7

Determining Costs, Budget, and

Earned Value

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 Chapter Concepts

• Estimating the costs of activities

• Determining a time-phased baseline budget
• Determining the earned value of the work performed
• Analyzing cost performance
• Forecasting project cost at completion
• Controlling project costs
• Managing cash flow

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 Learning Outcomes

• Estimate the cost of activities

• Aggregate the total budgeted cost
• Develop a time-phased baseline budget
• Describe how to accumulate actual costs
• Determine the earned value of work performed
• Calculate and analyze key project performance
measures
• Discuss and apply approaches to control the project
budget
• Explain the importance of managing cash flow
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 Project Management Project Cost
Knowledge Areas from
PMBOK® Guide
Management

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 Dynamic Consequences of Cost, Schedule, and
Performance
• Cost Overrun Causes • Future Combat System
• Budget pressure project
• Schedule pressure • Initial budget $130
• Changing user billion
requirements • 2005 baseline increase
• Solutions to $160 billion
• Compare planned • Further analysis
• EAC $210 billion in 2022
schedule and budget
• 86% performance
• Make changes
• Terminated project
depending upon ratio

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 Power Transmission Project Cost Management

Causes for Problems Lessons Learned Solutions

• High employee turnover • Clear understanding of the
• Continuing training of new scope of work
personnel • Sufficient time to spend
• Shortage of staff with the subcontractors
• Increased project costs • Realistic schedule and cost
• Inflated bid prices estimates
• Heavily imposed restrictions • Sound conceptual design
• Hearings and approvals • Visits to the project sites
• Complete task before
another assigned

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 Estimate Activity Costs

Elements Good Practices

• Labor • Have the person responsible
• Materials estimate costs
• Equipment • Use historical data to inform
• Facilities current project
• Subcontractors and • Be reasonable and realistic
consultants • Estimate near-term activities
• Travel more accurately
• Reserve • Elaborate other costs as
additional information known

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 Consumer Market Study Project
Estimated Costs

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 Describe the two steps
Student Discussion of the project budgeting
process.

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 Possible responses to • First step
Student Discussion • Allocate costs to the work
• Describe the two steps of packages in the work
breakdown structure
the project budgeting
• Second step
process.
• Distribute the cost of the work
package over the duration of
the work package

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 Aggregate Total Budgeted Cost
• Establish a TBC for each
work package
• Determine the process
• Top-down
• Bottom-up
• If sum of initial estimates
exceeds sponsor budget,
then reduce costs and
recalculate

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 Packaging Machine Project
Aggregate Total Budgeted Cost

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 Develop Cumulative Budgeted Cost

• Distribute each total budgeted cost (TBC) over work

package duration
• Create the time-phased budget
• Calculate cumulative budgeted cost
• Provides a baseline against which actual cost and
work performance are measured

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 Packaging Machine Project
Develop Cumulative Budgeted Cost

• Determine budgeted
cost by period

• Graph the cumulative

budgeted cost curve

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 Determine Actual Cost

• Actual Cost
• Collect data regularly for funds actually expended
• Charge to work package numbers
• Committed Costs
• Periodically assign portion of total cost to actual cost
• Include costs for items that will be paid for later
• Compare Actual Cost To Budgeted Cost
• Calculate cumulative actual cost
• Compare to cumulative budgeted cost

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 Packaging Machine Project
Determine Actual Cost

• End of Week 8
• Planned cost = $64,000
• Actual cost = $68,000

• Compare CAC with CBC

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 Determine Value of Work Performed

Example Project At Day 5

• Paint 10 similar rooms • $1,000 has been spent
• Total budgeted cost of • 3 rooms have been painted
$2,000 • Earned value =
• Budget is $200 per room 0.30 X $2,000 = $600
• Have expended $400 more
than the Earned Value

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 Packaging Machine Project
Determine Value of Work Performed

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 Analyze Cost Performance

• Four cost-related measures

• TBC – total budgeted cost
• CBC – cumulative budgeted cost
• CAC – cumulative actual cost
• CEV – cumulative earned value
• Use to analyze project cost performance
• Plot CBC, CAC, and CEV curves on the same graph
• Reveal any trends toward improving or deteriorating cost
performance

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 Packaging Machine Project
Analyze Cost Performance

