Estimation & Budgeting-10

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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

Estimates Initially Based On Opinion/ Judgement of Experts To Be RefinedLater As More Information Becomes Available

Estimating Events Further in Future More Difficult Due To Higher Degreeof Uncertainties

For Medium/ High Complex Activities Planning is An Ongoing ProcessThroughout 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 Manager’s Role in the Estimating Process

Varies Between

Collecting Estimations From Other People/ Functional Experts Developing Detailed Financial Cost-Benefit Analysis Themselves

As Projects Near Completion the Estimates for Final Times/ Resources/Costs Become More Accurate

Estimation Activity Continues Throughout Life-Cycle of Projects

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/ ApplicationDepends on the Stage in the Project Life-Cycle When Estimates Being Made

Cost Estimates Used to Develop Budgets That Become Baseline AgainstWhich Project Performance Get Evaluated

Rate of Actual Cost Expenditure Compared To Budgeted Rate of

Estimated Expenditure Measures Project Work Performance ThroughoutProject Life-Cycle



PROJECT PHASE & ESTIMATION TYPE

Project Phase Estimate Type Purpose Inaccuracy

Initiation Phase Client: Indicative Cost Estimate Assess Project Viability ± 20%

• To Sanction ‘Go-Ahead’ with Planning/ Designing/Tendering

Planning/ Design Client: Preliminary Cost Estimate Budget Project Completion ± 15%Phase Cost & To Give ‘Go-Ahead’

for Execution

Initial Stages of Client: Approximate Cost Estimate Provides Base-Line for ± 10%Execution Phase for Project Budgeting Controlling Cost Objectives

(70- 80)% Project Client: Definitive Cost Estimate To Determine Cost At ± 5%Execution Phase Completion

Project Cost at Client: Historical Actual Cost To Account ActualProject Completion Completion Excluding

Unresolved Disputes & Claims

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





COST ESTIMATION METHODS

Types of Estimates Estimation Methodology Inaccuracy Effort (% of Project Cost)

Client: Indicative Cost Unit Service Method/ Cost ±20% 0.01 to 0.1Estimate Indices/Capacity Curves

Capacity Ratios

Client: Preliminary Cost Parametric Cost Estimate ±15% 0.05 to 0.2Estimate Supported By Prevailing Cost

Indices/ Capacity CurvesCapacity Ratios

Client: Approx. For Budgeting Pricing Based on Quantity Take- ±10% 0.1 to 0.5Estimate Project Cost off from Designs/Drawings/

Supported with SupplierQuotation/ Tendered Amount/ Overhead Estimates

Client: Definitive Cost Detailed Pricing Supported with ±5% 1.0 to 3.0Estimate Actual Cost Data During

Execution

Contractors’ Tender Detailed Pricing at Market Rate ±2% to 5% 0.1 to 1.0Estimate Supported with Quotations from

Potential Contractors/ Suppliers

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 ofSuch Cuts

Method Not Very Good for Generating Accurate Estimates

Top-Down Costing Method

Top Management Allocates Certain Amount of Money To Completethe 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

Senior Management/Project Sponsor

Project Owner

Project Manager

Top Down Bottom Up

Costs

FixedExternally

ToProject

Project

ManagerAllocatesBudgets

ToSub-Projects

Costs

SetBy TheProject

Members

ProjectManagerCollates

Estimates

Sub-Projects

Activities



ELEMENTS OF ACTIVITY LEVEL COSTS

Time – Direct Labour Inputs Into Activities

Overheads – Provision for Running of Headquarters/ ProvidingCentral Support Services Office Financial & Legal Support

Salaries & Perks for Managers & Other Non-Direct Staff

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

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 CompletionResidual Value Estimated and Reduced from the Cost

Maintenance/ Running Costs

Depreciation Offset Against Activities

Materials – Consumables & Other Items Used in the Process Material Costs

• Cost Incurred By Company To Acquire Material

• Cost of Material + Margin Added



ELEMENTS OF COSTS

Project

Overheads

GeneralOverheads

Profit

PrimeCost

Direct Materials

Direct Labour

=Price

+

+

+

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

General Overheads Calculated as a Percentage of Total Cost

TotalCost

Project Overheads Include Indirect Expenses for the Project



COST BUILD-UP - EXAMPLE

Estimate the cost of running a commercial training course required by the coursecoordinator to work out how much to charge each participant for making a desiredprofit. 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 х 3) + (1K х 3) = Rs. 93, 000

