Cost Management: PMP Study Guide (PMBOK 6th Edition)

cost management pmp study guide

Project Cost Management involves planning, budgeting, and managing costs. Cost management does not happen in isolation – the project manager needs input from the project team and key stakeholders. Cost management should occur early in project planning in order to establish a framework for all cost management processes and ensure that the project does not go over budget. In this PMP study guide, we’ll cover all the processes in the Cost Management Knowledge Area in PMBOK 6th Edition.

Although estimating cost and determining budgets can be one process on small projects, PMI separates them into two processes because the exam assumes the PM is managing a large project. Many financial management techniques, such as ROI, payback, and discounted cash flow, are used during this process.

Plan Cost Management

  • Plan Cost Management process establishes the framework/policies/procedures for how to estimate and manage costs
  • The key benefit of this process is that it provides guidance and direction on how costs are managed from project initiation to closure
  • There are many ways to fund a project, including: 1) Self-funding, 2) Funding with equity, or 3) Funding with debt
  • The Cost Management Plan is a component of the Project Management Plan that details how cost management processes will be carried out. This plan will describe how project costs are planned, estimated, and controlled.
  • The cost management plan also establishes the following:
    • Units of measure
    • Level of precision
    • Level of accuracy
    • Control thresholds
    • Reporting formats
    • Organizational procedures links
    • Rules of performance measurement
  • Life Cycle Costing – Looking at the cost of the whole product life cycle, not just the cost on the project
  • Value Analysis – Finding less costly ways to do the same work. Value analysis involves identifying required project functions, assigning values to these functions, and providing these functions at the lowest cost without sacrificing performance.

Estimate Costs

  • Estimate Costs is the process of establishing an approximate monetary value to each project activity.
  • The key benefit of this process is that it determines the amount of money needed to complete project work
  • Cost estimate is a prediction of how much an activity will cost upon completion given the information we know now.
  • When estimating cost, you need to know whether you are only estimating the direct project costs or whether your estimates need to include indirect costs as well.
  • To estimate costs, you need to look at the project schedule to see which activities need which resources.
  • Types of Estimation:
    • Analogous Estimating – use similar historical project activity costs to determine the current project activity costs. Relies of expert judgment. Use this technique when you have limited information available. Also called top-down estimating.  
    • Parametric Estimating – use mathematical calculations or models to determine activity costs (generally more accurate). E.g. it costs $100 to install 20m of wires, thus, it will cost $1000 to install 200m.
    • Bottom-up Estimating – detailed estimating is done for each activity (if available) or work package (if activities are not defined), and the estimates are then rolled up into control accounts and finally into an over project estimate
  • Contingency Reserves – the part of the budget set aside to deal with negative risks that may occur
  • Vendor Bid Analysis – analyzing the bids from qualified vendors. If cost estimates vary significantly, it could mean that the scope is not well defined. If third-party vendors are used on the project, the PM needs to make sure their cost estimates are included in the project budget.
  • Activity cost estimate – an estimation of what the activity will cost upon completion based on information known to date.
  • Supporting details for activity cost estimates:
    • Basis of estimation
    • Assumptions
    • Constraints
    • Range of possible estimates
    • Confidence level of final estimate
  • Types of costs:
    • Variable costs – these costs change with the amount of production or the amount of work
      • Examples: cost of material, supplies, and wages
    • Fixed costs – these costs do not change as production changes
      • Examples: rent, equipment, etc.
    • Direct costs – these costs are directly attributable to the work on the project
      • Examples are team travel, team wages, recognition, and costs of material used on the project
    • Indirect costs – indirect costs are overhead items or costs incurred for the benefit of more than one project
      • Examples include taxes, fringe benefits, and janitorial servicesCost of quality – The total cost of all efforts related to quality
  • Accuracy of Estimates
    • Rough Order of Magnitude (ROM) Estimates
      • This type of estimate is usually made during the initiating process
      • A typical range from ROM estimate is a +/- 50% from actual, but this range can vary depending on how much is known about the project when creating the estimates
    • Budget estimate
      • This type of estimate is usually made during the planning phase and is in the range of -10% to +25% from actual
    • Definitive estimate
      • Later during the project, the estimate will become more refined. Some project managers use the range of +/- 10% from actual, while others use -5% to +10% from actual

 