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 Cost Performance Index

• Measure of the cost efficiency with which the project

is being performed

• Cost performance index =

Cumulative earned value/Cumulative actual
cost

CPI = CEV/CAC

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 Packaging Machine Project
Cost Performance Index
End of Week 8 Determine CPI
• $64,000 was budgeted • CPI = CEV/CAC
• $68,000 was actually = $54,000/$68,000
expended = 0.79
• $54,000 was the earned
value of work actually For every $1.00 actually
performed expended, only $0.79 of
earned value was received.
• CEV = $54,000
• CAC = $68,000

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 Cost Variance

• Indicator of cost performance

• Difference between the cumulative earned value of
the work performed and the cumulative actual cost

• Cost variance =
Cumulative earned value – Cumulative actual cost

CV = CEV – CAC

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 Packaging Machine Project
Cost Variance
End of Week 8 Determine CV
• $64,000 was budgeted • CV = CEV – CAC
• $68,000 was actually = $54,000 – $68,000
expended = –$14,000
• $54,000 was the earned
value of work actually The value of the work
performed performed through week 8
is $14,000 less than the
• CEV = $54,000 amount actually expended.
• CAC = $68,000

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 Estimate Cost at Completion

• Forecast what the total costs will be at the completion

of the project or work package
• 3 different methods
• FCAC = TBC/CPI
• FCAC = CAC + (TBC – CEV)
• FCAC = CAC + Re-estimate of remaining work
• Another method
• TCPI = (TBC – CEV)/(TBC – CAC)

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 Packaging Machine Project
Estimate Cost at Completion
End of Week 8 Determine FCAC
• $64,000 was budgeted • FCAC = TBC / CPI
• $68,000 was actually expended = $100,000/0.79 = $126,582
• $54,000 was the earned value
of work actually performed • FCAC = CAC + (TBC – CEV)
= $68,000 + ($100,000 – $54,000)
= $68,000 + $46,000
• CEV = $54,000 = $114,000
• CAC = $68,000
• CPI = 0.79 • TCPI = (TBC – CEV)/(TBC – CAC)
• TBC = $100,000 = ($100,000 − $54,000)/( $100,000 − $68,000)
= $46,000/$32,000
= 1.44

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 Control Costs

• Analyze cost performance on a regular basis

• Determine which work packages require corrective action
• Decide what specific corrective action
• Revise the project plan
• Evaluate negative cost variance
• Take corrective actions
• Near term activities
• Activities with large cost estimate
• Reduce costs of activities
• Evaluate the trade-off of cost and scope
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 Manage Cash Flow

• Ensure that cash comes in faster than it goes out

• Negotiate payment terms
• Provide a down payment
• Make equal monthly payments
• Provide frequent payments
• Avoid only one payment at end of project
• Control outflow of cash

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 Cost Estimating
for Information Systems Development
• Common errors in estimating costs
• Underestimating the work time necessary to complete an
activity
• Requiring rework to meet the user requirements
• Underestimating growth in the project scope
• Not anticipating new hardware purchases
• Making corrections to flaws in excess of the reserve
planning
• Changing the design strategy
• Increasing resources to fast-track phases of the SDLC

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 IS Example: Estimated Activity Costs

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 Project Management Information Systems

• Store all costs associated with each resource

• Calculate the budget for each work package
• Determine cost for the entire project
• Define different rate structures for each resource
• Analyze cost performance

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 Critical Success Factors
• Estimated activity costs must be based on the estimated activity resources.
• The person who will be responsible for performing the activity should
estimate the costs for that activity. This generates commitment from the
person.
• Cost estimates should be reasonable and realistic.
• Once the project starts, it is important to monitor actual costs and work
performance to ensure that everything is within budget.
• A system should be established to collect, on a regular and timely basis, data
on costs actually expended and committed, and the earned value (percent
complete) of the work performed, so they can be compared to the
cumulative budgeted cost (CBC).
• If at any time during the project it is determined that the project is
overrunning the budget, or the value of the work performed is not keeping
up with the actual amount of costs expended, corrective action must be
taken immediately.

