Do you know what you pay for? Managing project costs step by step

Do you know what you did wrong in that last financial analysis?

Of course, mistakes do happen to all project managers, but in the time of crisis avoiding them is even more important than before. For that reason, project cost management should become an inevitable part of your management - and here’s how to use the process to generate profits.

What is project cost management? 

Cost management in project includes planning, managing and controlling the project budget and all project costs from an initial estimate to a summary by the end of the project. In short, it provides a complete coverage of all the costs in project scope and it is a base for project management for financial purposes.

The point of the cost management is very simple, yet crucial for IT companies: it is to ensure the profitability of the project on every stage of the project life cycle. 

4 stages your cost management process needs to have 

Just like any other process that is supposed to cover the entire project life cycle, cost management plan is also divided into a few stages a project manager can use to control critical financials, such as cost overruns or variable costs. In short, cost management plan was designed to help project managers stay on top of the operation regardless of its changes in time, resource planning or future project costs. 

These stages include: 

Resource planning 

Resource planning process has a very simple objective: to divide the project into stages and tasks, to assign the right people to each one of them, and to make assessing actual costs easier for project managers interested in a perfect cost control.

The process requires either a work breakdown structure, or a detailed project scope that act as a base for allocations throughout the project life cycle. However, both of these documents are prone to human mistakes or a scope crawl, causing delays and allocation problems. Here are a few examples of such issues - and some tips on how to avoid them. 

Main challenges of resource planning

Resource planning processes usually suffer from problems such as: 

• lack of historical data on similar projects that could help realistically assess the amount of work in each task or stage. We highly recommend acquiring projects your company has some experience completing; otherwise, your operation may be prone to scope crawl or being unprofitable, as their project budget may change with additional work, 
• no knowledge of people’s availability throughout the duration of the project resulting in overbooking or gaps in allocations. This usually ends with unavailable people being assigned to a project - and they won’t be able to complete it! 
• creating a project plan based on manager’s own perception instead of consulting with other experts. Project management software can help you solve that problem and improve your project budgets!
• underestimating the amount of work needed to complete the project, 
• not including any delays or risks in the resource plan and creating unrealistic project schedules as a result. 

Cost estimation

If you have already finished creating your resource plan and included some additional time for possible minor delays, you can now begin to estimate costs of the entire project. 

At this point, you should try to calculate the costs of work using real hourly rates or wages of the employees you suggested to assign to the project in your resource plan. This is vital for the accuracy of our estimates, as choosing different specialists may affect both costs of work and its pace due to the availability of the resources. 

Such a cost estimation must be done in a very precise manner, as it will act as a base for further comparison with the actual data collected throughout project cost management. 

Main challenges of cost estimation

Still, while cost estimation in project cost management might seem simple, there are a few crucial problems you may want to avoid while conducting your process. These include: 

• using unrealistic data for your calculations. No average hourly rates, and no assumptions; work only on the real information from the resource plan to avoid making mistakes. 
• using an overly optimistic resource plan in your calculations. Once again, we urge you to leave some room in the project for unexpected events! 

Cost budgeting 

Having prepared some accurate estimates, you can now go on to prepare a project budget. 

What should be included in cost budgeting for project management?

Your calculations should include: 

• costs of work calculated using the real hourly wages or salaries of employees assigned to a project and its stages. Do not use average rates here - they are not accurate enough to provide you with correct estimates! 
• project overheads, such as costs of equipment, software or project-related travels, 
• a fraction of organizational overheads the project will need to cover with its profits. We have explained how to divide and calculate these costs in our article on cost allocation, 
• costs of any additional risk factors that your project may need to cover. 

Such a budget will be used at a later stage of the project cost management as a base for comparison with actual costs of the operation. 

Main challenges of cost budgeting

Major mistakes you can make while preparing a project budget include: 

• not including the price of overheads in your budget,
• leaving no room for error or random delays - remember, these things may just happen for no apparent reason and they shouldn’t be disregarded! 
• not having the information on the costs of overheads. If you do not keep track of such data, you should start doing that; otherwise, you might be up for an unpleasant surprise while assessing the financial performance of your company. 

Cost control 

Last but not least, you need to control the spendings throughout the project to ensure that it won’t become unprofitable after some time. To do so, you can:

Use project financial analysis 

When the project is still in progress, you can use the elements of project financial analysis to see whether its budget hasn't been strained so far. The best way to do this is to calculate cost performance index. 

This indicator shows whether the number of hours in the project has exceeded the expectations. Therefore, this indicator can be later used to show a fraction of the budget that is left to be used. 

Cost performance index - example

Let’s assume that half of project A is already done. It was supposed to take 1600 hours. However, completing the work up to this point took 750 hours. Therefore, we have to multiply the progress (in this case, it is 0,5, because 1 stands for a fully completed project) by 1600 estimated hours, and then divide the result by 750. In this case, the CPI is 1,07 - the project has used 7% more budget than it was supposed to. 

Track your progress with specialized tools 

Of course, in the 21st century, you do not need to calculate the progress of the project by hand on a daily basis. Some advanced tools - such as Primetric - can use the time tracked in the project to calculate the cost of work automatically, providing you with real costs of your project in the real time. 

Main challenges of cost control

Just like any other part of project cost management, cost control also has some issues you may want to avoid in your process. These include: 

• failing to enforce sufficient time tracking in your company. There won’t be any cost without tracked time, so it is essential to convince all the employees to fill in their timesheets! 
• using wrong or average wages for calculations. We cannot stress it enough - any mistake here will affect all the calculations! 
• spending too much time on the calculations. Manager’s time is precious, too, and it should be saved whenever possible. Therefore, we highly recommend using specialized tools for such calculations - they are capable of automating the entire process! 

Benefits of project cost management 

At this point, you may ask yourself: but what is it all for? 

Project cost management has numerous benefits that should convince you to use this process on a daily basis. These advantages include: 

• preventing cost overrun and ensuring that your projects are as profitable as they can be,
• helping you accurately calculate the price of a project, 
• avoiding risks and budgeting problems in the future, 
• helping managers find the financial problems in the project and solve them before they become more pressing matters. 

Do you want to bring your cost management to a whole new level? 

We can help you do that - and we will give you a hand with a few other things, too! 

Visit our blog to learn more about: 

• reducing employee bench and saving thousands of dollars, 
• improving the profitability of an IT company, 
• cost overrun - and preventing it, 
• measuring company’s financial performance, 
• including overheads in the price of billable hours, 

and many more. 

Or, if you already feel like you could improve your financial processes with a new tool, book a demo with our advisors or start a trial with Primetric right now!