Direct Material Cost = 15 х 800 = Rs. 12, 000

Prime Cost = 93000 + 12000 = Rs. 105, 000

(Fixed)

(Variable cost - Depends onNo. of Participants)

Indirect Labour - administrative Time of 10 days = 1K х 10 = Rs. 10, 000

Cost = 105000 + 10000 = Rs. 115, 000

Overhead Cost = 115000 х 0.60 = Rs. 69, 000

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

Participant Fee =184000 ‚ 15= Rs. 12, 267



COST ESCALATION

Accurate Cost Estimation Difficult As It Starts at Conception Stage LongBefore All Necessary/ Final Information About Project Becomes Available

Estimated Costs Differ Substantially from Actual Final Figures By Way ofCost Overruns

Actual Amount of Increase Creating Cost Overrun of Initial EstimatedCosts Called ‘Cost Escalation’

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 %

20% Cost Escalation Common in Projects

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 CostsCost-Plus: Contractor Has Little Incentive to Control Cost



COST ESTIMATION PROCESS

Cost Estimating Process Starts By Breaking the Project Down IntoWork Phases – Design/ Engineering/ Development/ FabricationWork Packages from WBS

Project Team Including Functional Area Representatives & ContractorsDiscuss 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 & ExpertiseWhen In-sufficient Information Available & Carried Out at the Conception Stage

To be Followed Later By More Detailed and in-Depth Cost AnalysisWhen Project is Unique/ First Time Project – Euro Tunnel Project

Analogy Estimate: Cost Estimate Developed By Reviewing Costs from aPrevious 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 inCurrent 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 company’s engineers investigate the relationship between several building parameters and the materials for

eight recent projects comparable in terms of general architecture, layout andconstruction material. Using the method of least squares, they develop the followingformula , a multiple regression model that relates material costs (y) in US Dollars tofloor space (x₁) in terms of 10, 000 sq ft and the number of shipping/ receiving docks (x₂) In a building:

y (US $) = 201, 978 + (41, 490) x₁+ (17, 230) x

₂

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 docksUsing the model.

Estimated Material Cost, y = 201, 978 + (41, 490 х 30) + (17, 230 х 2)

Facility Floor Space, x₁= 300,000 ‚ 10,000 = 30 No. of Docks, x₂ = 2

Substituting values of x₁ & x₂ in the formula

= $ 1, 481, 138



COST ENGINEERING ESTIMATE

Estimating Cost Using Cost Engineering Involves Detailed Cost Analysisof Individual Cost Categories at the Work Package/ Task Levels

Cost Engineering Provides Most Accurate Estimate of Cost But ConsumesConsiderable Time & Requires Detailed Work Definition & DesignInformation – May Not Be Available at Initiation Phase

The Method Starts with Breaking Down Project Into Activities/ ProjectPackages Which Get Further Broken Down into Basic Areas of Work

Engineering Fabrication

Engineering/ Fabrication Packages Further Divided Similarly Till WorkContent 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 х Basic Labour Hourly Rate Materials Cost: Estimated Material Consumption Quantity х Materials Unit Price Equipment Utilization Cost: Estimated Equipment Utilization Hour х Basic

Equipment Hiring Hourly Rate

At Task Level Detailed Estimates Derived from Standard Manuals thatContain 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 BySupervisors Referring to

Previous Similar Work Standards Manuals Reference Documents

Rules of Thumb

Supervisors Submit Their Estimates to Work Package Managers WhoCheck/ Revise/ Aggregate & Pass Work Package Level Estimates to PM

Project Manager & Independent Estimators Review the Time & MaterialsEstimate 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 ByStandard 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





RECONCILING ESTIMATES

Project Manager Submits To Top Management Final Cost Estimates/ ProjectSchedules & Forecasts Showing Time/ Cost Effects of Potential Escalation

Factors – Inflation/ Exchange Rates/ Project Risks

If Gross Estimate Much Smaller Project Manager Reviews Work PackageEstimates To Examine incorrect Assumptions/ Padding

If Gross Estimate Substantially Larger Project Manager Reviews EachWork Package Estimate To Identify Oversight/ Over Optimism (Estimator Ego)

Management Decide To Accept it/ Send it for Revision To Project ManagerBased 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

To Reconcile Differences Pushing Across-the-Board Cut Across AllEstimates 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 ManagersWorking in Perpetual Cycle of Seeking Approval & Allocation of Funds

