Project Planning

Cost Estimation and Budgeting

Project Cost Management
• Project Cost Management includes the processes required to ensure that the project is completed within the
approved budget.

• It overview of the following major processes:

• 1 Resource Planning—determining what resources (people, equipment, materials) and what quantities of
each should be used to perform project activities.

• 2 Cost Estimating—developing an approximation (estimate) of the costs of the resources needed to complete
project activities.

• 3 Cost Budgeting—allocating the overall cost estimate to individual work items.

• 4 Cost Control—controlling changes to the project budget.

 RESOURCE PLANNING
• Resource planning involves determining what physical resources (people,
equipment, materials) and what quantities of each should be used to perform
project activities.
• Example:
• A construction project team will need to be familiar with local building codes.
• Such knowledge is often readily available at virtually no cost by using local labor.
• However, if the local labor pool lacks experience with unusual or specialized construction
techniques, the additional cost for a consultant might be the most effective way to secure
knowledge of the local building codes.
 Cost Estimation
• Estimating is the process of forecasting or approximating the time and cost of
completing project deliverables.
• Estimating processes are frequently classified as top-down and bottom-up.
• Top-down estimates are usually done by senior management. Management will
often derive estimates from analogy, group agreement, or mathematical
relationships.
• Bottom-up estimates are typically performed by the people who are doing the
work. Their estimates are based on estimates of elements found in the work
breakdown structure.
• Cost, time, and budget estimates are the lifeline for control; they serve as the
standard for comparison of actual and plan throughout the life of the project.
• Project status reports depend on reliable estimates as the major input for
measuring variances and taking corrective action
Top-Down Approach Bottom-Up Approach
• The top-down approach to project • The bottom-up approach to project
management means that you start with the management means that you begin with
final deliverable (project goal) and break it brainstorming possible solutions to meet that
down into smaller, more manageable tasks. final deliverable.
• These tasks can be further broken down into • In other words, you know what the project goal
subtasks — great details — and then assigned is, but are not sure (yet) how to get there.
to individual teams and/or team members • A bottom-up approach involves all members of
within that team. the team working together to determine the
necessary tasks to reach that final end product.
Example: You need to update the FAQ section on Example: You are embarking on an entirely new
your website. This is a task your team has product based on feedback from your customers.
completed in the past. The scope is clear, the You need input from the entire team as this is a
timeline defined, the subtasks straightforward. A process you’ve never been through before. A
perfect time for a simple, top-down approach. bottom-up approach works best in this situation.
Top-down tends to be more autocratic (we are Bottom-up tends to be more democratic (we are
telling you what to do, now go do it). not sure how to do it, but as a team, we’ll figure it
out).
Top-Down Approach Bottom-Up Approach
Many companies use the top-down approach in their Many companies use the bottom-up approach in their
management and decision-making processes, including: management and decision-making processes, including:
1. IBM 1. Toyota
2. Microsoft 2. Hyundai
3. Google 3. Ford
4. Apple 4. Volkswagen
5. Amazon 5. Samsung
6. GE 6. Nokia
7. Intel 7. Dell
8. JPMorgan Chase 8. Hewlett-Packard
9. Goldman Sachs 9. Cisco Systems
10. Procter & Gamble. 10. Oracle
More Examples More Examples
• Company Management Structure: A CEO creates a • Cooking a Meal: A chef starts with individual
strategic plan for the company and delegates tasks to ingredients and combines them to create a dish.
department managers, who in turn delegate to their • Assembly Line: Workers assemble individual parts to
subordinates. create a final product.
• Software Development: A software architect creates a • Problem-Solving: Breaking down a large problem into
high-level design, which is then divided into smaller smaller parts and solving each one individually.
tasks for software engineers to implement.
Top-Down Approaches for Estimating Project
Times and Costs
• Delphi (Consensus) Method: Uses the pooled experiences of senior and/or

middle managers to discuss thoroughly and ultimately reach an agreement of

best estimate of the total project duration and costs in the initial stage.

• Apportionment (analogous) technique: Uses good historical data of past

projects that are relatively standard with minor variation or customization as a

reference to allocate duration and costs to the current project

Apportion Method of Allocating Project Costs
Using the Work Breakdown Structure
Top-Down Approaches for Estimating Project
Times and Costs
• Ratio Method (Parametric Method)

• Function Point Method

• Learning Curves
Parametric estimating technique

• If you are estimating the cost of building a new office space and you
know from historical data that the cost per square foot for similar
projects is $200:

• Project Size: 10,000 square feet

• Cost per Square Foot: $200

• Estimated Project Cost = 10,000 sq ft * $200/sq ft = $2,000,000

Function Point Method
• Difficulties in developing realistic estimates for large-scale software
projects.