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 Critical Success Factors (continued)
• It is important to use the time-phased cumulative budgeted cost (CBC), rather
than the total budgeted cost (TBC), as the baseline against which cumulative
actual cost (CAC) is compared. It would be misleading to compare the actual costs
expended to the total budgeted cost because cost performance will always look
good as long as actual costs are below the TBC.
• To permit a realistic comparison of cumulative actual cost to cumulative budgeted
cost, portions of the committed costs should be assigned to actual costs while the
associated work is in progress.
• The earned value of the work actually performed is a key parameter that must be
determined and reported throughout the project.
• For each reporting period, the percent complete data should be obtained from the
person responsible for the work. It is important that the person make an honest
assessment of the work performed relative to the entire work scope.
• One way to prevent inflated percent complete estimates is to keep the work
packages or activities small in terms of scope and duration. It is important that the
person estimating the percent complete assess not only how much work has been
performed but also what work remains to be done.

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 Critical Success Factors (continued)
• The key to effective cost control is to analyze cost performance on a
timely and regular basis. Early identification of cost variances (CV) allows
corrective actions to be taken immediately, before the situation gets
worse.
• For analyzing cost performance, it is important that all the data collected
be as current as possible and be based on the same reporting period.
• Trends in the cost performance index (CPI) should be monitored carefully.
If the CPI goes below 1.0 or gradually decreases, corrective action should
be taken.
• As part of the regular cost performance analysis, the estimated or
forecasted cost at completion (FCAC) should be calculated.
• The key to effective cost control is to aggressively address work packages
or activities with negative cost variances and cost inefficiencies as soon as
they are identified. A concentrated effort must be applied to these areas.
The amount of negative cost variance should determine the priority for
applying these concentrated efforts.
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 Critical Success Factors (continued)
• When attempting to reduce negative cost variances, focus on activities
that will be performed in the near term and on activities that have large
estimated costs.
• Addressing cost problems early will minimize the negative impact on
scope and schedule. Once costs get out of control, getting back within
budget becomes more difficult and is likely to require reducing the project
scope or quality, or extending the project schedule.
• The key to managing cash flow is to ensure that cash comes in faster than
it goes out.
• It is desirable to receive payments (cash inflow) from the customer as
early as possible, and to delay making payments (cash outflow) to
suppliers or subcontractors as long as possible.

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 Summary
• The total project cost is often estimated during the initiating phase of the project
when the project charter or a proposal is prepared, but detailed plans are not usually
prepared at that time.
• The project budgeting process involves two steps: the budget for each work package
is determined and the budget for each work package is then distributed over the
expected time.
• Aggregating the estimated costs of the specific activities for the appropriate work
packages in the work breakdown structure will establish a total budgeted cost (TBC).
• The cumulative budgeted cost (CBC) is the time-phased baseline budget that will be
used to analyze the cost performance of the project.
• At any time during the project, it is possible to forecast what the total costs will be at
the completion of the project or work package based on analysis of actual cost
expended and the earned value of work performed.
• The key to effective cost control is to analyze cost performance on a regular and
timely basis.
• It is important to manage the cash flow on a project.

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 Chapter Questions

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 • It is necessary to prepare a
Question 1 budget, or plan, for how and
• Describe why it is when funds will be spent over
necessary to develop a the duration of the project to
baseline budget for a ensure that everything is
project. within budget.

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 • Labor
Question 2 • Estimated hours and hourly rate for
each person or classification
• List and describe items • Materials
that should be included • Need to be purchased for the project
when estimating activity • Subcontractors and consultants
costs. • People who have the resources or
experience to perform certain tasks
that the project team cannot
• Equipment and facilities rental
• Special equipment, tools, or facilities
for the project
• Travel
• If it is required during the project
• Reserves
• Amount saved out to cover
unexpected situations that may arise
during the project

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 • Reserves are funds to cover
Question 3 unexpected situations that may
occur during the project.
• What does the term • The contractor or project team may
reserves mean? include an amount for
• Should a reserve amount contingencies to cover unexpected
situations that may come up during
be included in a project the project within the estimated
proposal? Explain your budget in the proposal.
answer. • For example, items may have been
overlooked when the project cost
estimates were prepared, tasks may
have to be redone because they did
not work, or the costs of labor
(wages, salaries) or materials may
escalate during a multi-year project.

