Project cost management: everything you need to know
Last updated on: December 22, 2021
When your business takes on a new project, the success or failure of your work depend on the efficiency of your project management efforts – and the most important element of your project management efforts is handling project management costs.
Project management is a process that aims to help initiate, plan, execute, control, and finish a project by meeting specific requirements and goals, all before a specific deadline.
Cost management is the process that involves planning, controlling, and otherwise handling the budget of a business – cost management helps the business predict unavoidable expenses with as much accuracy as possible.
Project management costs involve all costs that cover the tasks related to project management, i.e. everything involving initiating, planning, executing, controlling, and finishing a specific project.
And, finally, project cost management is a process that involves the estimation and allocation of project budget and subsequent costs, as well as project cost control.
The benefits of proper project cost management stem from the main objectives of cost management, which include:
- project delivery, according to the value criteria established at the start of the project
- monitoring and documenting all transactions, payments, and project-related changes
- efforts to reduce business costs overall
The efficacy of your cost management efforts are directly influenced by several factors:
- project costs
- project budget
- project cost estimates
- project management software
What are project costs?
Overall, project costs are the total funds needed to monetarily cover and complete a business transaction or work project.
Project costs involve:
- Direct costs – Direct costs are those directly involved with, and necessary in order to complete said project.
- Indirect costs – Indirect costs for a project are costs which do not directly lead to project completion but are still vital for the company or individual working on said project. As such, they are a part of individual project costs.
Direct costs include the cost of:
- professionals working on the project – i.e. company employees or outsourced contractors and freelancers
- equipment – i.e. the tools and machines the employees, contractors, or freelancers use to finish the project
- materials – i.e. physical materials (that are not tools or machines) needed to finish the project
- project management tasks – i.e. all tasks meant to facilitate project completion before a given time, and according to specific requirements
- engineering tasks (if needed) – i.e. all research, design work, and installation of equipment made in order to finish the project
- transportation (if any) – i.e. custom rates, bringing the finished product to retailers, etc.
Indirect costs include the cost of:
- operating overhead expenses, i.e. office rent, utilities, insurance, general office equipment, and materials
- target annual salary, i.e. the clean profit the company or individual wants to make, in addition to the money needed to cover overhead and other expenses
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The purpose of project cost management is to handle direct and indirect costs and keep them within the project budget.
Do you need project management software?
One of the more important project costs in project management is a project management software – and one of the more important project management questions revolves around project management software cost.
Of course, the entire purpose of using a project management software is to speed up the project management process and make it more precise, accurate, and cost-effective, so, by using such software, you’re essentially saving money in the long run.
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How to calculate project management costs?
According to PMI’s research on project management, the larger the project, the smaller the project management costs when compared to the total installed cost of the project itself.
The research suggests that project management costs take between 7% and 11% of the project’s total installed cost, which in practice comes down to the following:
- Small projects have a total installed cost of $100,000 or less – project management costs for them fall between $7,000 and $11,000 dollars, or less.
- Medium projects are those that have a total installed cost between $100,000 and $1 million – project management for them costs fall between $7,000 (or $11,000) and $70,000 ( or $110,000).
- Large projects are those that have a total installed cost between $1 million and $10 – project management costs for them fall between $70,000 (or $110,000) and $700,000 (or $1,100,000).
If you add project control support to the total installed cost, your project management costs go up to 9-15%:
- Small Projects – project management costs fall between $9,000 and $15,000, or less.
- Medium Projects – project management costs fall between $9,000 (or $15,000) and $90,000 ( or $150,000).
- Large Projects – project management costs fall between $90,000 ( or $150,000) and $900,000 (or $1,500,000).
In essence, your project management costs will range between 7% and 15% of your initial project costs, but also depend on your choice of project management software.
What is the project budget?
The project budget is the total amount of money planned and allocated for the execution of a project within a specific time period (deadline). The project budget is based on the initial cost estimate of the project and usually depends on the efficacy of the project cost control – project cost control techniques are meant to make sure you cover all project expenses, including equipment, work hours, materials, and other direct costs while staying within the budget.
There are 4 main project budget management techniques:
- Incremental – You track time on your tasks within a project, and gain an understanding of the realistic time you’ll need to finish said tasks in the future.
- Activity-based – You calculate your ideal revenue, consider how many projects and what price you need to work on during the year to reach said revenue, and determine each individual project budget by calculating the costs for that project.
- Value proposition – you add items to your budget based on the value they bring to your project. If an item/task/professional is important for the project, he/she/it gets added to your planned budget.
- Zero-based – this budget management technique is similar to value proposition. The difference (and the ultimatum for the item to be included in the budget) is that the item must be justified and proven useful for each new business period, and not just one project. All items that are important for a new business time period are approved for the budget.
Budget cost management techniques
In order to make sure you stick to the budget (and cut the costs you can), you should:
- train employees to be efficient with their time – following the right time management tips and increasing the right time management skills will help your team be more time efficient, which will help you save costs.
- make use of the latest technology – apart from a project management tool, you’re advised to introduce other business tools to help automate your work in a cost-effective manner.
- outsource tasks – hiring a reputable professional from outside the company to handle a portion of your work (business-related or project-specific work) will help you cut costs.
