Project Cost Estimation & Budgeting

Module X

COST ESTIMATION
Decision To Take up a Project Depends on
Real Need for the Outcome Time Required to Complete Project Estimated Cost Involved in Completing the Project

Estimation Involved in All Elements of Project Times/ Resources/ Costs

Project Cost Estimates/ Budgets/ WBS/ Project Schedules Interrelated & Any Change in One Will Affect Others & The Total Project
Project Cost Estimates Based Upon Elements of WBS & Prepared at Work Package Level & Even Lower at Activity/ Operational Levels If Necessary Estimating Events Further in Future More Difficult Due To Higher Degree of Uncertainties Estimates Initially Based On Opinion/ Judgement of Experts To Be Refined Later As More Information Becomes Available

For Medium/ High Complex Activities Planning is An Ongoing Process Throughout Project Life-Cycle As Changes Inevitable in Large Projects
Project Activities Get Greatly Affected By Changes in
Inputs: Project Brief Changes By Customer Can be Significant in Long Duration Projects Constraints: Degree of Uncertainty Increases in Long Duration Planning As Financial & Other Conditions Change - Different Interest Rates/ Cash Availability/ Investor Confidence Mechanisms Availability of People/ State of Technology Difficult To Predict Over Long Time

Feedback From Previous Projects Used as Guide for Time/ Cost Estimation

TYPES OF ESTIMATION
For Preparing Proposals Project Managers Role in the Estimating Process Varies Between
Collecting Estimations From Other People/ Functional Experts Developing Detailed Financial Cost-Benefit Analysis Themselves

Estimation Activity Continues Throughout Life-Cycle of Projects As Projects Near Completion the Estimates for Final Times/ Resources/ Costs Become More Accurate Five Types of Estimates Used in Project Management
Client: Indicative Cost Estimate Client: Preliminary Cost Estimate Client: Approximate Cost Estimate for Project Budgeting Client: Definitive Cost Estimate Client: Historical Actual Cost

Nature & Accuracy of Estimation Types Differ & Their Use/ Application Depends on the Stage in the Project Life-Cycle When Estimates Being Made Cost Estimates Used to Develop Budgets That Become Baseline Against Which Project Performance Get Evaluated Rate of Actual Cost Expenditure Compared To Budgeted Rate of Estimated Expenditure Measures Project Work Performance Throughout Project Life-Cycle

PROJECT PHASE & ESTIMATION TYPE

Project Phase Estimate Type Purpose Inaccuracy

Initiation Phase

Client: Indicative Cost Estimate

Assess Project Viability To Sanction Go-Ahead with Planning/ Designing/ Tendering

Budget Project Completion Cost & To Give Go-Ahead for Execution Provides Base-Line for Controlling Cost Objectives To Determine Cost At Completion To Account Actual Completion Excluding Unresolved Disputes & Claims

20%

Planning/ Design Phase Initial Stages of Execution Phase (70- 80)% Project Execution Phase

Client: Preliminary Cost Estimate

15%

Client: Approximate Cost Estimate for Project Budgeting Client: Definitive Cost Estimate

10% 5%

Project Cost at Client: Historical Actual Cost Project Completion

Client Cost Estimation Refers to Estimation Prepared By Client Organization

Starts with Indicative Cost & Continues Till Actual Cost Determined at Completion

Cost Estimating Method Varies with

Nature of Project Life-Cycle Phase of Project Purpose of the Cost Estimation Degree of Accuracy Required Estimating Effort Employed

CONTRACTORS TENDER COST ESTIMATION

On Receipt of Request For Quotation (RFQ) from Client Contractor Prepares Detailed Cost Estimate To Make Their Offer
Contractor Quotes Estimated Price That Becomes Financial Commitment for Executing the Project Tendering Requires Detailed Cost Estimation As Inaccuracies in Costing Affects Pricing & Ultimately the Contractors Business
Quoting Less May Get Business But Will Affect Project Quality/ Margins Quoting High May help Competitor To Take Away Business

