There are different types of project cost – your budget isn’t made up of one big lump of cash. Although it can sometimes feel like that!
Understanding the different types of project cost is helpful because they help you review the different categories of spend. You can use mindmapping to check that you haven’t left out any budget items.
The infographic below shares the 5 different types of project costs that you should consider for your budget. However, what it doesn’t make clear is that the project cost categories overlap. You can have fixed direct costs and variable indirect costs, for example. Sunk costs remain sunk!
Within the different categories you can break down your budget even further. For example, cost of quality might be something you consider for your budget formulation, but it could be a fixed, variable, direct or indirect cost, depending on how you are going to build quality into your project.
Your project plan is made up of lots of different elements, and cost management is one of those. When you’re planning your project, your cost management plan sets out the processes required to make sure that your project hits its budget targets.
Your cost management plan should include these items:
1. Process descriptions
What processes are you doing to be using on the project for cost management? These include planning, estimating costs and how you will establish the overall budget. Add in some detail about what processes you’ll be following and where these can be found, for example if you intend to do bottom-up estimating or bypass the standard cost planning process on advice from your project accountant.
2. Accuracy levels
How accurate do you intend to be? Of course it would be great to say that you’ll be 100% accurate in all your estimates, but that’s unrealistic! State here what you are aiming for. You can also add that this will change as the project progresses. For example, you will start the project with lower accuracy targets because you won’t have as much information as you will later on. Then as you get further into the project you can amend your estimates with the latest, more accurate figures. Set out here whether you intend to do that and how you will go about doing those revisions.
3. Variance thresholds
What variance is going to be acceptable before you have to flag a problem to your sponsor? Talk to them about how much leeway you have in your measurements and when they expect you to be bringing them issues. You may find that they are prepared to give you quite a big bracket either side of your target before it becomes a problem.
Set out the percentage deviation from each of your major measures such as baseline budget so that you know exactly where your boundaries are.
4. Performance measurements
If there are any specific rules for performance measurements, make a note of them in this section of the cost management plan. This is particularly relevant if you are following Earned Value processes. If you aren’t, you’ll probably find that you don’t need this section. If in doubt, talk to your Portfolio Office about what they expect to see.
5. Units of measure
How are you measuring things? It might seem obvious to you that ‘25’ refers to days of effort, but someone else could read that as hours of effort and come to a very different conclusion! Specify how you will be measuring time and budget figures. This is especially important if you are working in multiple currencies as you’ll need to specify that here.
6. Reporting protocols
When are you reporting? How frequently? Who to? These are all questions to answer in the reporting section of your cost management plan. Agree the format of your plans with the project sponsor and anyone else who will be receiving them. Then set out exactly how often you’ll produce these reports. It is also worth including what you’ll put in them so that there are no surprises. It can be difficult to gather new data items once the project has started if you haven’t built in a way to record them, so get a clear idea now about what your stakeholders want to see.
7. Anything else
Finally, don’t take this list as the only items to be included in your cost management plan! Your Portfolio Office may have other ideas and your corporate template may require you to complete other sections. Even if it doesn’t, you can still amend your document and add in anything else that will help you manage costs on this project – be flexible, even if you use a template.
Other things that may be useful include roles and responsibilities of those involved in cost management, a note referring back to any criteria set out in the business case, a link to any corporate policies that you will be following or any critical dates such as end of year reporting timelines or reforecasting milestones.
Your cost management plan should give you a working document to help manage spending on your project, so make it work for you and adapt any template (and this list) so it is a practical, comprehensive guide for everyone on the team.
In their book, Project Management Workflow, Dan Epstein and Rich Maltzman describe the different kinds of costs that make up the whole cost of a project. The 5 costs they cover are:
Let's look at each of these in turn.
Direct costs are those directly linked to doing the work of the project. For example, this could include hiring specialised contractors, buying software licences or commissioning your new building.
These costs are not specifically linked to your project but are the cost of doing business overall. Examples are heating, lighting, office space rental (unless your project gets its own offices hired specially), stocking the communal coffee machine and so on.
Fixed costs are everything that is a one-off charge. These fees are not linked to how long your project goes on for. So if you need to pay for one-time advertising to secure a specialist software engineer, or you are paying for a day of Agile consultancy to help you start the project up the best way, those are fixed costs.
