The Mathematics of Earned Value Management, Part – II

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.