Project cost management is all of the activities that ensure a project stays on budget. In this lesson, we’ll look at the steps in project cost management and its importance in business.
What Is Project Cost Management?
Dear old mom is getting up in years and can’t live alone anymore. You’ve decided to move her in with you, but you simply don’t have the spare room. After looking at options, you decide building an addition to your home for mom is your best choice. The first question, of course, is how much is this project going to cost?
Cost is usually one of the first questions that come up in any project. The question is usually answered through project cost management. Project cost management is the activities used to estimate, allocate, and control costs of a project. It produces an approved budget, monitors costs throughout the project, and provides a basis for decisions to control unexpected or extra costs. Let’s explore each of these components in more detail.
Let’s start with estimating costs. Like most projects, your home addition will go through a few different types of cost estimates. Generally, cost estimates start out as a rough figure and get more refined as the project work and materials are defined.
Estimates have a variance, which is how much the costs could differ based on final project requirements. In general, the more accurate the estimate, the narrower the variance range. Because of the wide variance, approving budgets or issuing purchase orders should never be done at this stage.
In starting your home addition project, you first call a general contractor for an estimate. You and the contractor walk around the house and talk design ideas. You tell the contractor that you want a large bedroom with a separate sitting room, a bathroom, and a private entrance.
Given these objectives and his quick walk around the home, the contractor tells you it can probably be done for around $80,000. He warns you, though, that custom materials, unseen infrastructure problems, or other factors could change the price.
After some additional inspection and a floor plan approval, you receive a contract for $72,500 that outlines the work to be done, what work and materials won’t be included, and an estimated timeframe for completion. Happy with that, you sign the contract, secure a loan, and schedule a project start date.
Another important part of cost management is monitoring costs. Once a project is underway, monitoring costs is important to ensure the project is completed on budget. When monitoring costs, the project manager compares the costs already incurred with the known remaining costs and forecasts whether the project budget is adequate.
During the construction of your new home addition, the contractor closely monitors the schedule and materials purchased. Early in the project, a week of rain brings a schedule delay, and though his workers can’t continue with the project until the weather clears, he is still obligated to pay them, increasing his costs.
In addition to monitoring costs, a project manager must control costs that risk exceeding the budget. Controlling costs requires measuring costs and taking positive action to ensure the budget is maintained. In controlling costs, the project team may have to decide to reduce costs in other areas or request more funds to compensate for unexpected costs. If additional funds are needed because project requirements have changed, a change request is done to authorize project changes.
In your project, the quartz countertops you wanted are not available. Talking it over with the contractor, you realize there isn’t another similar color in quartz that you like. The other colors you like are in granite, which is more expensive. Deciding the color is more important than the costs, you tell the contractor to go with the granite and you’ll pay the difference. This is a change request to your project, as the extra cost for granite was a change in the project requirements.
Importance of Cost Management
So why do we take these steps for cost management? Cost management is important to everybody involved in a project. It sets the baseline for what a project is expected to cost and takes actions to ensure the project is on budget. Without cost management, companies would lose money or customers would receive invoices for much more than expected.
Cost management in your home addition project was important to both you as a customer and the contractor. The contractor needed to estimate costs to ensure his profit margin was high enough to make the project worthwhile. Without a fairly accurate cost estimate, the contractor risks not making a profit or even losing money. Additionally, the customer wants an accurate cost estimate to ensure there’s enough funds for the entire project. Without an accurate cost estimate, you could easily fall short of money to finish the project.
Project cost management is the the activities used to estimate, allocate, and control costs of a project. There are three steps to project cost management:
- Estimate costs
- Monitor costs
- Control costs
Project cost management is important to everyone involved because it sets the baseline for what a project is expected to cost and takes actions to ensure the project is on budget.