Preparing Detailed Estimation Time-Consuming & Accuracy Depends On Time & Resource Available While Preparing the Estimate Steps Involved in Preparing Detailed Estimation By Contractor Includes
Reviewing Tendered Scope of Work Identifying Planning Data for Estimation Developing Contract WBS Preparing Outline for Plan of Work Determining Quantities Estimating Unit Rates for Manpower/ Materials/ Equipment
Obtaining Specialist Sub-Contractor Quotation Collecting Resource Suppliers Quote Calculating Direct Project Costs Determining Indirect Costs Adding Contingency Amounts Adding Profit Mark-Up Deducting Discounts, When Required

COST ESTIMATION METHODS

Types of Estimates Client: Indicative Cost Estimate Client: Preliminary Cost Estimate Estimation Methodology Unit Service Method/ Cost Indices/Capacity Curves Capacity Ratios Parametric Cost Estimate Supported By Prevailing Cost Indices/ Capacity Curves Capacity Ratios Pricing Based on Quantity Takeoff from Designs/Drawings/ Supported with Supplier Quotation/ Tendered Amount/ Overhead Estimates Inaccuracy 20% Effort (% of Project Cost) 0.01 to 0.1

15%

0.05 to 0.2

Client: Approx. For Budgeting Estimate Project Cost

10%

0.1 to 0.5

Client: Definitive Cost Estimate

Contractors Tender Estimate

Detailed Pricing Supported with Actual Cost Data During Execution

Detailed Pricing at Market Rate Supported with Quotations from Potential Contractors/ Suppliers

5%

1.0 to 3.0

2% to 5%

0.1 to 1.0

Note: Percentages Indicative Only : Depends on Type/ Size of Project

COSTING PROPOSAL BASIC APPROACH

Bottom-Up Costing Method
Estimates of Each Level in WBS (Work Breakdown Structure) Compiled & Added Together By Each Level of Supervision in Project Hierarchy Estimates Prepared By Handling Personnel/ Supervisors Hence Owned by the Team Members More Committed to Achieving If Figures Remain Unmodified by Project Manager Process Looses Credibility If PM Expected to Cut Costing Proposals & Consequently Staff Pad Up the Cost Estimates To Counter Effect of Such Cuts Method Not Very Good for Generating Accurate Estimates

Top-Down Costing Method

Top Management Allocates Certain Amount of Money To Complete the Project Activities The Amount Is Split Among Various Sub-Projects Based on
Senior Management Estimates Using the Target Costing Concept

Creates a Degree of Competition Between Supervisors of the Activities This Competition Often Beneficial for the Project

APPROACHES TO COSTING
Top Down Senior Management/ Project Sponsor Project Owner Project Manager Allocates Budgets To Sub-Projects Bottom Up

Costs Fixed Externally To Project

Project Manager

Project Manager Collates Estimates

Costs Set By The Project Members

Sub-Projects Activities

ELEMENTS OF ACTIVITY LEVEL COSTS

Time Direct Labour Inputs Into Activities Materials Consumables & Other Items Used in the Process
Material Costs Cost Incurred By Company To Acquire Material Cost of Material + Margin Added

Capital Equipment Means of Providing Conversion Process

Purchase Cost Full/ Part Depending On Use in the Project For Equipment with Potential for Further Use after Project Completion Residual Value Estimated and Reduced from the Cost Maintenance/ Running Costs Depreciation Offset Against Activities

Indirect Expenses Not Directly Related To Value-Adding Activity But Considered Necessary To Support Project (Project Overhead)
Transportation/ Training/ Project Administration

Overheads Provision for Running of Headquarters/ Providing Central Support Services

Office Financial & Legal Support Salaries & Perks for Managers & Other Non-Direct Staff

ELEMENTS OF COSTS
Profit General Overheads

Price

=
Direct Materials

Project Overheads

+
Total Cost

+
Prime Cost

Direct Labour

Project Overheads Include Indirect Expenses for the Project General Overheads Calculated as a Percentage of Total Cost

Elements of Costs Added with Desired Profit To Arrive At Price of Project

COST BUILD-UP - EXAMPLE

Estimate the cost of running a commercial training course required by the course coordinator to work out how much to charge each participant for making a desired profit. Assume the programme will be fully booked. Cost related details are as follows: Programme requires a consultant to do the 3 days training at Rs. 30K/ day Services of administrator will be required @ Rs. 1K/ day for all the 3 days Maximum 15 participants will be able to take part in the training Cost of printed material and stationery estimated at Rs. 800/ participant Administrative time required to arrange the programme was 10 days Assume overhead cost (hall rent + electricity + procurement + cost of funds) at 60% of total cost.

