Project Cost Management: What It Is and How To Use It
Updated June 24, 2022
Companies use project cost management to oversee the budget on a project. This tool helps ensure they spend money responsibly and have the financial resources to execute a project plan. Effective project cost management is an essential skill that allows a project manager or team leader to determine the financial viability of their projects. In this article, we discuss what project cost management is, how to calculate it, how it differs from project cost estimation and the benefits of each.
Related: What Is a Budget?
What is project cost management?
Project cost management is a process for assessing costs before and during a project. It allows a company to make informed financial decisions by identifying whether a proposed plan's benefits justify its projected cost. This tool also enables managers to make decisions proactively, as an up-to-date budget forecast can help them make adjustments to their project plan.
What are project costs?
There are many costs associated with project completion. There are direct costs, which are costs related to producing your good or service, and indirect costs, which are incidental expenses to keep your business operating. The industry and type of project also factor into making these projections. Common items to note in your calculations include:
This is an indirect cost that refers to the spaces you and your team use to work on the project. Take into consideration any office and manufacturing space that the project team needs. Property costs are generally a fixed price, meaning they're unlikely to change, though a project requiring expansion may alter the budget.
Projects typically involve raw and manufacturing materials, both of which are direct costs. Raw materials, such as lumber, steel or fabric, commonly provide the basis in production projects. Manufacturing materials, like machinery lubricants or adhesives, are also part of production. If your project requires raw or manufacturing materials, include them in your cost estimations. As a direct cost, they may scale with project size, with increased purchase sizes reducing unit costs.
Staffing costs are a direct cost that often represents a significant portion of a project's budget. The more employee hours committed to a project, the more expensive that project becomes. When calculating staffing costs, it's important to consider both hourly wages and the prorated salaries for staff attached to ensure the project stays within budgetary restrictions.
Anything your staff needs to complete their tasks is an essential resource and affects the project's cost. Supplies can be direct or indirect costs. For example, the computers that software developers use to create software are direct costs. Office supplies for clerical work, such as pens or printing paper, are a common indirect resource cost since they don't directly contribute to production.
You may accumulate these costs if a project requires one or more staff members to travel or work outside of the office. Travel expenses include the cost of travel, such as airfare, and any accommodations staff require. Any money staff spend during travel, such as daily budgets or expensed meals, can also contribute to project costs. Most times, travel expenses are an indirect cost. However, for some service-based projects where travel is a necessity to provide your service, they may be a direct cost.
Many projects include marketing plans for pitching the developing product or service to the public. Marketing helps a product or service succeed by increasing interest and awareness, which can generate higher sales. Investing in distribution channels or advertising agencies, both of which are indirect costs, may help ensure the project's financial success. You can justify your marketing budget by projecting the campaign's ability to reach a wider audience and ultimately increase sales.
Some projects require your company to work with outside consultants and contractors. These experts offer advice or provide services you cannot complete internally. Accounting for contracting costs, which can be direct or indirect depending on their relation to the production process, helps ensure you make all required payments. For example, hiring a contractor for your marketing efforts would be an indirect cost, while hiring a computer programming contractor to help create a new application would be a direct cost. This allows you to maintain a positive relationship with your contractors.
Regulations or company rules may require insurance policies on a project to reduce liability. You can also add optional plans for extra protection against potential losses. Any premiums you pay into insurance factor into the project cost analysis as indirect costs, as do any deductibles. It might be helpful to budget for the maximum deductible you could pay to account for any unexpected situations.
How to calculate project costs
Here's how to calculate costs for a project:
1. Assess the project
The more comprehensive your understanding of the project is, the more effectively you can plan. Consider all the important factors for completion, such as the project goals and timeline. Also determine the resources you have available to carry out the project, such as staffing, supplies and property. Any areas of insufficient resources are where you may need to increase your investment to help ensure the project's success.
2. Gather research
Planning requires informed decisions. Gathering research can help you improve the accuracy of your project cost estimates. While the specific details depend on the project you're assessing, there are common elements that most projects involve. They often include the staff and materials required, operational costs and expected generated income.
3. Estimate your costs
Creating a project cost estimate at the start of a project prepares you for ongoing management and monitoring. Look at the expectations you gathered through your research and estimate a cost for each. If the estimated cost exceeds your available resources and funding, you can determine how much additional funding you require.
4. Allocate resources
If results from the project cost estimate are positive, meaning you have the resources and funds needed, the project can proceed. It's then important to create an outline of the project's elements. Begin by dividing your project into units, such as team groups or key tasks. Using the unit divisions and your available budget, assign financing and resources as needed to provide each segment with what it needs to complete the project.
5. Add the details
A detailed project management plan can provide valuable support for staff. After the initial allocation of resources, add additional details. This can include timelines for project elements and detailed specifications for what you expect. Besides providing a guide for staff to ensure their work aligns with the project's larger goals, being detailed can help you determine if your allocations are sufficient.
6. Monitor performance
Project cost management is an ongoing process. As your team executes the plan, it's important to remain in regular communication. Progress reports allow you to monitor how the project is proceeding and make adjustments as needed. Monitoring can also identify misallocation of funding, allowing you to transfer from a sector with excess to one in need. You can also seek additional funding if it's needed.
Differences between project cost management and project cost estimation
Although both project cost management and project cost estimation are important and share similarities, the two terms aren't synonymous. Their primary differences are:
Scope: The size of the two processes differs. A project cost estimation represents just one part of a larger project cost management effort.
Information: Because project cost management lasts for the duration of the project, it includes more information than a cost estimation. While budget estimations rely on predictions, project cost management includes information you gather while executing the project.
Adaptability: The additional information you gather during cost management makes it an adaptable process. While you create an estimate at the start of a project, project cost management plans can change in response to new information.
Benefits of estimating project costs
Some of the best reasons to include an estimation step in your project cost management are:
Creating a starting point: While you may adapt a plan during a project's execution, the cost estimate is a valuable first step. An accurate estimate allows you to more effectively plan and execute a project, which can help you avoid budget issues.
Planning responsibly: Project cost estimation allows you to spend money responsibly by providing a guideline that compares the expected costs to the expected profits. This helps you invest in projects that show the highest potential for positive results in alignment with company goals.
Identifying concerns: When a project cost estimate reveals excessive projections, you can make adjustments to ensure you're spending your budget more productively. You can also create an alternative, more cost-effective plan for the areas where excessive spending is occurring.
Benefits of managing project costs
Project cost management is an important part of successfully completing a project. Some of the best reasons to use project cost management when executing a plan include:
Responding to unforeseen circumstances: While an effective project plan reduces uncertainty, it's still possible to encounter challenges, such as supply chain difficulties or production levels below expectations. With ongoing project cost management, you can keep the project proceeding toward its planned targets.
Correcting miscalculations: When creating your cost estimates, there's the potential for a miscalculation that results in deficient funding, resources or staffing. With ongoing project cost management, you can correct any mistakes and assess the effects of proposed changes on project costs.
Reassessing priorities: As a project develops, you may want to change the goals of the project. For example, when running a marketing plan, you may adjust the budget that you allocate to different platforms if one proves to be more successful. Project cost management enables you to account for your proposed changes, then assess the effects of the new proposal to create a cost-effective plan.
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