4.5 Planning & Managing Budget

Cost management ensures the project is completed within the approved budget. It involves estimating costs, determining the budget, and controlling expenditures throughout the project.

Cost Management Processes

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Cost Estimating Techniques

Comparison of Techniques

Analogous Estimating (Top-Down)

Uses costs from previous similar projects as the basis for estimates:

Example: "The last website project cost $50,000, so this similar one should cost about $50,000."

Parametric Estimating

Uses statistical relationships between historical data and other variables:

Example: Cost per line of code x estimated lines of code

Bottom-Up Estimating

Estimates individual work packages and aggregates them:

Project Total: $530,000
├── Phase 1: $80,000
│   ├── WP 1.1: $30,000
│   └── WP 1.2: $50,000
├── Phase 2: $250,000
│   ├── WP 2.1: $100,000
│   ├── WP 2.2: $100,000
│   └── WP 2.3: $50,000
└── Phase 3: $200,000
    ├── WP 3.1: $150,000
    └── WP 3.2: $50,000

• Most accurate estimating technique
• Most time-consuming and expensive
• Requires detailed WBS

Three-Point Estimating

Uses optimistic, most likely, and pessimistic estimates:

Beta/PERT Formula: E = (O + 4M + P) / 6

Triangular Formula: E = (O + M + P) / 3

Example:

• Optimistic: $80,000
• Most Likely: $100,000
• Pessimistic: $150,000

PERT Estimate = ($80,000 + 4($100,000) + $150,000) / 6 = $103,333

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Estimate Accuracy Levels

Progressive Elaboration of Estimates

Estimates become more accurate as the project progresses:

1. Initiation: ROM estimate based on analogous data
2. Early Planning: Budget estimate using parametric methods
3. Detailed Planning: Definitive estimate using bottom-up approach

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Cost Baseline Development

The Cost Baseline is the approved, time-phased budget used to measure and monitor project cost performance.

From Estimates to Baseline

Visual Representation

                   Project Budget
                        ↓
    ┌─────────────────────────────────────┐
    │      Management Reserves            │ ← Unknown unknowns
    ├─────────────────────────────────────┤
    │      Cost Baseline                  │ ← Performance baseline
    │  ┌─────────────────────────────┐    │
    │  │   Contingency Reserves      │    │ ← Known unknowns
    │  ├─────────────────────────────┤    │
    │  │   Activity Cost Estimates   │    │ ← Work package costs
    │  └─────────────────────────────┘    │
    └─────────────────────────────────────┘

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Contingency and Management Reserves

Contingency Reserves

• Address identified risks (known unknowns)
• Part of the cost baseline
• PM has authority to use
• Calculated through risk analysis

Management Reserves

• Address unidentified risks (unknown unknowns)
• NOT part of the cost baseline
• Requires sponsor approval to use
• Typically a percentage of project budget

Reserve Calculation Example

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Funding Requirements

The funding limit reconciliation ensures that expenditures are reconciled with funding limits:

Funding Patterns

Cash Flow Planning

• Identify when funds are needed
• Align with organizational funding cycles
• Account for payment terms with vendors
• Consider revenue timing if applicable

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Earned Value Management (EVM) Basics

Earned Value Management integrates scope, schedule, and cost to assess project performance.

Key EVM Metrics

Performance Indices

Variance Analysis

Example

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Key Takeaways

• Analogous is fastest but least accurate; Bottom-up is most accurate but slowest
• Parametric uses statistical relationships with historical data
• Three-point accounts for uncertainty using optimistic, most likely, and pessimistic estimates
• Contingency reserves are for identified risks and are in the cost baseline
• Management reserves are for unidentified risks and are NOT in the cost baseline
• EVM uses PV, EV, and AC to measure cost and schedule performance