Direct Labour Cost = (30K 3) + (1K 3) = Rs. 93, 000

(Fixed)

Direct Material Cost = 15 800 = Rs. 12, 000 (Variable cost - Depends on No. of Participants) Prime Cost = 93000 + 12000 = Rs. 105, 000 Indirect Labour - administrative Time of 10 days = 1K 10 = Rs. 10, 000 Cost = 105000 + 10000 = Rs. 115, 000 Overhead Cost = 115000 0.60 = Rs. 69, 000

Participant Fee =184000 15 = Rs. 12, 267

Total Project Cost = 115000 + 69, 000 = Rs. 184, 000

COST ESCALATION
Accurate Cost Estimation Difficult As It Starts at Conception Stage Long Before All Necessary/ Final Information About Project Becomes Available Estimated Costs Differ Substantially from Actual Final Figures By Way of Cost Overruns Actual Amount of Increase Creating Cost Overrun of Initial Estimated Costs Called Cost Escalation 20% Cost Escalation Common in Projects Larger & More Complex the Project Greater the Potential for Cost Escalation
Concord Supersonic Airliner Cost More Than 5 Times Original Estimates Nuclear Power Plants Frequently Cost 2 to 3 Times the Estimate Cutting-Edge/High Technology/R&D Projects - Frequently Above Several Hundred %

Major Reasons for Cost Escalation in Projects

Uncertainty & Lack of Accurate Information Define Clear Objectives/ Scope Changes in Design Or Requirements Use Change Control Systems Economic & Social Variables in Environment - Inflation/ Strikes/ Material Shortages Work Inefficiency/ Poor Communication/ Lack of Control Poor P Management Involvement of Estimator Ego Honest Prediction Difficult By Non Professionals Type of Contract Fixed Price: Contractor Has Incentive To Control Costs Cost-Plus: Contractor Has Little Incentive to Control Cost

COST ESTIMATION PROCESS

Cost Estimating Process Starts By Breaking the Project Down Into
Work Phases Design/ Engineering/ Development/ Fabrication Work Packages from WBS

Project Team Including Functional Area Representatives & Contractors Discuss Work Phases/ Work Packages & To Receive Work Assignments Project Team Try To Classify Tasks in the Project as
Developmental: Requires Considerable Effort in Design/ Testing/ Fabrication Comparatively Difficult To Estimate Costs Due to Greater Uncertainty in Requirement of Labour Hours Off-the-Shelf: Adapting Existing Design/ Techniques/ Procedures Simpler To Estimate Costs as Material/ Labour Hours Required in Similar Projects Available

Estimated Costs Classified as

Recurring Costs: Occur Many Times Associated with Periodically Repeated Tasks Include Costs Related to Labour/ Material/ Quality Assurance/ Testing Non-recurring: Happens Only Once Associated with Unique Tasks/ Procurement of Special Items Include Costs Related to Development/Fabrication/Testing of One-of-a-kind Items

Estimated Cost Figures Determined Using Four Basic Techniques

Expert Opinion Analogy Estimate Parametric Estimate Cost Engineering

COST ESTIMATION TECHNIQUES

Expert Opinion: Cost Estimate Provided By an Expert
Provides a Reasonable/ Ball-Park Estimate Using Experience & Expertise When In-sufficient Information Available & Carried Out at the Conception Stage To be Followed Later By More Detailed and in-Depth Cost Analysis When Project is Unique/ First Time Project Euro Tunnel Project

Analogy Estimate: Cost Estimate Developed By Reviewing Costs from a Previous Similar Project
Can be Used at Any Level of the Project: Overall/ Work Package/ Tasks Cost of a Similar Project/ Work Package Analyzed & Adjusted for Difference in Current and Earlier Projects Adjustments Made to Account for Dates/ Project Scale/ Location/ Complexity/ Exchange Rates Extensive Database of Past Projects Archived for Reference During New Projects

Parametric Estimate: Cost Estimate Derived from an Empirical/ Mathematical Relationship

Can be Used with Analogy Project to Scale Costs Up/ Down Can be Used Directly When Costs are Function of Project Parameters Such as - Physical Features: Area/ Volume/ Weight/ Capacity - Performance Features: Speed/ Output Rate/ Power/ Strength

