actual Completion- AC (%) * Actual Budget
= 10% * Rs. 9, 00, 000
= Rs. 90, 000 Chapter 7 Design and implementation 56
 Contd.

 Cost Variance = EV – AC
= Rs. 90, 000 – Rs. 1, 00, 000
= Rs. - 10, 000

 Schedule Variance = EV – PV
= Rs. 90, 000 – Rs. 1, 35, 000
= Rs. - 45, 000

 Since the Cost Variance is negative, this means the project is over-budget and
Schedule Variance is negative, the project is behind schedule.
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Cost Performance Index (CPI)

 In software engineering, the Cost Performance Index (CPI) is a metric used

to assess how efficiently a project is utilizing its budget.
 It compares the value of the work completed (earned value) to the actual
amount of money spent (actual cost).
 It helps us to analyze the efficiency of the cost utilized by the project.
 The Cost Performance Index is evidence of how well the project remains on
budget.

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 Calculation of CPI

 The Cost Performance Index can be calculated by dividing the earned value by the actual cost.
CPI = EV / AC
Where,
 Earned Value (EV): Earned Value is the amount of the task that is completed.
 Actual Cost (AC): Actual Cost is the amount that has been spent on the task.
Interpretation of Cost Performance Index
CPI < 1: If the CPI is less than one, then the earning is less than the amount spent. In other words we can say that
project is over budget.
CPI > 1: If the CPI is greater than one, then the earning more than the amount spent. In other words we can say that
project is under budget.
CPI = 1: If the CPI is equal to one, then the earning and spending are equal. It can state that project is proceeding
exactly as per the planned budget.
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CPI in Project Management

 The CPI is a valuable tool for project managers to track progress and identify
potential issues. It helps them:
 Monitor budget performance: By regularly calculating the CPI, project
managers can identify cost overruns early and take corrective action.
 Make informed decisions: The CPI can inform decisions about resource
allocation, scope changes, and project timelines.
 Improve future estimates: Analyzing historical CPI data can help project
managers make more accurate cost estimates for future projects.
It's important to note that the CPI should be used in conjunction with other project
metrics, such as the Schedule Performance Index (SPI), to get a complete
picture of project health.
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Schedule Performance Index (SPI)

 Schedule Performance Index (SPI) describes how efficiently we are

progressing compared to the planned project schedule.
 It can be defined as a measure of schedule efficiency expressed as the ratio
of earned value to planned value.
 It gives information about the schedule performance of the project. It is the
efficiency of the time utilized on the project.

Chapter 7 Design and implementation 62

Calculation of Schedule Performance Index

 The Schedule Performance Index can be computed by dividing earned and planned values.
SPI = EV / PV
 Earned Value (EV): Earned Value is the amount of the task that is actually completed.
 Planned Value (PV): Planned Completion * Task Budget

Interpretation of SPI
SPI > 1: If the SPI is greater than one, then more work has been completed than the planned work. In other words we
can say that project is ahead of schedule.

SPI < 1: If the SPI is less than one then less work has been completed than the planned work. In other words we can
say that project is behind schedule.

SPI = 1: If the SPI is equal to one then work is being completed at about the same rate as planned. In other words we
can say that project is on time.
Chapter 7 Design and implementation 63
 Revision-
Performance measurement analysis

 The Project Management Institute recommends the earned value technique

(EVT), which is described in the PMBOK (Project Management Body of
Knowledge). There are a variety of calculations you can use:
 Planned Value (PV) = Budgeted cost for the work scheduled for an activity or
component of the Work Breakdown Structure.
 Earned Value (EV) = Budgeted amount for the work actually completed on
an activity or component of the Work Breakdown Structure.
 Actual Cost (AC) = Total cost incurred to accomplish the work completed on
an activity or component of the Work Breakdown Structure.

Chapter 7 Design and implementation 64

Contd.

 Cost Variance = EV - AC
 Schedule Variance = EV - PV
 Cost Performance Index (CPI) = EV / AC (a CPI less than 1 indicates a cost
overrun).
 Schedule Performance Index (SPI) = EV / PV (an SPI equal to or greater than 1
indicates the project is in a favourable condition).

Chapter 7 Design and implementation 65

Example:

 For example, the budgeted cost (planned value) for a project at the end of
month five is $40,000. The budgeted amount for the work completed (earned
value) is only $35,000.
 However, the actual costs incurred to date are $38,000. Consider the following
calculations:
 Cost variance = EV - AC = $35,000 - $38,000 = -$3,000
 Schedule variance = EV - PV = $35,000 - $40,000 = -$5,000
 Cost performance index = EV / AC = $35,000 / $38,000 = 0.92 (there is a cost
overrun).
 Schedule performance index (SPI) = EV / PV = $35,000 / $40,000 = 0.875 (the
project is behind schedule)
Chapter 7 Design and implementation 66
 Example Cost Performance Index (CPI)

Given a project to be completed in 12 months and the budget of the project is 1, 00, 000 INR.
1. Six months have passed and 60, 000 INR has been spent but on closer review, it is found that
only 40% of the total work has been done to date.
2. Find the Cost Performance Index for this project and conclude whether you are under budget or
over budget.
Solution:
Actual Cost (AC) = 60, 000 INR
 Planned Value (PV) = 50% of 1, 00, 000 INR (Planned Value (PV): Planned Completion * Task Budget)
= 50, 000 INR
 Earned Value (EV) = 40% of 1, 00, 000 INR
= 40, 000 INR
 Cost Performance Index (CPI) = Earned Value / Actual Cost
= 40, 000 / 60, 000
= 0.67
 Hence, the Cost Performance Index is 0.67.
 This concludes that earning is 0.67 INR for every 1 INR spent as the Cost Performance Index is less than one. In
order, it can be deduced that project is over budget.
Chapter 7 Design and implementation 67
 Example of Schedule Performance Index (SPI)

Given a project to be completed in 12 months and the budget of the project is 1, 00, 000 INR.
1. Six months have passed and 60, 000 INR has been spent but on closer review it is found that only
40% of the work has been completed till now.
[Link] the Schedule Performance Index and conclude whether the project is behind or ahead of
schedule.
Solution:
 Actual Cost (AC) = 60, 000 INR
 Planned Value (PV) = 50% of 1, 00, 000 INR
= 50, 000 INR
 Earned Value (EV) = 40% of 1, 00, 000 INR
= 40, 000 INR
 SPI = Earned Value / Planned Value
= 40, 000 / 50, 000
= 0.8
 Hence, the Schedule Performance Index is 0.8.
 Conclusion is that the project is behind schedule since the Schedule Performance Index is less than one.
Chapter 7 Design and implementation 68