The Project Cost Baseline

What do you get when you cross a project budget with a schedule? It's something that gives you an idea of the total budgeted costs of project activities per time period—otherwise known as the project's cost baseline.

A cost baseline, which is an output of the cost budgeting process, is a time-phased budget that is used to measure and monitor cost performance on a project. It is developed by summing the estimated costs by period. The cost baseline takes the form of a cumulative cost curve, or an S-curve.

Why does a project's cost baseline look like a curve? It has to do with the typical spending pattern, or "burn rate," of project funds. A cost baseline usually takes an "S" shape, when plotted on a graph, for the following reasons.

• Costs in the planning or design phase are usually low.
• Once production begins, costs increase quickly relative to the passing of time.
• Costs decrease toward the end of the project during wrap-up and delivery.

But why stop at just one type of curve? You also can plot and display the values of expected cash receipts and actual project costs. Plot these curves next to the cost baseline for comparative purposes.
Plot expected receipts next to the cost baseline to display a forecast of the project's cash flow. You may have several periods of time during the project where you have significant expenses but have not received payment for that work, especially if you are paid only for deliverables.

If this creates a need for short-term financing to cover bills, you will want to know the likely time frame in which this will occur. Then you will be able to predict the terms for any necessary loans.

Plotting budgeted costs and actual costs side by side enables you to quickly see whether cost performance is good, evaluate the size of cost variances, and easily report cost performance to stakeholders.

Before you can plot planned costs over time, you have to establish the coordinates—that is, what costs should be per time period. If you are using a computerized scheduling tool, simply input the data and generate a cost report by time period. The software will probably create the cost curve for you.

In the absence of computerized tools, you can use a bar-chart of your schedule to establish cumulative costs over time. Follow these steps.

1. Draw a chart of activity durations.
2. Assign a budget to each activity.
3. Measure the accumulated costs per time period.
4. Plot cost-per-time data on a graph with duration on the x axis and cost on the y axis.
5. Connect the dots to see the curve.

The cost baseline for your project is the plan against which you will measure, monitor, and control costs. Use the cumulative cost curve as a graphical representation of the baseline when comparing planned costs to actual costs.

Tools and Techniques for Cost Budgeting

Budgeting for your project is not simply a matter of taking the cost estimates for various activities and saying, "This is the budget for this task." Estimates provide merely the base or frame upon which you will build a finalized project budget.

You can use a number of tools and techniques to take your bare-bones estimates and create the budget that will guide all your cost-control efforts. The tools and techniques of budgeting are based on the tools and techniques for cost estimating. Several tools and techniques you can use for cost budgeting are described below.

1. Create contingency funds and a management reserve.
The main difference between an estimate and a budget is the additional cushion a budget has built into it. Budgeting takes your estimates a step further by adding contingencies based on previous experience and risks related to particular activities.

Contingency funds are specific provisions for unforeseen increases in costs at the project activity level. In other words, contingencies are added to work packages and activities at the lower level of the work breakdown structure.

While cost budgeting takes place at the project activity level, it also takes place at the project management level. General project budgeting takes into account overall risk and establishes a management reserve for the project. This account contains a percentage of the project's funds that are set aside for potential problems.

The management reserve is held over and above the budgets for individual work packages. The size of a management reserve depends on the type of project, industry standards, and the guidelines for establishing reserves found in the project's risk management plan.

Although a number of factors must be weighed when developing a management reserve, you can follow this general rule of thumb: find the optimal add-on percentage that will minimize risk and yet not be overly cautious. You want to ensure that actual costs don't exceed your estimates, but you also want to remain competitive and avoid creating a "fat" budget.

2. Identify the ranges of accuracy for each of the cost-estimating techniques.
You developed the cost estimates for your project using one or more of the cost-estimating tools and techniques that are listed below. How accurate do you think your estimates are? It depends on the method you used, since the degree of accuracy varies between estimating techniques. Cost budgeting uses the deemed accuracy of your estimates to come up with appropriate contingencies.

• Parametric modeling. Parametric models provide a rough order of magnitude. These estimates could have a range as great as plus or minus 35 percent. To increase accuracy for budgeting purposes, you may want to run project activities through a more detailed methodology, such as bottom-up estimating.
• Analogous estimating. The accuracy of estimates improves somewhat if you have based cost estimates on a similar project. An analogous, or top-down, estimate may be accurate to plus or minus 15 percent to 20 percent. The range will decrease relative to an increase in similarity between the two projects.
• Bottom-up estimating. Bottom-up estimates are the most reliable (plus or minus five percent to 10 percent) since you have examined each activity in the work breakdown structure. When preparing a budget based on detailed and finalized estimates, you can reduce contingencies and overrun allowances due to the reduction in risk.
• Computerized tools. Project management software greatly simplifies cost budgeting. You can use statistical analysis and simulation to generate a budget based on the probability that actual costs will be over or under the base estimates, giving you an accuracy range as low as plus or minus five percent.