These are the opposite of fixed costs - charges that change with the length of your project. It's more expensive to pay staff salaries over a 12 month project than a 6 month one. Machine hire over 8 weeks is more than for 3 weeks. You get the picture.
These are costs that have already been incurred. They could be made up of any of the types of cost above but the point is that they have happened. The money has gone. These costs are often forgotten in business cases, but they are essential to know about. Having said that, stop/continue decisions are often (wrongly) based on sunk costs. If you have spent £1m, spending another £200k to deliver something that the company doesn't want is just wasting another £200k. Epstein and Maltzman write:
"Sunk cost is a loss which should not play any part in determining the future of the project." Unfortunately, project sponsors and other senior executives (and even project managers) often value completion over usefulness and it does take courage to suggest to your sponsor that you stop a project that has already seen significant investment.
What other examples of these types of costs do you have on your projects? And have you ever taken the hit and stopped a project after incurring significant cost? Let us know in the comments.
When do you really know how much a project will cost? At the beginning, when you work out the business case? During the project start up phase, where you prepare your budget and establish the processes to track spending? While you are using Earned Value Management and can forecast forward predicted spend? After you have spent your contingency budget? When you do the close out report?
There are so many moments where you can calculate your project’s cost. Michael Cavanagh, in his book Second Order Project Management (Gower, 2012), argues that none of the points I have mentioned are right.
He believes that you don’t find out how much your project is going to cost until after the project is complete – a long time after.
“Although it has been said often that the only time you know the cost and duration of a project is when it has been delivered, in truth, you don’t,” he writes. “Post-delivery costs including fault correction, maintenance, support and disposal are all subject to the vagaries of implementation in the real world and should be addressed and included in the estimation process.”
In other words, you’ll never know during the project implementation what the overall cost of your project will be. This is perhaps less of a problem for the project manager. I think you can justifiably say that we are only responsible for managing the budget up until the point the project is closed. That’s what we plan for and budget for, and manage towards. Any costs that are incurred after this are not part of the project and therefore Not Our Problem. Project managers manage project costs, and as soon as it stops being a project cost it is hard to consider it our responsibility.
However, this is a problem for the contracting process. You can’t have a project that enters into a contract where the contract is only fit for the project stage. Unless your contract is with a vendor who will only be around during the project implementation, like a hired-help contractor. If you are buying software or a service, or equipment, you want the contract to include maintenance and support. Those are after-the-project costs.
So while you might not know how much your project will cost overall, you can do something about helping the operational team who come after you to manage their costs. Get them involved in the contracting. Ask them how they manage ongoing costs and how you should be factoring this in. What is the lifespan of the product or equipment you are buying? What decommissioning costs should you factor in? Ideally get the project sponsor or the operational team representative to represent themselves during the contract discussions. You’ll get a better result, even if it does mean sitting in the room with lawyers for several days.
Do operational teams get involved with preparing the cost predictions for projects in your company? And when do you think the responsibility of the project manager ends when it comes to managing the budget?
Today I’m interviewing Todd Williams, author of the popular book, Rescue the Problem Project. In the book, Todd talks about cost audits. Even if your project doesn’t need rescuing, cost audits are a useful technique to use, so I talked to Todd to find out more.
Todd, what is a cost audit?
A cost audit is a relatively simple task of reviewing all of the costs on a project and ensuring they are in line with the project’s anticipated spend. It validates the right amount is going to the right people at the right time. Simple, right? The sticky part is usually that last clause—at the right time. Projects have specific milestones for when items should be paid for. Usually it is when a tangible item is delivered. Some form of acceptance document is signed and the vendor gets paid. Internally, the demarcation point is resources moving on to new tasks. If they still have lots of loose end to tie up, then you keep spending money on something that is supposed to be complete. In other words, money starts leaking out of the project.
It can, however, be a little more tricky. When you are determining the cost of internal resources, you need to determine they are performing to expected goals. Are they spending time on non-project tasks or inefficiently getting toward deliverables? They may be salaried and simply billed to your project. In this case you need to be diligent ensuring hours (which translate to money) are spent on completing their work and that these hours are in compliance with industry standards. If time gets excessive you have a problem.