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 • Cost estimates should be aggressive
Question 4 yet realistic.
• If cost estimates are overly
• What is the problem with conservative, the total estimated
making cost estimates too cost for the project is likely to be
conservative or too more than the customer is willing to
aggressive? pay—and higher than competing
contractors.
• On the other hand, if cost estimates
are overly optimistic and some
unexpected expenditures need to
be made, the contractor is likely to
either lose money or have to suffer
the embarrassment of going back to
the customer to request additional
funds to cover cost overruns.

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 • The project budgeting process
Question 5 involves two steps.
• Describe the project • First, the project cost estimate
is allocated to the various work
budgeting process. packages in the project work
breakdown structure.
• Second, the budget for each
work package is distributed over
the duration of the work
package.

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 • TBC: total budgeted cost
• Top-down = a portion of the total project cost is
allocated to each work package
Question 6 • Bottom-up = the sum of the costs of all the activities
that make up that work package
• Define the • CBC: cumulative budgeted cost
• The amount that was budgeted to accomplish the work
following: TBC, CBC,
that was schedule to be performed up to that point in
CAC, CEV, CPI, CV, time
FCAC, and TCPI. • CAC: cumulative actual cost
• The amount that was actually spent to accomplish the
• How is each work that was scheduled to be performed up to that
point in time
calculated? • CEV: cumulative earned value
• = % complete X TBC (for the work package)
• CPI: cost performance index
• = CEV/CAC
• CV: cost variance
• = CEV – CAC
• FCAC: forecasted cost at completion
• FCAC = TBC/CPI
• FCAC = CAC + (TBC – CEV)
• FCAC = CAC + Re-estimate of remaining work to do
• TCPI: to-complete performance index
• = (TBC – CEV)/(TBC – CAC)
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 • It is necessary to track actual
Question 7 and committed costs so that
• Why is it necessary to they can be compared to the
track actual and CBC.
• In order to take corrective
committed costs once a
action before it’s too late.
project starts?

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 • It is important to calculate the
Question 8 earned value of work performed so
that if the work performed is not
• Why is it necessary to keeping up with the actual cost,
calculate the earned corrective action can be taken.
value of work performed? • Even if the actual cost is in line with
the CBC
• How is this done? • Determining the earned value
involves collecting data on the
percent complete for each work
package and then converting this
percentage to a dollar amount by
multiplying the TBC of the work
package by the percent complete.

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 • Cost performance index =
Question 9 CEV/CAC
• Give an example of • If CPI is less than 1.0, it means
calculating a cost that for every dollar
performance index. expended, less than one
• What does it mean when dollar of earned value was
the CPI is below 1.0? received.
• What does it mean when • If CPI is greater than 1.0, it
the CPI is above 1.0? means that for every dollar
expended, more than one
dollar of earned value was
received.

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 • Cost variance = Cumulative earned
Question 10 value – Cumulative actual cost
• If the CV is negative, it means that
• What does it mean when the value of the work performed is
cost variance is negative? less than the amount actually
• What does it mean when expended.
• If the CV is positive, it means that
cost variance is positive?
the value of the work performed is
• When evaluating a work more than the amount expended.
package with a negative • One should focus on:
cost variance, on what • Activities that will be performed in
the near term. If you put off
two types of activities corrective actions until some point in
should you focus? Why? the distant future, the negative cost
variance may deteriorate.
• Activities that have a large cost
estimate. Usually, the larger the
estimated cost for an activity, the
greater the opportunity for a large
cost reduction.
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 • The key to managing cash
Question 11 flow is to ensure that cash
• What is the key to comes in faster than it goes
managing cash flow? out.
• How can this goal be • This can be accomplished by
accomplished? asking the customer to:
• Provide a down payment at the
start of the project
• Make equal monthly payments
based on the expected duration
of the project
• Provide frequent payments,
such as weekly or monthly
payments, rather than quarterly
payments

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 Question 12a
• Refer to the table
below.
• What is the
cumulative
budgeted cost at
the end of week 6?
• Amounts are in
thousands of
dollars. • The cumulative budgeted cost at the
end of week 6 is $100,000.

