What is cost management?
Cost management is the process of planning and controlling the budget of a business. Having a good cost management system in place makes it easier for an organization to estimate and allocate its budget.
Cost management is a form of management accounting that helps a business reduce the chance of going over budget with more accurate forecasts of impending expenditures. Many businesses use cost management tactics for specific projects and for the overall business.
When applied to a project, expected costs are calculated while the project is being planned and are approved beforehand. All project expenses are recorded and monitored to ensure they align to the cost management plan. After the project is finished, the actual total costs are compared to the predicted costs. This analysis enhances future cost management predictions and cost budgeting.
4 steps of cost management
Cost management is an integral part of project planning and management. Cost management strategies are developed alongside the project plan.
The following are the four main steps to cost management.
The setup phase determines what's included in the cost management plan. It identifies who the stakeholders in the plan are, the tools used to manage costs and the data structure needed to track costs.
2. Resource planning
This planning phase identifies the resources needed to complete a project. These could be physical materials, information assets, staff and cloud computing resources. Resource planning determines resource allocation, including how much of a resource is needed, for how long and how it will be allocated.
3. Budgeting and cost estimation
In this stage, project teams develop a project budget. Budgeted cost estimates get more specific as the project scope is refined. A picture of the full project costs emerges as resources are allocated.
Project managers compare the current project to earlier ones to gain insight. They can use top-down and bottom-up estimation methods. In the top-down approach, upper management in an organization determines the project duration, the tasks and project activities involved and the estimated costs for each of them. In a bottom-up approach, each team estimates the duration and allocated budget of their individual tasks. Management uses that information to determine the project's duration and estimated budget.
4. Cost control
This phase involves monitoring and controlling costs as the project progresses, using data from different project teams. Managers track how costs differ from the estimated budget and take action to accommodate cost overruns, reduce deviations from the budget and cap the budget when necessary.
Effective cost management processes require accurate cost reporting. This involves access to real-time cost data and insight using data visualization. Variances from budgeted costs must be measured, and corrective measures taken.
Benefits of cost management
The benefits of cost management include the following:
- Reduces overspending. Cost controls help project managers keep their budget on track and not let costs get out of control.
- Encourages planning. Cost management helps identify what is and isn't working. It provides insight into resources and processes that helps managers make faster and better decisions about the current project and future ones.
- Facilitates financial health. Continuous monitoring, cost control and cost reporting contribute to a company's long-term financial health. These efforts provide the data necessary for good decision-making. Implementing a cost management structure for projects helps a business keep its overall budget under control.
- Mitigates risk. Cost management typically involves setting a risk allowance for unforeseen costs, a useful step to prevent overspending.
- Supports standards. Consistent cost control, analysis and reporting help organizations adopt standards for assessing future cost data and productivity levels.
- Improves visibility. Many cost management tools for cloud services give real-time visibility into cost management metrics, like savings. They also provide a list of the users' assets, and some use machine learning to provide suggestions on areas where users can change behaviors to save money.
Challenges of cost management
Common challenges of cost management include the following:
- Change management. Project changes are inevitable. Teams must be able to adapt to changing circumstances and manage the budget accordingly.
- Effective communication. Reporting can be perceived in different ways, depending on who sees it. A project manager may view results differently than project stakeholders.
- Tool sprawl. Lack of a dedicated project management or cost management tool can make managing cost over multiple tools difficult and complex. This can cause data integrity issues and hamper reporting and visualization capabilities.
- Project scope. Poorly defined project scope can lead to cost overruns from inaccurate estimates.
- Underestimation. If a project manager underestimates costs that go into a budget, it can lead to a lack of resources and project delays.
- Vendor lock-in. Some cloud vendors offer proprietary tools to help IT teams calculate the cost of using their service. The downside of this is that the tool only works with their service, and this locks the client into using the service.
Cost management tools
While cost management software is useful, it's not imperative for executing a cost management plan. These tools commonly include the following functions:
- time tracking
Several business intelligence programs offer cost management software to help organizations monitor costs and increase profitability. Some of these include Google's Looker, Microsoft Power BI and Oracle Analytics Cloud.
Cloud vendors also offer proprietary cost management tools to help users track and optimize costs. Two such tools are the following:
- Azure cost management tools. The Azure cloud computing service includes a pricing calculator, alerts and dashboards that let Azure users optimize their spending and clearly monitor use. Cloud users are charged per use, sometimes per second, so using these tools is important for keeping costs down. These tools integrate with Azure budgets for planning and cost optimization. Azure cost alerts aid monitoring and tracking, and Azure cost analysis can suggest potential adjustments based on monthly cost breakdowns. The tool also integrates with other third-party tools, such as VMware Aria Cost and Apptio Cloudability.
- Amazon Web Services (AWS) Cost Management. This tool set provides dashboards and billing reports that help users track AWS cloud use and set budget goals. AWS Cost Management tools included are AWS Budgets, AWS Cost Explorer, AWS Cost and Usage Report, and AWS Cost Anomaly Detection, which uses machine learning to monitor cloud use and detect unusual spending.
Vendors may refer to cost management software applications as cost accounting, spend management or cost transparency products. Cloud cost management tools may also be referred to as FinOps.
Cost management is particularly important in cloud management, where bills can skyrocket because of unaccounted-for service fees. Learn eight ways to cut cloud costs and avoid unexpected bills.