The
Mathematics of Earned Value Management, Part – II
Before
I directly plunge into the mathematics of Earned Value Management, I want to
clear the concept of the cost management. Like time-management, cost management
is very important thing in the field of project management. Most of the projects
fail due improper management of cost. Even successful project goes over-budget.
For successful project manager neither of the situations is appropriate.
CONCEPTS
OF COST MANAGEMENT.
Project
Cost Management consists of three knowledge areas Cost Estimation, Determine Budget and Control Cost, these three spread over in two processes groups Planning Process Group (Estimate Cost
and Determine Budget) and Monitor and
Controlling Process Group (Control Cost).
• Cost Estimating: Developing an approximation
of the costs of the resources needed to complete project activities. Resource
consists not only Human Resource but anything required to complete the project.
• Cost Budgeting: Aggregating the estimated
costs of individual activities or work packages to establish a cost baseline.
• Cost Control: Influencing the factors that
create cost variances and controlling changes to the project budget.
While calculating the cost we should consider the
following factors:
-
Cost of Quality
-
Cost of Risk
-
Cost of Human
Resource
-
Cost of Project
Manager’s Time
-
Cost of Project
Manager’s Activities
-
Cost of Training
(if required)
-
Office Expenses.
-
Other over-head
cost.
We
can segregate any cost in two ways, namely:
• Variable Costs: Costs that change with
the amount of production or the amount of work. Examples, cost of material,
Fuel Charges.
• Fixed Costs: Costs that do not change with
the change in production changes. Examples include set up cost, warehouse
rental, etc.
Also
a cost can be either direct or indirect:
• Direct Costs: Costs those are directly
attributable to the work on the project. Examples are team salary, team wages, or
material used on the project.
• Indirect Costs: Any kind of cost which does
not directly associated with the project. Example include office space
expenses, CEO salary etc.
COST
ESTIMATION AND BUDGETING
While
doing the Cost Estimation we should have following inputs:
·
Scope Baseline:
While making the estimation, we must know what is within the scope and what is
out of the scope of the project. Once this is clear to us, we can easily
estimate the cost of the project.
·
Schedule:
This is another input to the cost estimation, this clearly tells us, in what
quantity and which type of resource is required at what time. Once it is clear
the timing of the resources, then we can plan the cost accordingly.
·
Human Resource:
Since Human Resource is one of the major components of any project, in order to
estimate cost we must know the quantity and quality of the Human Resource.
There is another factor which we must know to increase the accuracy of the
estimation, i.e. Rewarding Plan of the Human Resource.
·
Risk Register:
It is another key input which helps to estimate cost, e.g. we know there is a
risk in the earlier stage of the project and to mitigate that risk, we need to
buy an insurance plan. This helps us to improve the costing of the project.
·
Project Management Cost: There are few cost are associated with Project
Management.
·
Company Culture and Existing System: For a company with global presence, we need to
understand, how the procurement is done and the cost of it.
COST ESTIMATION TECHNIQUES
Those
estimation techniques uses in calculation of Time Estimation are used for Cost
Estimation. In my previous write-up I have explained those techniques:
-
One Point Estimation
-
Analogous Estimation
-
Parametric Estimation
-
Three Point Estimation
Apart
from all these techniques there is another technique which is used in the Cost
Estimation;
-
Bottom-up Estimation: In this technique estimation start at activity lever
or at work package level if it is defined in the WBS, so we need a detailed and
accurate Work Breakdown Structure. Below is an example of the Bottom-up
Estimation.
Figure 1: Cost Aggression and Budgeting Example
Here
we can see, how the cost of individual activity sum-up to Work Package level
and from Work Package to Control Account and so on. This way we can achieve the
total budget of the project.
Reserve Analysis: Reverse Analysis is one the very important ideas in
the project management.
At
the of analyzing the risk, we try to find out which activity in the project has
the significant risk attached to it and much time and cost is associated with
it. Then the project manager keep that much of time and money aside to deal
with the risk if it happened in the future. The reserve fund has two parts, one
is Contingency Reserve which is used to deal identified risk or the known risk,
another part is the Management Risk, which is kept by the management to deal
with the unidentified risk or unknown risk.
Accuracy of Estimate: This is another important concept in terms of
estimation. When we try to cost estimation of the project, we must understand
what should be the degree of accuracy of the estimation. May be at the earlier
stage of the project we have less degree of accuracy (i.e. less accurate), but
as we progress in the project, we make higher degree of accuracy (i.e. more
accurate).
In
order to understand estimation, we must clear that it is very difficult to
measure the exact amount of any activity, so we always have range of the
estimation. From the project management perspective we have three such range of
estimation:
-
Rough Order of Magnitude Estimate (ROM): At the initial
stage of the project this kind of estimation is done, it has a range of ±50
percent of the project cost.
-
Budget Estimate: It is done at the planning stage of the project. This is more accurate
that ROM with range of ± 20 percent.
-
Definitive Estimate: As we progress in the project the accuracy become more refined. It has
range of ±10 (or ±5) percent depending on the project manger and the industry
where project is happening.
BUDGET
A budget is a compilation of the individual cost
estimates. Activity costs are rolled up to work package level then Work package
costs are rolled up to control account costs and finally into project costs.
This process is called cost aggregation. Please refer Figure-1 for more
clarification. Budgeting determine the amount of fund is required for the
project. The stage no six of the Figure-1 give us the baseline of the cost.
This create some kind of benchmark of the cost control, any deviation from the
baseline will create an alarm for the project (either positive or negative side
of the baseline).
I
have already discussed the concept of reserve analysis, when contingency fund
(amount of fund keep for unknown risk) is add up with the Cost Baseline we
create total fund requirement for a project.
COST CONTROL
In
the Cost Control process we try to measure the cost in-line with the cost
baseline, so we do not deviate from it. The main reason of the cost control is
to manage the project within the approved project budget. Not only managing
changes but the preventing the unnecessary changes help us to correct the
deviation. So both corrective and preventing action is important for us.
Whenever the project manager finds or foresees any deviation of the cost from
its baseline, he gets an alarm message and tries to find root-cause of the
problem. And try to provide solution without affecting the original budget.