Parametric Estimation Most Suitable Technique When Cost Estimates Needed Quickly To Fix Preliminary Design Characteristics

PARAMETRIC COST ESTIMATE - EXAMPLE

Warren Eisenberg, President of Wonder Works, Inc. a Warehouse facilities contractor, wants a quick way to estimate the material cost of a facility. The companys engineers investigate the relationship between several building parameters and the materials for eight recent projects comparable in terms of general architecture, layout and construction material. Using the method of least squares, they develop the following formula , a multiple regression model that relates material costs (y) in US Dollars to floor space (x) in terms of 10, 000 sq ft and the number of shipping/ receiving docks (x) In a building: y (US $) = 201, 978 + (41, 490) x+ (17, 230) x

The least square method also indicates that the standard error of the estimate is small, which suggests the model provides fairly close to actual costs for the eight projects.
Estimate the material cost required to construct a 300, 000 sq ft facility with two docks Using the model.

Facility Floor Space, x= 300,000 10,000 = 30

Substituting values of x & x in the formula

No. of Docks, x = 2

Estimated Material Cost, y = 201, 978 + (41, 490 30) + (17, 230 2) = $ 1, 481, 138

COST ENGINEERING ESTIMATE

Estimating Cost Using Cost Engineering Involves Detailed Cost Analysis of Individual Cost Categories at the Work Package/ Task Levels
Cost Engineering Provides Most Accurate Estimate of Cost But Consumes Considerable Time & Requires Detailed Work Definition & Design Information May Not Be Available at Initiation Phase The Method Starts with Breaking Down Project Into Activities/ Project Packages Which Get Further Broken Down into Basic Areas of Work
Engineering Fabrication

Engineering/ Fabrication Packages Further Divided Similarly Till Work Content of Each Element Can be Used to Estimate Time Required & Costs Each Element of Work Packages Absorbing the Cost Categories
Labour Cost: Estimated Labour Effort in Man-Hours Basic Labour Hourly Rate Materials Cost: Estimated Material Consumption Quantity Materials Unit Price Equipment Utilization Cost: Estimated Equipment Utilization Hour Basic Equipment Hiring Hourly Rate

At Task Level Detailed Estimates Derived from Standard Manuals that Contain Time & Cost Information about Labor and Materials to Perform Particular Tasks

COST ESTIMATE FOR TOTAL PROJECT

Estimates of Time & Material Arrived at By Each Work Team Checked By Supervisors Referring to
Previous Similar Work Standards Manuals Reference Documents Rules of Thumb

Supervisors Submit Their Estimates to Work Package Managers Who Check/ Revise/ Aggregate & Pass Work Package Level Estimates to PM Project Manager & Independent Estimators Review the Time & Materials Estimate To Ensure
No Cost Overlooked/ Duplicated Estimators Understood What They Were Estimating Correct Estimating Procedures Used Allowances Made for Risks/ Uncertainties

Estimates Then Aggregated & Converted into Dollars By Multiplying By Standard Wage Rates & Material Costs - Current/ Projected Cost Estimate for Total Project Arrived at By Project Manager Adding In
Project-Wide Overhead Rates - Cover Project Management + Administrative Costs Company-Wide Overhead Rates - Cover General Company Expenses

CONTINGENCY AMOUNT
Throughout the Estimating Process Contingency Amount Added To Estimates For Taking Care of Uncertainties & Reducing Probability of Actual Cost Overruns Complex Projects/ Less Well-Defined Situations Demand Higher Contingency Amounts Activity Contingency: Contingency Amount Added By Estimator To Initial Estimate of Activity/ Work Package To Account for Known Unknowns- Highly Likely Sources of Cost Increase Scrap & Waste Design Changes Increases in Scope/ Size/ Function of End Item Delays Due to Weather Base Estimate: Total Project Cost + Activity Contingency

Project Contingency: Amount Added By Project Manager To Base Estimate To Account for Unknown Unknowns External Factors that Affect Project Costs Fluctuation of Exchange Rates Shortages in Resources Changes in Market/ Competitive Environment
Final/ Most Likely Cost Estimate: Base Estimate + Project Contingency Overrun Allowance: Amount Set Aside By Corporations For Developmental Projects Over & Above Most Likely Cost Estimate that PM Can Use Only With Prior Approval

