Types of Cost in Project Management

Are you tasked with managing cost estimation for projects at Simpliaxis? Cost estimation plays a crucial role in ensuring project profitability and success. As a responsible Project Manager at Simpliaxis, you might wonder about the best approach to cost estimation for your projects. To initiate the process, it's essential to identify the types of expenses your project will incur. However, understanding the nuances of project costs can be complex. Therefore, gaining insight into the various types of costs in Project Management is paramount.

 Let's examine the five fundamental types of project costs to simplify your understanding and streamline your cost estimation process.

Estimate the Type of Expenses:

When you are estimating the cost of your project,  you can instigate by identifying the kinds of expenses that your project will bring in. The thing to remember here is that you can do it in multiple ways. To keep confusion at bay, it is better to gain a detailed understanding of the 5 different types of cost in Project Management:

• Direct Cost
• Indirect Cost
• Fixed Cost
• Variable Cost
• Sunk Cost

Before understanding what these five costs involved, it is better to understand what project cost is all about:

What is the Project Cost?

Regardless of the types of project costs, they are the funds needed for the performance of planned business endeavors. These costs are often part of project cost management budgeting. Costs are nothing but entities that you estimate when you develop a project budget. These are costs that you actually spend on the project, and they are the costs that you track and control until the project comes to a concluding point.

1. Direct Cost:

Direct costs are costs that are straightly liable and perceptible for the production of project results. For instance, in a product manufacturing unit, the raw materials used for the creation of the product can be regarded as the direct cost. Further, costs spent on human resources, logistics and project development also come under the category of direct cost. Also, in some organizations, the equipment rentals and supplies costs are denoted as direct costs.

2. Indirect Cost:

Indirect costs are among the different types of costs in Project Management. These costs cannot be attributed to a particular project. Nevertheless, it is used in two or more projects. For instance, the money spent on Project Management software that many projects in an organization use is an indirect cost to all projects that use this software.

Indirect costs are otherwise called oversight costs. The money spent by an organization on Project Managers is an indirect cost to the project. The reason is that in many organizations, Project Managers supervise more than a single project at the same time. But, the money paid for people working on a particular project like Designers and Developers, is a direct cost for any project.

3. Fixed Cost:

When discussing the types of costs in Project Management, fixed costs are those that stay constant throughout the project lifecycle. They will not change until the project’s completion. 

For instance, if an organization is engaged in road construction, the costs associated with bulldozers and excavators are fixed costs. When it comes to projects that involve software development, the development of computers and physical development space are examples of fixed costs for the project.

4. Variable Cost:

As opposed to fixed costs, variable costs change throughout the project lifecycle. The cost will change as the company increases or decreases its production outputs. 

Consider that a hardware development company decides to produce 100 USB flash drives for $15. The company has decided on this cost based on the total of all direct expenses. In this case, the variable cost for the project will be around $1500. In another instance, the company decides to produce 500 USB Drives. In this case, the variable project cost will increase up to $7500.

5. Sunk Cost:

Sunk costs are costs that a company has spent previously. Nevertheless, the company has failed to add any value to the business with this spending. This is why this type of project cost is denoted as a sunk cost. 

Let us understand this cost with an example from our day-to-day life. You bought a particular vegetable and other veggies and stored them in the refrigerator. You forget about it and you find it only when you intend to clean the refrigerator after a few days. By this time, the vegetable might have gone to waste, and you cannot use it anymore. Your spending on this vegetable is sunk cost. The reason is that the spending has not solved any purpose. You cannot recover the cost anymore and it is lost forever. So, it is a sunk cost for you.

Key Differences Between Direct Cost Vs. Indirect Cost:

In short, as a Project Manager, you will be able to identify direct costs easily. But, it is hard to evaluate indirect costs when framing your budget.

Key Differences Between Fixed Costs Vs. Variable Costs:

When talking about the types of cost in Project Management, understanding the differences mentioned above will help you categorize the costs associated with your project with ease. This knowledge will help when you are framing a budget for a project and during the final submission of the project report to your organization. As a Project Manager, you will be involved right from budgeting to the final submission of the project report. 

As a Project Manager, you will be particularly interested in cutting costs as much as possible. Of course, it might be possible to cut some costs. But, it will never be possible to avoid certain costs. Some spending turns out to be the base for the project's progression. Only when this type of spending is done can you march forward with the production. For instance, spending on raw materials is something that you cannot avoid. But, you can avoid some sunk costs.

Know about Semi-Variable Costs:

Apart from fixed and variable costs, some projects also face semi-variable costs. It means that a certain portion of the costs will be variable, while some portions will be fixed. An excellent example is the wage paid to the sales force in an organization. Here, a portion of the wage paid to the salesperson might be in the form of a fixed salary. The remaining portion might be a commission on sales. When you categorize project costs, allocate a particular fixed portion of the cost as fixed costs and a specific portion as a variable cost. As a project manager, you should have complete knowledge of the project to make it easier to plan your project budget accordingly. 

Conclusion:

In conclusion, mastering the understanding of the five fundamental types of project costs - Direct Cost, Indirect Cost, Fixed Cost, Variable Cost, and Sunk Cost - is crucial for effective cost estimation in Project Management at Simpliaxis. As a responsible Project Manager, it is essential to differentiate between these cost types to streamline your cost estimation process and ensure project profitability. Enroll in our course today to deepen your knowledge and enhance your project management courses at Simpliaxis.