What is cost management? Definition, steps and benefits
Cost management is the process of planning and controlling a business budget. A good cost management system helps an organization estimate and allocate its budget.
A form of management accounting, cost management gives a business accurate forecasts of impending expenditures, reducing the chance of exceeding budget. Many businesses use cost management tactics for specific projects and the overall business.
When applied to a project, expected costs are calculated during project planning and approved. All expenses are recorded and monitored for alignment with the plan. Upon project completion, actual costs are compared to predicted costs. This analysis enhances future cost management predictions and budgeting.
While cost management can refer to project cost management in any industry, it also often encompasses estimating and managing cloud services costs to reduce cloud waste. In modern business, cost management transcends individual projects, covering long-term financial planning and advancing alignment with broader organizational goals.
4 steps of cost management
Cost management strategies are developed alongside the project plan as an integral part of project planning and management. Here are the four main steps:
1. Setup
The setup phase determines what's included in the plan. It identifies who the stakeholders are, the tools used to manage costs and the data structure needed to track them. Key performance indicators (KPIs) should be defined at this stage to measure cost management effectiveness throughout the project.
2. Resource planning
This planning phase identifies the resources needed to complete the 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. Advanced resource planning tools integrated with cost management software can streamline this process and provide real-time updates on resource availability and cost impact.
3. Budgeting and cost estimation
In this stage, project teams develop a project budget. Budgeted cost estimates become more specific as the project scope is refined. As resources are allocated, a picture of the full project costs emerges.
To gain insight, project managers compare the current project to earlier ones. They can use top-down and bottom-up estimation methods. In the top-down approach, upper management determines the project duration, tasks, activities and estimated costs for each. In a bottom-up approach, each team estimates the duration and allocated budget for their individual tasks. Management uses that information to determine the project's duration and budget. Advancements in predictive analytics and machine learning can facilitate more accurate budgets by analyzing historical data and identifying cost patterns.
4. Cost control
This phase involves monitoring and controlling costs using data from different project teams. Managers track how costs differ from the estimated budget and take action to accommodate or remediate cost overruns, reduce budget variances and cap the budget when necessary. Effective cost management processes require accurate cost reporting. This involves access to real-time data and insight, ideally leveraging data visualization. Variances from budgeted costs must be measured and corrective measures taken. Integrating automated cost control tools can help flag anomalies in real time, enabling proactive measures to keep the project within budget.
The role of technology in cost management
Technology plays a pivotal role in modern cost management by streamlining processes, enhancing accuracy, and providing actionable insights. Here are some enabling technologies:
- Artificial Intelligence (AI) and machine learning (ML). AI-driven tools can forecast costs based on historical data and provide recommendations to optimize resource allocation. ML algorithms help identify inefficiencies and cost-saving opportunities in real time.
- Cloud-based solutions. Cloud platforms like AWS and Azure offer integrated cost management tools that provide detailed insights into usage and spending. These tools can help organizations avoid unnecessary expenses and optimize resource utilization.
- Data visualization tools. Tableau, Microsoft Power BI and similar software help project managers visualize cost trends and variances, simplifying decision-making.
- Integration with project management tools. Cost management software now seamlessly integrates with platforms like Jira and Asana, allowing teams to monitor costs and have cohesive visibility into task progress and deadlines.
By leveraging these technologies, businesses can better support cost management, reduce human error, and achieve better financial outcomes.
Benefits of cost management
Cost management benefits include:
- Lowers the risk of overspending. Cost controls help project managers keep their budgets on track and costs in control.
- Encourages planning. Cost management helps identify what is or isn't working. It provides insight into resources and processes that helps managers make faster, better decisions.
- Facilitates financial health. Continuous monitoring, cost control and cost reporting contribute to a company's long-term financial health. Implementing a cost management structure for projects provides data that eases evaluation and decision-making, helping the business stick to its budget.
- 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 generate suggestions on areas where users can change behaviors to save money.
Challenges of cost management
Common challenges of cost management include:
- Change management. Project changes are inevitable. Teams must be able to adapt to changing circumstances and manage the budget accordingly through change management.
- Effective communication. Diverse stakeholders can interpret reports in different ways. A project manager might view results differently than some of these stakeholders.
- Tool sprawl. Managing costs using multiple tools might be necessary and that is difficult. If data integrity issues emerge, reporting and visualization capabilities can become compromised.
- Project scope and budget accuracy. Poorly defined project scopes can lead to cost overruns due to inaccurate estimates. If a project manager underestimates costs, the result is typically 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. If the tool only works with their service, this locks the client into using the service, a potentially disadvantageous dependency.
Addressing these challenges requires robust planning, regular training, and the use of integrated tools that centralize cost management functions.
Cost management tools
While cost management software is useful, it's not imperative for executing a cost management plan. Core functions these tools address include the following:
- Budgeting.
- Time tracking.
- Reporting.
- Analytics.
Several business intelligence programs offer cost management software to help organizations monitor costs and increase profitability. Examples include the following:
- Google Looker offers strong analytics for monitoring costs and generating actionable insights.
- Microsoft Power BI visualizes cost trends and integrates with project management tools.
- Azure Cost Management is part of a cloud computing service that includes a pricing calculator, alerts and dashboards that let Azure users optimize their spending and monitor use clearly. The tool also integrates with third-party tools, such as VMware Aria Cost and Apptio Cloudability.
- AWS Cost Management is a tool set that provides dashboards and billing reports that help users track AWS cloud use and set budget goals.
When selecting a tool, organizations should consider their specific needs, such as integration capabilities, scalability and real-time reporting features.
Vendors might refer to cost management software applications as cost accounting, spend management or cost transparency products. Cloud cost management tools are also sometimes referred to as FinOps.
Cost management is particularly important in cloud management, where bills can skyrocket because of unaccounted-for service fees. Learn ways to cut cloud costs and avoid unexpected bills, as well as cloud cost management tools you should know about.