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 Question 12b
• Below is a table of actual costs.
What is the cumulative actual cost
at the end of week 6?
• Determine whether there is a cost
overrun or underrun.
• What is causing it?
• Amounts are in thousands of
dollars.
Week
1 2 3 4 5 6
Cumulative 10 36 54 66 95 112

There is a cost overrun of $12,000. The actual cost of Task 1 was $34,000 while
only $30,000 was budgeted for it. The actual cost so far of Task 2 is $68,000,
while only $60,000 had been budgeted up to week 6. The actual cost of Task 3
is $10,000 which equals its budgeted amount at week 6.
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 Question 12c
• Below is a table of the cumulative
percentages of work completed by
the end of week 6.
• What is the cumulative earned
value of the project at the end of
week 6?
• Is it good?
Cumulative Earned Value
By Week
TBC 1 2 3 4 5 6
Task 1 30 9 24 30 30 30 30
Task 2 70 7 17.5 24.5 38.5 45.5
Task 3 40 4 8
Task 4 30
Total 170 9 31 47.5 54.5 72.5 83.5

The cumulative earned value at the end of week 6 is only $83,500; however,
$112,000 has already been spent.
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 • CPI = 83,500 / 112,000 = 0.7455
Question 12d • CV = 83,500 – 112,000 = –28,500
• What is the CPI at the end
of week 6?
• What is the CV?
Week
1 2 3 4 5 6
Cumulative 10 36 54 66 95 112
Cumulative Earned Value
Week
TBC 1 2 3 4 5 6
Task 1 30 9 24 30 30 30 30
Task 2 70 7 17.5 24.5 38.5 45.5
Task 3 40 4 8
Task 4 30
Total 170 9 31 47.5 54.5 72.5 83.5

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 • Method 1: Assuming the
Question 12e same rate of efficiency
• Calculate the FCAC using • FCAC = TBC/CPI
• FCAC = $170,000 / 0.7455 =
the first two methods
$228,034.87
described.
• Method 2: Perform the
remainder of the work
according to budget
• FCAC = CAC + (TBC – CEV)
• FCAC = $112,000 + ($170,000 –
$83,500)
• FCAC = $112,000 + $86,500
• FCAC = $198,500

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 Cost Analysis Tools
Cost Forecasting
Internet Exercises PMFORUM
PM World Today

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 • Add “project management” to the
Internet Exercises search and examine the difference
in the results.
• Using your favorite Web search
• ProjectSmart provides project
engine, perform a search for cost
management resources for project
analysis tools and cost
managers at all levels. The site
forecasting. Describe what you
features articles, presentations, and
found.
other information of interest
• Visit Project Smart website.
around the world.
• Explore the site.
• The White Papers link contains to a
• Click on the “Cost
number of papers on topics to help
Management” or “Earned Value
improve project management
Management”. Explore the
articles. performance. The site’s articles,
• Click on the “Methods & Tools” books, presentations, and case
link. studies that help reinforce the
• Do a search for “Cost Planning.” project management concepts.

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 A Not-For-Profit Medical
Case Study 1 Research Center

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 Case Study 1 • If using Microsoft Project,
Question 1 enter the rates of the work
• Using the schedule from and material resources on the
Chapter 5, estimate the Resource Sheet.
cost for each activity. • Assign the cost resource
amount on the Task
Information window for the
task where the resource is
assigned.
• Any resources that are not
assigned for the duration of a
work package should have a
percent of effort assigned, or
change the task to a fixed
duration and the amount of
work changed.
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 Case Study 1 • The determination of the TBC
Question 2 for the project is completed
• Determine the total using the top-down approach
budgeted cost for the or the bottom-up approach.
project. • If using Microsoft Project and
the costs are assigned to the
work packages, the approach
is the bottom-up approach.
• Approaches:
• Top-down = a portion of the
total project cost is allocated to
each work package
• Bottom-up = the sum of the
costs of all the activities that
make up that work package

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 Case Study 1 • If using Microsoft Project, the
Question 3 Cash Flow report depicts the
• Prepare a budgeted cost amount of cost per quarter,
by period table (similar to week, or day and the
Figure 7.5) and a cumulative budgeted cost
cumulative budgeted cost curve.
(CBC) curve (similar to • The Cash Flow report
Figure 7.6) for the provides a table of the costs
project. and the total costs per week
for the project.