RECONCILING ESTIMATES
Project Manager Submits To Top Management Final Cost Estimates/ Project Schedules & Forecasts Showing Time/ Cost Effects of Potential Escalation Factors Inflation/ Exchange Rates/ Project Risks Management Decide To Accept it/ Send it for Revision To Project Manager Based On Reconciliation of Two Cost Estimates
Final Cost Estimates Prepared By Project Team Using Upward Accumulation of Work Package Estimates Known as Bottom Up Approach Gross Estimates Prepared Based On Expert Opinion/ Analogy to Other Similar Projects Known as Top Down Approach

If Gross Estimate Substantially Larger Project Manager Reviews Each Work Package Estimate To Identify Oversight/ Over Optimism (Estimator Ego) If Gross Estimate Much Smaller Project Manager Reviews Work Package Estimates To Examine incorrect Assumptions/ Padding To Reconcile Differences Pushing Across-the-Board Cut Across All Estimates Not Recommended As It Will Affect Morale of the Project Team To Identify Mistakes in Estimation that Can Happen in Both Directions
Project Manager Approves Bottom-Up Estimates of Work Packages Functional Units Approve Top-Down Estimates for Work Expected From Them

Final Estimates Mutually Agreed Upon By Project & Functional Managers

BUDGETING
Written Statement of Money Showing Where it is Drawn From/ The Amount/ How it is to be Spent Defined as a Budget Most Operations Need Managers to Perform Budgetary Analysis Annually Managing Within Budget is Key Cost Control Tool of Project Managers Working in Perpetual Cycle of Seeking Approval & Allocation of Funds Budget Applications/ Grants Generally Contain Following Categories
Labour Materials Consumables Capital Expenditure (Cap-ex) Travel Subsistence

These are Basic Elements Used in

Developing Bottom-Up Costs Providing Headings Within Project Codes to Relate Activities/ Resources for Cost Allocation

In Public Sectors Environments Budgets/ Grants Often Allocated Using Zero- Base Budgeting Approach

PROJECT BUDGET
Estimates Prepared First & Approved Estimates Become Basis for Budgets Organizations Committed To Perform Work According to the Budget Budgets Contain the Agreed-Upon Contracted Amount of What Work Should Cost Which Becomes Baseline for Tracking & Controlling the Work Project Budgets Similar to Fiscal Operating Budgets With Only Difference in Duration Covered By Each Project Budget Covers Full Life of the Project Fiscal Budget Covers One Year at a Time

Project Budget Essentially A Planning Document Outlining the Financial Plan of the Project
Project Budget Quantifies in Monetary Terms the Project Cost Objective Project Budget Allocates Responsibility for
Attaining The Objectives Reflects Resources Earmarked Pin-Points Results to be Achieved By the Responsible Person

Provides a Standard for Measuring Effectiveness/ Efficiency of Performing Activities

ZERO-BASE BUDGETING
Drawing a Budget Without Reference to Last Budget Requiring Managers To Justify All Expenditures Afresh/ Not Just the Increases Over Last Year Where Project Activities Ongoing But Reviewed Periodically Zero-Base Approach Takes into Account Previous Performance As Well Further Funding Made Available to Projects Only When Progress is Demonstrated Where Progress Found Unsatisfactory Funding for Remaining Activities Denied/ Cut For This Reason Stipulation for Attracting Private Funding to Supplement Government Grants Often Added in Such a Project For Tracking Costs as Project Progresses Direct Labour & Material Costs Allocated & Costs Tracked Through Job Costing Systems For Accounting Purposes Separate Codes issued To Different Jobs & All Related Costs Recorded Against These Codes Project Manager/ Budget Holder Periodically Checks For Accuracy of the Cost Records

LIMITATIONS IN BUDGETING SYSTEM

Funds Left in a Budget at End of Project/ Accounting Period Often Spent Just To Avoid Showing Unused Funds in the Accounts By
Making Unnecessary Purchases Rushing Acquisitions To Beat Deadlines