3. Use cost-budgeting techniques based on the cost-estimating techniques you used.
As you work with your base estimates to develop a project budget, remember how your estimates were developed and their level of accuracy, since you will use cost-budgeting techniques based on the cost-estimating techniques you used.

For example, you may have used a parametric model or analogous estimating to develop your cost estimates. If you based estimates on another accurate budget or used an accepted model, why not base the new budget on these, making allowances for any differences? You can use the accuracy range of your estimates to find the "most likely" total cost of your project. Set your budget somewhere between the low and high cost.

If accuracy is not paramount and you are looking for a general contingency, you can use the formula: Most Likely = Estimate + (x percent ÷ 2). Take the maximum cost based on the range of results, divide it in half, and use it as the "most likely" amount. This dollar figure, or percentage amount, is what you add over and above the estimated amount.

Have you used the bottom-up technique to develop the cost estimates for your project? If so, you can use statistical sums to develop the cost budget. The most common approach is to use the Expected Value calculation for each estimate. This formula is: Expected Value = (a + 4m + b) ÷ 6.

In this formula, Expected Value is the mean or average of the base, most likely, and maximum values, a = low or most optimistic forecast, m = the most likely estimate, and b = high or most pessimistic forecast for cost outcomes. Sum up the values for each estimate and base your budget on the total.

You can follow a number of guidelines for setting base budgets when you have used an estimating technique other than bottom-up estimating. Use computerized tools to assess risk and determine appropriate contingencies. You can also use the contingencies from other similar projects as a benchmark. The most likely cost will fall somewhere between the maximum and the base estimate.

In summary, cost budgets are based on the general accuracy of, and statistical information about, cost estimates. Budgeting depends on the assessed risk related to individual activities and the project as a whole. Appropriate contingencies are based on known risks. The higher the impact and probability of the risk, the more contingency you will want to allocate in your budget.

Four Inputs to Project Cost Budgeting

You will want to enter the cost budgeting phase of a project well-equipped. To do this, you will need to know what the inputs to cost budgeting are, and you should understand their importance to the budgeting process.

During cost budgeting, a number of project elements come together to form the project's cost baseline. The following four inputs are used in the cost budgeting process.

1. The project's work breakdown structure (WBS)
The project's work breakdown structure is important in cost budgeting because it organizes all project activities into work packages. Cost budgeting involves assigning a budget, or cost account, to each work package.

Can you imagine trying to assign budgets to project elements if the work was not organized in some way? Without reference to the WBS, vital costs may be overlooked. Any omissions would cause variances later on between planned and actual costs, and cost performance may be reported as "poor."

Part of creating the work breakdown structure is assigning accounting codes to project tasks and activities based on the organization's chart of accounts. Budgeting is simplified when the cost accounts are integrated in this way.

2. The cost estimates for the work
You have made predictions about the costs of the resources required to complete your project's activities. These cost estimates are another important input to cost budgeting.

The budget for each work package is based on the estimates you have prepared. For budgeting purposes, you should be using budget or control estimates with a range of 15 percent or better. The budgeting process may increase an estimate's range by adding an appropriate allowance or contingency to cover the risk of overruns.

3. The project schedule
The third input to cost budgeting is the project schedule. In fact, it is the application of the schedule to the project budget that produces your main tool for cost control: the project's cost baseline.

Once budgets have been assigned to work packages, use the schedule to distribute the predicted costs over time. The project schedule includes the expected start and finish dates for each activity to which costs will be allocated. This information is important to the cost budgeting process because allocated funds must be assigned to the time period in which the costs will be incurred.

As you develop the control budget for your project, you'll find that a bar-chart diagram can be useful. Use it to measure the total costs that fall within each week for planning or comparative purposes. You can easily measure the cumulative costs as the project progresses.

Time-phasing the budget in this way provides the project's cost baseline. Information about cumulative costs over time is also used to determine the project's "burn rate"—that is, the rate at which funds are expended.

4. The risk management plan
Finally, the risk management plan is an important input to cost budgeting. It outlines strategies for dealing with potential risks that could cause project cost overruns. It also can include cost contingencies that are based on the reliability of your cost estimates. You will build contingencies into the budget to compensate for potential cost overruns.

An accurate and appropriate budget is one of a project manager's greatest assets when it comes to cost management. Understanding the inputs to cost budgeting will help you to create such a budget.