Project Cost Estimation and Budgeting

Project Cost Estimation and
Budgeting
Sources of Cost Escalation and Overruns
Uncertainty and Lack of Accurate Information
Changes in Requirements or Design
Economic and Social Factors
Inefficiency, Poor Communication, and Lack of Control
Ego Involvement of the Estimator
Project Contract
Bias and Ambition

Cost
•Costis defined as a “resource sacrificed or foregone to achieve a specific objective”
(Cost Accounting)
•Money
•Time -> Money
•Project managers must understand project cost management in order to effectively
control these tangibles
•Project cost management includes the processes required to ensure that a project
team completes a project within an approved budget
•Endgame: satisfy stakeholders
Processes of Cost Management
•Estimating costs–developing an approximation/estimate of the costs of the

resources needed to complete a project
•Determining the budget–allocating the overall cost estimate to individual work

items to establish a baseline for measuring performance
•Controlling costs –controlling changes to the project budget

Cost Estimation
● Accurately estimating project budget

● It is the first natural step in determining the viability of the project
● Cutting edge, high tech and R&D projects frequently shows escalations of
several 100%
Common source of Project cost
● Labor: becomes complex as range of skills increases

● Material: Specific equipment and supplies
● Subcontractors: Used to get non core skills and knowledge
● Equipment and facilities: Use of equipments for offsite projects
● Travel: All costs associated with travel, fares, hire cars, accommodations,
meals, incidentals, special taxes.
Profits
•Profits are revenues minus expenditures
•Profit margin is the ratio of revenues to profits
•Example: $100 revenue generates $2 profit
•2% profit margin
•Deduction: $98 invested
•Executives primarily concerned with profits

Life Cycle Costing
● Developing the project cost estimate is closely tied to the phases of project life cycle.
● Life cycle costing allows you to see a big-picture view of the cost of a project throughout its
life cycle
● Considerations:
○ Total cost of ownership
○ Development plus support costs
● Project managers must make estimates of the costs and benefits of a project throughout its
life cycle
● Life cycle cost should emphasize spending up front to reduce defect repair costs after
implementation
Purpose of life cycle cost analysis
● To anticipate the realities of operating, maintaining, and (ultimately) disposing
of the end-item system
● To establish target costs for operating, maintaining, and disposing of the end-
item system.
● To design the system so it will meet those target costs.
Cash Flow Analysis
● Cash flow analysis is a method for determining the estimated annual costs
and benefits for a project and the resulting annual cash flow.
•Used to determine NPV (net present value)
● Cannot have too many concurrent projects with high cash flow needs
•Capital expenses
Tangibles vs Intangibles
● Tangible costs / benefits are those costs or benefits that an organization can
easily measure in dollars
○ Example: it costs $100,000 to perform internal labor on a project versus $75,000 to outsource
● Intangible costs/benefits are costs or benefits that are difficult to measure in
monetary terms
○ Examples: goodwill, political capital, prestige
Direct and Indirect Costs
● Direct costs are costs that can be directly related to producing the products
and services of a project
● Indirect costs are costs that are not directly related to the products or services
of the project
● Sunk cost is money that has been spent in the past
Recurring and Non Recurring Costs
● Recurring costs or repeating costs are caused every now and again and on
an occasional or periodic premise. For instance, lease and power bills are
obligatorily brought about every month
● Non-recurring expenses or non-repeating costs are not repetitive in nature
and may regularly bring about just a single time.
Fixed and Variable Costs
● Fixed costs are expenses that remain the same regardless of the level of
production, Rent, advertising, and administrative costs are examples of fixed
costs.
● variable costs change based on the production output, examples of variable
costs include raw materials, sales commissions, and packaging.
Normal and Expedited Costs
● Normal costs refer to those incurred in the routine process of working to

complete the project according to the original, planned schedule agreed to by
all project stakeholders at the beginning of the project.
● Expedited costs are unplanned costs incurred when steps are taken to speed
up the project's completion.
Learning Curve Theory
● Learning curve theory states that when many items are produced repetitively,
the unit cost of those items decreases in a regular pattern.
● Factors:
○ Domain knowledge
○ Relationships
○ Lessons learned
Planning Cost Management
● Developing a cost management plan requires the following inputs:

