This is the fifth post in an eight part series that covers the fundamental theory of project management. The focus of this post is Project Cost Management. The entire series is based on our online learning course Hands on Project Management Theory and Practice.
In this post we will discuss project costs and income. We will classify the types of costs that are typical in a project environment. We will focus on cash flow management and cash flow considerations in project planning monitoring and control and their impact on scheduling and mode selection. We will see how the detailed project budged information in the should be used to support better project planning and trade off analysis. Finally we will discuss the integration of different cost components in an effort to minimize the total project cost and to maximize its profit.
Cost classification is important, as it is the basis for some cost, time, and resource trade-off analysis.
Four major types of cost are discussed next:
- The first class of costs is the direct cost of the resources required to perform project activities. We distinguish between two types of direct costs that are typical in projects:
- fixed direct costs, such as the cost of material needed to perform some activities and
- time dependent direct costs such as the cost of leasing a truck—a cost that is a function of the duration of the activity for which the truck is used.
- The second class of costs is the overhead paid per period during the project. This cost is not related to a resource required for the execution of a specific project activity. For example, consider the cost of running a canteen for the employees of a project performed in a remote location. As long as the project is going on and there is a need to provide meals, the canteen will cost money.
- The third class of costs is the fixed overhead paid for the entire project, which is not dependent on the duration of a specific activity or the duration of the entire project. For example, the one-time cost of hauling the canteen trailer to the project site.
- The fourth class of costs is the cost associated with residual risks, which are risks that are not mitigated by the project plan. This cost, known as management reserve, is a buffer used to absorb the cost of such risks should they occur.
Project managers usually strive to minimize the total cost of the project composed of the above four costs, plus other costs such as a penalty paid if the project is late.
A good project plan should include information on the cost associated with each activity, with each resource and with the entire project.
At the activity level, each mode in the activity should include the fixed cost associated with that mode, as well as the type of resources needed, and the amount per period of each resource type required to perform the activity in that mode of operation.
At the resource level the plan should include the following information for each resource type:
- The cost per period
- The idle cost per period
- The cost of assigning or releasing a resource unit
At the project level the project team needs to identify the penalty per period when the project is late, as well as the bonus per period if the project finishes early.
In addition to the cost information, the project team should consider the sources of cash in the project:
- At the activity level, income associated with the successful completion activities that are defined as payment milestones.
- In the project level, the project budget or initial cash available
Once a project plan is developed, the project team should consider the estimated cash flow during the project lifecycle. This can be examined on a per period basis – showing the total cost/income for that period, or on a cumulative basis showing the project budget for that time period.
The project manager should closely review this information and pay special attention to situations where the project might run out of budget.
If cash is tight, it may be necessary to schedule activities that generate cash, also known as payment milestones, to start early in order to avoid the risk of the project running out of cash and facing bankruptcy.
The risk of bankruptcy is present in some projects and it can be monitored by focusing on periods in which the cash position of the project turns negative.
In many projects, the goal is to minimize the total cost of the project. This cost is composed of the different components discussed earlier. This is done by trade off analysis, where the impact on the project costs of different modes are evaluated, as well as the impact of different scheduling options, such as early start, late start and some hybrids of these two.
The minimization of project cost is a very difficult problem, as the possible modes of execution for each task are discrete in nature. This means that there are a limited number of resource combinations that can be used to perform each activity. The cost is not a linear function of the modes selected.