Determine Budget

  • Determine Budget is the process of aggregating individual activity or work package costs into the project budget.
  • The Key Benefit of this process is that it determines the cost baseline against which project performance is measured.
  • Cost aggregation – the process of rolling up individual activity costs into work packages and work packages into control accounts and control accounts into the project budget
  • Funding limit reconciliation – Comparing plan project expenditures against funding limits to determine if any variances exist.
  • Cost baseline – approved time-phased project budget. The cost baseline tells you how much you should have spent at any given point in time. Any changes to the cost baseline must be approved by the change control board.
  • Control accounts – During reporting, the key stakeholders may want more details than the overall project cost, but less details than the work packages costs. Control accounts aggregates related work packages together. The PM will report at the control accounts level.  
  • Reserve analysis:
    • Management reserves
      • “Unknown-unknown risks”
      • Not part of the project baseline
      • Sponsor must approve the use of management reserves and then the project must be “re-baselined”
    • Contingency reserves  
      • “known-unknown risks”
      • Used at the discretion of the project manager
      • Part of the project budget
  • The summation of control accounts gives you your cost baseline.
  • Cost baseline + contingency reserves = project budget
  • Funding occurs in incremental stages that are not continuous or evenly distributed.
  • Funding requirements are derived from the cost baseline

Control Costs

    • The Control Costs process is the process of monitoring actual project costs against the cost baseline and managing changes to the cost baseline.
    • The key benefit of this process is that it allows the PM to detect cost variances early and take corrective actions to bring the project back on budget.
    • Any changes to the budget must be approved through the Perform Integrated Change Control process.
    • Project Cost Control components:
      • Ensuring timely implementation of change requests
      • Issuing cost-related change requests when necessary
      • Monitoring cost performance and understanding the root causes of variances
      • Monitoring activity costs against project budget
      • Reporting cost performances to key stakeholders
      • Ensuring the project do not exceed funding limits
      • Preventing unapproved changes from using up the budget
      • Bringing cost overruns to within acceptable limits
    • Variance analysis – The procedure of analyzing the difference between the actual cost and the budgeted cost (from the cost baseline).
  • Return on investment (ROI) – a technique to estimate the potential profitability of an investment
  • Progress Reporting
    • 50/50 rule
      • An activity is considered 50% complete when it begins and gets credit for the last 50% only when it is completed
    • 20/80 rule
      • An activity is considered 20% complete when it begins and get credit for the last 80% only when it is completed
    • 1/100 rule
      • An activity does not get credit for partial completion. It only gets credit for full completion
  • Earned Value Management – This methodology is used to measure project performance against the scope, schedule, and cost baselines.
Acronym Term Interpretations
PV Planned value As of today, what is the estimate value of the work planned to be done?
EV Earned value As of today, what is the estimated value of the work actually accomplished?
AC Actual cost (total cost) As of today, what is the actual cost incurred for the work accomplished?
BAC Budget at completion How much did we BUDGET for the TOTAL project effort?
EAC Estimate at completion What do we currently expect the TOTAL project to cost (a forecast)?
ETC Estimate to complete From this point on, how much more do we expect it to cost to finish
VAC Variance at completion As of today, how much over or under budget do we expect to be at the end of the project?

pmp formulas part 1pmp formulas part 3

pmp formulas part 2

To find a list of all formulas that you will see on your PMP exam, read this article.

Things to Remember

  • Notice the EV comes first in every formula. Remembering this one fact alone should help you get about half the earned value question right
  • If it is variance, the formula is EV minus something
  • If it is an index, it is EV divided by something
  • If the formula relates to costs, use AC
  • If the formula relates to schedule, use PV
  • For variance interpretation:
    • Negative is bad and positive is good
    • E.g. A -200 CV means that you are over budget
  • For indices interpretation:
    • Greater than 1 is good
    • Less than 1 is bad

Before you go…

Lastly, don’t forget to check out the other study notes in this series and download our free 200 practice questions by clicking the links below:

Integration Management – PMP Study Guide

Scope Management – PMP Study Guide

Time Management – PMP Study Guide

Cost Management – PMP Study Guide

Quality Management – PMP Study Guide

HR Management – PMP Study Guide

Communications Management – PMP Study Guide

Risk Management – PMP Study Guide

Procurement Management – PMP Study Guide

Stakeholder Management – PMP Study Guide