○ Expert judgment
○ Analytical techniques
○ Meetings
● These will drive a cost estimation–a variety of techniques for predicting how
many resources will be required to complete an activity or collection of
activities (project)
Types of Cost Estimates
● Rough order of magnitude (ROM) is an estimate of what a project will cost

like swag, ballpark estimate, or guesstimate
● Accuracy is typically -50% to +100%, though may be much wider
● Some IT professionals automatically double estimates for software
development
● A budgetary estimate is used to allocate money into an organizations

budget
● Many organizations develop budgets at least two years into the future
● More accurate than ROM -10% to +25%
● A definitive estimate provides an “accurate” estimate of project costs

● Made closer to project completion
● Accuracy -5% to +10%
● Based on hard facts, such as cost of hardware
Cost Management Plan
● A cost management plan is a document that describes how the organization

will manage cost variances on the project
● Based on estimation, but acted on through monitoring and controlling
● Labor costs are a large percentage of total project cost (time = money)
● Note that labor cost per resource (run rate) is often much higher for
contractors than full time employees
Example: $45/hr FTE, $75/hr contract

Cost Estimation Tools & Techniques
● Developing a cost estimate is difficult, but can be made easier with tools and
processes
○ Analogous cost estimate / Top down estimate
○ Bottom-up estimate
○ Parametric modeling
○ Activity based estimate
Estimation Techniques
● Analogous estimates use the actual cost of a previous, similar project as the basis for estimating the
cost of the current project it is also known as top-down estimate
● Less costly than other techniques.
● Bottom-up estimates involve estimating individual work items (activities) and summing to the project
total
● Preferred if there is a detailed WBS available
● Parametric modeling uses project characteristics (parameters) in a mathematical model to estimate

project costs, Example: cost per line of code based on difficulty, talent, and size
● Most reliable when model has empirical input for parameters
● Downside: can be more inaccurate than other models if executed incorrectly (lack of experience)
Estimation Techniques
● Activity based estimate:

○ Projects use activities and activities use resources
○ Assign costs to activities that use resources
○ Identify cost drivers associated with this activities
○ Compute cost rate per cost driver unit
○ Compute for the volume of cost drivers used in project.
Estimation Challenges
● Low initial estimates - Caused by

○ Underestimation of scope or technical complexity
○ Desire to win work at any cost
○ Corporate culture that rewards over optimism
● Unexpected technical difficulties - caused by
○ Assumption that technical difficulties will be minimum
○ Not identifying all the unknowns
● Lack of definition - caused by
○ Poor scope development from poorly defined features / goals or purposes
○ External factors
Developing budget contingencies (Risk)
● Budget contingencies are allocation of extra funds to cover uncertainties and
improve the chance of finishing on time also called as Budget or Management
reserve.
● Reserves are included in a cost estimate to mitigate cost risk by allowing for
future situations that are difficult to predict
● Contingency reserves allow for future situations that may be partially planned
for “known unknowns”
○ Examples: employee vacations, employee turnover
● Management reserves allow for future situations that are unpredictable
“unknown unknowns”
○ Examples: illness, natural disasters, weather

Project Cost Estimation and Budgeting

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Project Cost Estimation and Budgeting

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Project Cost Estimation and

Uncertainty and Lack of Accurate Information

Changes in Requirements or Design

Economic and Social Factors

Inefficiency, Poor Communication, and Lack of Control

Ego Involvement of the Estimator

Bias and Ambition

•Estimating costs–developing an approximation/estimate of the costs of the

•Determining the budget–allocating the overall cost estimate to individual work

•Controlling costs –controlling changes to the project budget

● Accurately estimating project budget

● Labor: becomes complex as range of skills increases

•Profits are revenues minus expenditures

•Profit margin is the ratio of revenues to profits

•Example: $100 revenue generates $2 profit

•2% profit margin

•Deduction: $98 invested

•Executives primarily concerned with profits

•Used to determine NPV (net present value)

● Normal costs refer to those incurred in the routine process of working to

● Developing a cost management plan requires the following inputs:

● Rough order of magnitude (ROM) is an estimate of what a project will cost

● A budgetary estimate is used to allocate money into an organizations

● A definitive estimate provides an “accurate” estimate of project costs

● A cost management plan is a document that describes how the organization

Example: $45/hr FTE, $75/hr contract

● Parametric modeling uses project characteristics (parameters) in a mathematical model to estimate

● Activity based estimate:

● Low initial estimates - Caused by

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