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 Case Study 2 The Wedding

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 Case Study 2 • If using Microsoft Project,
Question 1 enter the rates of the work
• Using the schedule from and material resources on the
Chapter 5, estimate the Resource Sheet.
cost for each activity. • Assign the cost resource
amount on the Task
Information window for the
task where the resource is
assigned.
• Any resources that are not
assigned to work the duration
of a work package should
have a percent of effort
assigned or the task changed
to fixed duration and the
amount of work changed.
© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
 Case Study 2 • The determination of the TBC
Question 2 for the project is completed
• Determine the total using the top-down approach
budgeted cost for the or the bottom-up approach.
project. • If using Microsoft Project and
the costs are assigned to the
work packages, the approach
is the bottom-up approach.
• Approaches:
• Top-down = a portion of the
total project cost is allocated to
each work package
• Bottom-up = the sum of the
costs of all the activities that
make up that work package

© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
 Case Study 2 • If using Microsoft Project, the
Question 3 visual report, Cash Flow
• Prepare a budgeted cost report, depicts the amount of
by period table (similar to cost per quarter, week, or day
Figure 7.5) and a and the cumulative budgeted
cumulative budgeted cost cost curve.
(CBC) curve (similar to • The Cash Flow report
Figure 7.6) for the provides a table of the costs
project. and the total costs per week
for the project.

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 Appendix Time–Cost Trade-Off

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 Time–Cost Trade-Off Methodology
• Used to reduce the project duration with the smallest
associated increase in cost
• Each activity has a normal and crash duration and cost
• Normal duration – time under normal conditions
• Normal cost – cost if complete in normal time
• Crash duration – shortest estimated time to complete
• Crash cost – cost to complete in crash time
• Incrementally accelerate the time with more resources
• Assume acceleration cost is linear
• Acceleration cost per time
• (Crash Cost – Normal Cost)/(Normal Time – Crash Time)

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 Acceleration Costs

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 Time–Cost Trade-Off • The time–cost trade-off
Question 1 methodology is a way to
• What is the time–cost incrementally reduce the
trade-off methodology, project duration with the
and when is it used? smallest associated increase
in incremental cost.
• It is used when the project’s
schedule needs to be
accelerated.

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 Time–Cost Trade-Off • You need to calculate normal
Question 2 and crash times and costs in
• Why do you need both order to determine the costs
normal and crash times associated with accelerating
and costs for this the project from a normal
procedure? timeframe to a crash
timeframe.

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 Time–Cost Trade-Off • The activity’s duration can be
Question 3 reduced by 4 weeks at most.
• Assume that an activity • This will result in an increased
has a normal time of 20 cost of $7,000/week.
weeks, a normal cost of
$72,000, a crash time of
16 weeks, and a crash
cost of $100,000.
• By how many weeks, at
most, can this activity’s
duration be reduced?
• What is the cost per week
to accelerate this activity?

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 Time–Cost Trade-Off • It is not appropriate to crash
Question 4 all of the activities because
• Why isn’t it appropriate expediting activities not on
to crash all of the the critical path will not
activities in a project to reduce the project
achieve the shortest completion time but will
project schedule? increase total project cost.

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 Appendix Microsoft Project

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 Appendix • This fourth appendix activities
Microsoft Project are
• Most widely used project • Enter costs for resources
management software system in • Produce cost reports
the business environment today. • Examine cash flow and earned
• It is powerful, easy to use, and
value
available at a very reasonable
price.
• A free trial version is included with
new copies of the text or on the
Microsoft website.
• The Gantt Chart View and the Task
ribbon are the default view when
Microsoft Project is first opened.
• Other views are chosen by clicking
on the arrow in the View group on
the Task ribbon and selecting the
name from the drop down list.

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 Figure 7A.1 Resource Sheet with Work and Material Rates

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 Figure 7A.2 Cost Resource Entry for Task

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 Figure 7A.3 Work Overview Report

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 Figure 7A.4 Cash Flow Report

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 Figure 7A.5 Visual Cash Flow Report,
Displayed in Microsoft Excel

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 Figure 7A.6 Tracking Gantt to Display Actual
Finish Dates

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 Figure 7A.7 Task Cost Overview Report

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 Figure 7A.8 Cost Variance Table for Tasks

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 Figure 7A.9 Cost Variance Table for Resources

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 Figure 7A.10 Change in Status Date

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 Figure 7A.11 Earned Value Table

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 Figure 7A.12 Visual Reports–Create Report Window

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 Figure 7A.13 Visual Earned Value Over Time
Report, Displayed in Microsoft Excel

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