What is Project Cost Management?
Cost management is an activity we are confronted with daily. Shopping, buying a car, or preparing for a vacation are all activities that beg the question: What is my budget, and how much can I spend? This question also arises for any company and any project; the challenge is to respect the defined budget as much as possible.
Keep in mind that on average, one out of every two projects is delivered with a deviation in one of the project Triple Constraints (scope, cost, time).[1] This means that cost, one of these three elements, plays an important role in project success and must be closely managed.
In this first article of a three-part series, we will explain what cost management is and the different types of costs that exist. Written by our very own consultants who work on global industrial projects, we hope this article helps you to apply these concepts in your own projects.
What is Cost Management in Project Management?
Project Cost Management is the process of assessing, monitoring, and controlling the costs of a project, in line with both the project budget and the organization’s financial requirements. It is also one of the core functions of Project Controls, a typical part of PMO operations, along with schedule and risk management. The scope of cost management is vast, including the control, analysis, or even forecasting of a given budget.
As project cost management is so connected to the budget, you may wonder what is the difference between cost and budget management? Budget management is actually more related to the management of the company, whereas cost management is more project-focused. Nevertheless, project cost managers naturally have budgetary responsibilities. After all, following the budget is one of their primary objectives in keeping projects on track.
Cost management has been around since the dawn of project management itself, especially when project success is often determined by its financial outcomes. However, cost management has long been managed internally and rarely outsourced to external contractors. A lack of companies’ in-house expertise in this area, a greater diversity of cost types, as well as the advancement of project management methodologies have paved the way for a more developed financial mindset.
Project Cost Management is the process of assessing, monitoring, and controlling the costs of a project, in line with both the project budget and the organization’s financial requirements.
As companies’ focus has expanded around reducing costs and increasing profitability, this pressure is increasingly reflected in projects, putting proper cost management at the forefront. Today, therefore, we see a greater need for specialized cost managers on project teams.
The primary objectives for effective cost management are:
- Understand the project environment to set up an accurate budget forecast.
- Ensure compliance with the budget and analyze the project contingencies
- Monitor the progress of the budget regarding the project schedule and scope.
The Importance of Cost Management
The demand for greater profitability as well as the increase in audit frequency have led companies to need more refined and robust cost and budget management. The challenge is to be able to control, analyze, report, and anticipate costs more precisely. This requires specialized cost managers who have the experience and rigor to do so.
A Global View of Finance
Today a company is constrained in how to record and report their financial transactions by various governing bodies. Guidance is provided by organizations, such as the International Accounting Standards Board (IASB), who provide standard principles such as the International Financial Report Standards (IFRS). Then there are also tax laws in each country.
This whole legal envelope is first applied to the company, whose finance staff takes it into account for regulatory reporting, tax filing, and management reporting. They put in place rules and procedures to ensure their organization follows all legal requirements. These rules and procedures are passed on to the project to be managed by the cost manager.
As long as the company remains within this framework, it can adjust its cost management plan as the law leaves room for it. A company can also manage its costs very globally or in a more detailed way. Either way, the cost manager must be financially accountable because the project (and therefore the company) must be held to account. It’s all about being answerable to the above entity, whether they are local, national, multinational, or global.
Consider the following financial and reporting obligations:
- Management Reporting (KPI’s, Cost Tracking and Management, Incentive Awards)
- Financial Reporting (Financial Statements, Loan Agreements, Transaction Details, Investment Valuation, Other securities filings)
- Tax Accounting
Depending on the type of accounting they choose (cash basis or accrual basis), companies can decide when their fiscal reporting year starts and stops based on what best captures their financial cycle. This enables them to fulfill their financial and reporting obligations.
A company’s accounting requirements must be considered in their project cost management strategy. Additionally, there are 4 types of project costs:
The 4 types of cost and why they matter for project management
There are different types of costs, which often complement each other:
- Direct and Indirect Costs: These distinguish between costs directly related to the production of a unit (good or service) and those that are not. If we take the example of a cookie manufacturing company, the raw materials or the number of hours required to make a cookie are direct costs. On the other hand, property rental, advertising, computer equipment or salaries are indirect costs because they cannot be linked directly to the production of a cookie.
- Fixed and Variable Costs: These distinguish between costs that evolve according to the quantity produced and those that do not. In our example of cookie production, raw materials, electricity or transport costs are variable costs because they depend on the level of activity, while the facility rental, advertising, or telephone subscriptions are fixed.
- Recurring Costs (RC) and Non-Recurring Costs (NRC): Most expenses in companies are recurring costs, i.e., they occur several times during the same accounting year (salaries, subscriptions, rents, etc.). Non-recurring costs are not intended to exist throughout the life of the company, for example: asset impairments, restructuring costs or legal costs. Generally speaking, these are exceptional costs.
- Operating Expenditures (OPEX) and Capital Expenditures (CAPEX): Operating expenses are current expenses that allow a business or product to run. Capital expenditures relate to capital assets and are expenditures that have long-term value. Both are often found in companies and can define how to manage costs within a project.
We can also distinguish the different costs by their nature within a project, which is more granular than those described above. Here are some examples of different costs that can be found in a project:
- Acquiring machines, software, etc.
- Building a factory/operating site
- Start-up/testing costs
- Energy costs
- Transportation and travel
- Workforce
- Protection costs (insurance, video surveillance, fire)
- Maintenance, repair and operations costs
- Production downtime cost
- Cost related to the environment (pollution clean-up cost)
- Cost of dismantling and decommissioning
- Cost of intellectual property management
- Overhead
- Training
Understanding these different types of cost as well as the legal accounting requirements makes it possible to define the methods used in managing a project. This allows us to budget, analyze, plan, and control the project costs.
In our next article, we will look at the four phases of cost management.
This article series was written by Aurélien CRÔNIER and Mehdi DARD with contributions from Fanny DA SILVA and the MI-GSO | PCUBED Cost Management Community of Practice.
[1] Source: The Standish Group
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