The best measure of this is a cost performance index. But that indicator is imperfect. If deliverables are being signed off as complete when there is still work to do, then people need to keep working to get a workable product. Money to cover the expense, with the best of intentions, can get pulled out of some other budget. This is similar to the Ponzi schemes we have seen in the headlines recently and can be hard to find until after it is too late.
OK, so I guess you don’t want to wait until the end of the project to carry out a cost audit. When is the best time to do one?
The minute you get a funny feeling in your gut that something is not right. This goes for the Project Manager or the project sponsors and executives. Often the latter can get someone to come in and find the problems in short order, before they get too big. Always assume positive intent—the mistakes are honest misunderstandings.
For some organizations it is a matter of course; however, it takes a significant amount of time. This is far from a lean process and I do not recommend it. If you are dealing with the government, you are often required to have some audit process in place. In any case, if you see the cost performance index starting to go awry, it is a good time to do one.
You mentioned bringing someone in. Can project managers carry out cost audits themselves or should someone else do it?
Using and internal or external auditor? Answering this question with a question will make my point. Would you trust a company where you have a significant amount of your savings invested if you knew they did their own audits instead of having an independent auditor do the work? Of course not. You would want them to have an outside firm review the books to ensure there were no mistakes. It is of little value to have the person that was making the mistakes try to find them—it is harder for me to discover that I do not understand something than for someone else. In addition, if someone is cooking the books, the exercise of an internal audit is a waste of time.
Right, so say I get someone in to do a cost audit on my project. What form does the output take?
I am sure there is a formal layout that finance people like to see, but I simply put the variances items in a spreadsheet showing the anticipated cost, actual cost, and whether it can be recovered. Then I total out what is lost and what can be recovered. The last step is to give a set of recommendations for fixing the issues and preventing them from recurring.
I bet the reports have lots of interesting things in them. You must have uncovered some sneaky deals.
Although I said to always assume positive intent, there are times when people do not have the best intentions. I have seen people who were buying equipment that was not needed so they could get a gift from the vendor. They labeled the purchase order as if it was an item that was needed and the audit found it sitting unused on a shelf. The buyer had a positive intent (beyond the gift)—to improve the capabilities of the deliverable. Unfortunately that functionality was out of scope and it was questionable if the purchased equipment would meet original scope.
In cases like this, the report, or that section of the report, should be confidential. Covert and clandestine discoveries are the exception. The information should be an educational tool to reduce the chance of the mistake recurring. Remember that the data can be sensitive and publicity can cause a lot of pain. I am sure the readers can think of some big items in the press.
I know that now you are very experienced in doing cost audits, but tell us about the first time you were asked to carry out this type of review.
I am not a finance guy. After all, I have a bachelor of science in chemistry. Being called in by the CFO, I was certain I was being set up and was scared to death. I started by reviewing all the invoices and reconciling them to the material we had on hand and the functions that were supposed to be delivered. Finding numerous major discrepancies, I got even more nervous thinking I was doing something wrong. After double-checking the numbers, I called a couple vendors. They got very defensive. It turns out that the vendors had learned the client would pay anything without validating the fit of the deliverable. They could meet their revenue numbers by delivering and billing early.
Unfortunately, the vendor’s management would not let them work on the items that had been delivered and invoiced since there was no more revenue to gain. There were hundreds of thousands of dollars that had been spent on partially delivered items. With new confidence, on a regular basis I would walk into the CFO’s office and write the new funds found and recovered. The value dwarfed my billings by an order of magnitude. Needless to say, the CFO was pleased.
I’m sure he was! Thanks, Todd.
About my interviewee:
For twenty-five years, Presidents, V-Level, and C-Level executives of manufacturing and service companies have asked Todd Williams to help them build leading-edge systems, improve organizational efficiency, and rescue problem projects. From this experience, he has developed methods to streamline organizations, turn-around troubled projects, and help prevent recurring failures.
As President of eCameron, Inc. and a professional member of the National Speakers Association, he is an expert in project rescue, failure prevention and engaging people in the solution. He maintains a blog that has been quoted on CIO Update, ZDNet, IT Business Edge, Center for CIO Leadership, and CIO Essentials, among others. He has been chosen to speak to numerous companies including NASA, AMA and PMI.