- cut down your overhead expenses – insurance is a non-negotiable overhead expense, but there are some overhead expenses you could work (and live) without. Examples include a stylish office in the city center for your freelance work, or fashionable, but otherwise less than useful utilities. Cut what you can to make the most of your budget.
The importance of cost management in projects and the listed cost management techniques is almost self-explanatory – when you aim to manage your cost to adhere to the set project budget, you’re essentially letting the set budget guide your decisions. If you don’t aim to manage your project costs, they’ll likely spiral out of control, and your entire project will likely fall apart due to faulty management.
What is project cost estimation?
Project cost estimation is the process of predicting the cost, quantity, and the price of all the resources you need in order to finish the project. Considering that the estimation is made before project completion (meaning it cannot account for unexpected expenses and changes) it is often uncertain and serves only as a starting point to setting a project budget and handling cost management.
When estimating your project, make sure you:
- be precise – don’t over-estimate, but don’t under-estimate either. Make the estimation in relation to what you’re looking to accomplish, with what resources, and in what time period.
- be accurate – the most important element in your project are the consultants, workers, freelancers who work on it, and the most important element in your project estimation is the time you’ll spend on it. So, it’s important that you track time on all projects you work on – you’ll get an accurate number of hours for each project type, so it’ll be easier to estimate the time needed to finish projects in the future.
- understand the project requirements (and limitations) – project misunderstandings are the most common reason projects go over budget. You underestimate the realistic time, number of team members, and the monetary resources you need overall to finish.
Various professionals approach project estimation in various ways – there are several effective types of cost estimates in project management:
Types of cost estimates in project management
Expert judgment – estimation based on previous knowledge and experience of the estimator. Most suitable for seasoned professionals and experts who are versed enough to give their expert opinion on the spot.
Cost of quality – estimation based on the money spent to manage potential failures and prevent poor project quality. This type of cost estimation is somewhat speculative, but it helps you minimize losses and analyze where you can save money.
Vendor bid analysis – estimation mostly used at public project tenders. The client compares bids for the project and makes the choice. This type of cost estimation technique requires you to analyze your competition and guess their bids, before making your own.
Using a project estimation software – estimation that relies on numbers provided by a specialized project estimation software. You can use apps or compare spreadsheets in order to predict your final project cost.
Reserve analysis – estimation used to accommodate potential project risks, and the reserve resources that need to be secured in order to accommodate said risks.
Three-point estimates – average estimation of the most likely estimation (A), an optimistic estimation (B), and a pessimistic estimation (C). For example A= $60,000, B = $55,000, C = $80,000. According to formula, (B + 4A+C)/6, the three-point estimate for the example estimates, is $62,000.
Analogous estimating – estimation based on data compiled from previous similar projects. The less accurate technique, and usually used at the early stages of the new project, and in conjunction with another estimation technique.
Parametric estimating – estimation based on statistical modeling. A similar process to analogous estimating, and the difference is that historical data used is based on the relationship between various project variables.
Bottom-up estimating – estimation based on previously defined work packages. You compare the current project with the work packages you’ve already established, and then make your estimate for the current project.
How best to estimate a project
Here’s a project cost estimation example with a project management budget template, one that takes into account the professionals working on the project, their hourly rates, materials they use, as well as the time they need to finish specific tasks:
- First, you list all professionals you’ll need to include in the project
- you list their respective hourly rates
- you list all the physical resources you’ll need, including all equipment and materials
- you make an estimation on the time you’ll need to finish the project
- you calculate the final price based on these numbers
List of professionals working on a project with hourly rates
According to this template and calculation, you’ve estimated that your team members will spend 300 hours in total on the project-related tasks they were assigned to – more specifically:
- Lisa Johnson (hourly rate: $45) expects to spend 30h on Task 1
- John Bautista (hourly rate: $45) expects to spend 70h on Task 2
- Katie Stark (hourly rate: $50) expects to spend 50h on task 3
- Austin White (hourly rate: $40) expects to spend 120h on Task 4
- Thomas Clark (hourly rate: $50) expects to spend 30h on Task 5
For the total 300 hours estimated for this project, here’s the formula:
= $45 x 30 + $45 x 70 + $50 x 50 + $40 x 120 + $50 x 30 = $13,300
Your price estimation for 300 hours of work for this project is $13,300 – add the clean costs of your materials, equipment, and other similar expenses, and you get your final project estimation (and budget estimation).
Of course, you’ll likely go over or under the estimated time (and budget), so it’s important to always keep track of your progress. This way, you’ll be able to reshuffle your schedule to leave more time for certain tasks (or move extra time from one task to another) and track when the planned budget reaches its limit, and the deadline closes in.
💡Clockify pro tip
Want to learn more about project estimation? Check out our video tutorial on project estimates.
How it all ties together, to ensure successful project cost management?
In the end, your estimated time and resources, as well as your other estimated expenses, determine your budget.
Your budget and project size determine the project management costs and the cost of your project management software. All your project-related decisions should be governed by your estimated project budget.
If your overall project costs don’t exceed the budget, you can conclude that your project cost management was successful.