In Public Sectors Environments Budgets/ Grants Often Allocated Using

‘Zero- Base’ Budgeting Approach

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



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 WorkShould Cost Which Becomes Baseline for Tracking & Controlling the Work

Project Budgets Similar to Fiscal Operating Budgets With Only Differencein 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 FinancialPlan 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

Where Project Activities Ongoing But Reviewed Periodically Zero-BaseApproach Takes into Account Previous Performance As Well

Further Funding Made Available to Projects Only When Progress isDemonstrated

Where Progress Found Unsatisfactory Funding for Remaining ActivitiesDenied/ Cut

For This Reason Stipulation for Attracting Private Funding to SupplementGovernment Grants Often Added in Such a Project

For Tracking Costs as Project Progresses Direct Labour & Material CostsAllocated & Costs Tracked Through Job Costing Systems

For Accounting Purposes Separate Codes issued To Different Jobs & AllRelated Costs Recorded Against These Codes

Project Manager/ Budget Holder Periodically Checks For Accuracy of the

Cost Records

Drawing a Budget Without Reference to Last Budget Requiring ManagersTo Justify All Expenditures Afresh/ Not Just the Increases Over Last Year



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 MoreEfficiently Resulting in Any Unspent Funds

Limitation of Conventional Budgeting System Avoided If RewardGranted for Cost Efficiency Through Greater Allocation of Fundsin the Future

Budgeting System Imposes Constraints in Movement of FundsBetween Different Categories Often Creating Anomalies/ Waste

Exhausted One Category of Expenditure Though Project ActivitiesRemain 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 Systemof Manpower/ Materials/ Facilities

To Reduce Confusion/ Improve Accuracy/ Expedite Procedures ProjectManagement Needs A System to Compute Estimates/ Store & ProcessBudgets & Track Costs

Project Cost Accounting System (PCAS) Refers to Structure & MethodologyThat Enables Systematic Planning/ Tracking & Control of Project Costs

PCAS Set Up & Used By Project Manager/ Project Accountant/ RelatedFunctional Managers

PCAS Enable Total Project & Sub-Activity Cost To Be Accumulated/ Credited& Reported Once Project Execution Phase Gets Started

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 EstimatesThat Becomes Basis For Creating Total Project & Work Packet (WP) Budgets

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



PCAS - ELEMENTS

Work Package

Cost Information

Actual PerformanceInformation(Work Completed& ExpenditureIncurred)

Total Project Cost Estimates

Time-Phased BudgetFor Cost Accounts

Variance

Analysis

RevisedBudgets

PCAS OutputsPCAS Inputs

Project CostAccounting

System(PCAS)

Estimating&Budgeting

Tracking&

Control

PCAS Supports Project Managers By Providing Information Related To

How Project Progressing When Expenses IncurredWhere Problems Developing

PCAS Uses Time-Phased Budget To Create Output Reports That Help Project

Managers To Control Project Costs



TIME-PHASED BUDGET

Time-Phased Budget Shows How Budgeted Costs Distributed OverTime In Accordance With the Project Schedule

Throughout Duration of the Project PCAS Generates Time PhasedReports (TPR) For Every Work Package

TPR Allows Managers To Review & Compare Actual ExpenditureWith 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

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



Charge RateMonths Totals

1 2 3 4 5 6 Hrs Cost

Direct Labour

(Professions)

35/ Hr

20/ Hr

50

100 100 100

50

100

100

400

3, 500

8, 000

Direct Labour CostLabour Overhead

Other Direct Costs

75%1, 7501,312

2,0001,500

100

2,0001,500

2,0001,500

3,7502,813

11,5008,625

100

Total Direct Cost

General /Admin 10%

3,062

306

3,600

360

3,500

350

3,500

350

6,563

657

20,225

2,023

Total Costs

Profits 15%

3,368 3,960 3,850 3,850 7,220 22,248

Billing Total

Project:Department:

Date:

Work Package Description:

Number/ Code:

TIME-PHASED BUDGET



BUDGETING USING COST ACCOUNTS

In Small Projects Planning & Performance Monitoring Done Using SimpleBudget for the Whole Project

For Larger Projects Project-Wide Budgets Broken Down Into SmallerBudgets 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 beMonitored Using PCAS & the Cost Account Structure

Cost Accounts Also Established for Non-Direct Project Cost Where CostsCan Not Be Readily Attributed To Any Work Package/ Specific Task



Any Questions PL?