This Practice Does Not Encourage Good Use of Resources Project Management is Not Rewarded for Managing Cost More Efficiently Resulting in Any Unspent Funds Limitation of Conventional Budgeting System Avoided If Reward Granted for Cost Efficiency Through Greater Allocation of Funds in the Future Budgeting System Imposes Constraints in Movement of Funds Between Different Categories Often Creating Anomalies/ Waste Exhausted One Category of Expenditure Though Project Activities Remain Unfinished May Force a Manager to Pursue Even Cost Inefficient Activities If Budget Allows Funds from Another Category

PROJECT COST ACCOUNTING

Project Management Needs to Estimate/ Budget/ Control Complex System of Manpower/ Materials/ Facilities To Reduce Confusion/ Improve Accuracy/ Expedite Procedures Project Management Needs A System to Compute Estimates/ Store & Process Budgets & Track Costs Project Cost Accounting System (PCAS) Refers to Structure & Methodology That Enables Systematic Planning/ Tracking & Control of Project Costs PCAS Set Up & Used By Project Manager/ Project Accountant/ Related Functional Managers PCAS Tracks Project Costs By Relating to Schedules & Work Performance & Also Permits Tracking/ Control of Schedules & Work Progresses PCAS Enhanced To PMIS To Handle Project Planning/ Control/ Reporting PMIS Accumulate Work Package Cost Estimates To Total Project Estimates That Becomes Basis For Creating Total Project & Work Packet (WP) Budgets PCAS Enable Total Project & Sub-Activity Cost To Be Accumulated/ Credited & Reported Once Project Execution Phase Gets Started

Time-Phased Budgets Used To Monitor/ Allocate Costs To Appropriate WP

PCAS - ELEMENTS
PCAS Inputs Estimating & Budgeting Work Package Cost Information PCAS Outputs Total Project Cost Estimates Time-Phased Budget For Cost Accounts

Project Cost Accounting System (PCAS)

Actual Performance Information (Work Completed & Expenditure Incurred)

Tracking & Control

Variance Analysis Revised Budgets

PCAS Supports Project Managers By Providing Information Related To How Project Progressing When Expenses Incurred Where Problems Developing PCAS Uses Time-Phased Budget To Create Output Reports That Help Project Managers To Control Project Costs

TIME-PHASED BUDGET
In Most Projects Simultaneous Control of Work Schedules & Cost Expenditures Extremely Difficult Time-Phased Budgets Created By Consolidating Two Primary Tools For Project Control
Project Schedules Project Budgets

Time-Phased Budget Shows How Budgeted Costs Distributed Over Time In Accordance With the Project Schedule Throughout Duration of the Project PCAS Generates Time Phased Reports (TPR) For Every Work Package TPR Allows Managers To Review & Compare Actual Expenditure With Planned Expenditure Every Month Time-Phased Reports Used
To Perform Cost Variance Analysis To Ensure Work Actually Completed & Charged Accurately To Revise Estimates & Budgets As Needed

TIME-PHASED BUDGET
Project: Department: Date: Work Package Description: Number/ Code: Rate 35/ Hr 20/ Hr 75% 50 100 1, 750 1,312 3,062 306 3,368 15% 2,000 1,500 100 3,600 360 3,960 100 2,000 1,500 3,500 350 3,850 100 2,000 1,500 3,500 350 3,850 Months 1 2 3 4 5 50 100 3,750 2,813 6,563 657 7,220 6 Hrs 100 400 Totals Cost 3, 500 8, 000 11,500 8,625 100 20,225 2,023 22,248

Charge Direct Labour (Professions) Direct Labour Cost Labour Overhead Other Direct Costs Total Direct Cost General /Admin Total Costs Profits Billing Total

10%

BUDGETING USING COST ACCOUNTS

In Small Projects Planning & Performance Monitoring Done Using Simple Budget for the Whole Project For Larger Projects Project-Wide Budgets Broken Down Into Smaller Budgets Known As Cost Accounts For Better Control Cost Account Used as Basic Project Tracking & Control Unit of PCAS System of Cost Accounts Set Up In a Hierarchy Identical To the WBS Similar To Work Packages Each Cost Account Includes
Description of Work Time Schedule Responsible Person Material/ Labor/ Equipment Required Time-Phased Budget

Cost Performance of a Package/ Group of Packages/ Whole Project Can be Monitored Using PCAS & the Cost Account Structure Cost Accounts Also Established for Non-Direct Project Cost Where Costs Can Not Be Readily Attributed To Any Work Package/ Specific Task

Any Questions PL?