• Function point analysis is a system for estimating the size of software

projects based on what the software does.

• Function points are standard units of measurement that represent

the functional size of a software application.
Function Point Method
• Suppose a local restaurant commissioned a firm to develop a
replenishment and ordering system to ensure that minimum levels of
foods and beverages are always maintained.

• The restaurant wants the application to have a reasonable number of

input screens, output screens, a small number of query options and
interfaces, but large and detailed report generation capabilities.
Function Point Method
• Assume, we know that in building an input function for the
application, a system with high complexity is approximately three
times more complicated (and requires more effort) than one with low
complexity.

• Also, assume we know from past experience that one programmer

working for one month (a “person-month”) at our firm can generate
an average of 10 function points.
Simplified Basic Function Point Count Process
Function Point Method
• Suppose we determined from our interviews with the restaurant
owners that the estimate for relative complexity was inputs
(medium), outputs (high), interfaces (low), queries (medium), and
files (low).

• Further, we know that the clients require the following numbers of

each function: input screens (15), output screens (20), interfaces (3),
queries (6), and report files (40).
Simplified Basic Function Point Count Process
for a Prospective Project or Deliverable
Function Point Method
• We know that our organization estimates that each resource can perform
10 function points each “person-month.” Therefore, we calculate the
expected number of person-months to complete this job as 409/10 = 40.1.

• If we assigned only four programmers to this job, it would take

approximately 10 months to complete. On the other hand, by assigning 10
programmers, we would expect to complete the job in just over four
months.

• Function point analysis is not an exact science. Complexity determinations

are based on historical estimates that can change over time and so must be
continuously updated.
LEARNING CURVES
• Cost estimation, particularly for labor hours, often takes as its assumption a steady
or uniform rate at which work is done.
• In the case of having to perform multiple activities, the amount of time necessary to
complete the first activity is not significantly different from the time necessary to
complete the nth activity.
• For example, in software development, it may be considered standard practice to
estimate each activity cost independently of other, related activities with which the
programmer is involved.
• Therefore, in the case of a programmer required to complete four work assignments,
each involving similar but different coding activities, many cost estimators will simply
apply a direct, multiplicative rule-of-thumb estimate:
LEARNING CURVES
• Consider a project that requires 25 units of a complex electronic device to
be assembled.
• The firm is experienced in building electronic equipment but has never
before made this specific device, which differs significantly from the items
routinely assembled.
• Experience might indicate that if the firm were to build many such devices,
it would use about 70 hours of direct labor per unit.
• If labor is paid a wage of $12 per hour, and if benefits equal, the estimated
labor cost for the 25 units is

• ($12/hr)*(25 units)*(70 hr/unit) = $21000

 LEARNING CURVES
• Human performance usually improves when a task is repeated
• This happens by a fixed percent each time the production doubles
• More specifically, each time the output doubles, the worker hours per unit
decrease to a fixed percentage of their previous value. That percentage is called
the learning rate.
• If an individual requires 10 minutes to accomplish a certain task the first time it is
attempted and only 8 minutes the second time, that person is said to have an 80
percent learning rate.
• If output is doubled again from two to four, we would expect the fourth item to be
produced in 8(0.8)= 6.4 min
• Similarly, the eighth unit of output should require 6.4(0.8) = 5.12 min and so on.
LEARNING CURVES
• The time required to produce a unit of output follows a well-known formula:

𝑇𝑛 = 𝑇1 𝑛𝑟
𝑊ℎ𝑒𝑟𝑒:
𝑇𝑛 = time required for the nth unit of output
𝑇1 = time required for the initial unit of output
n= the number of units to be produced
r= learning curve slope
= log decimal learning rate/log(2)
LEARNING CURVES
• In the example of the electronic device just given, assume that after producing
the twentieth unit, there is no significant further improvement (i.e., assembly
time has reached a steady state at 70 hours). Further assume that previous study
established that the usual learning rate for assemblers in this plant is about 85
percent.
Example
• Assume the need to conduct a project cost estimation in the case of construction,
where one resource will be tasked to perform multiple iterations of a similar
nature (e.g., fitting, riveting, and squaring).
• The worker must do a total of 15 of these activities to reach the steady state.
• Also, assume that the time estimated to perform the last iteration (the steady
state) is 1 hour, and we know from past experience the learning rate for this
highly repetitive activity is .60.
Example
• Your firm designs PowerPoint slides for computer training classes, and you have
just received a request to bid on a contract to produce the slides for an eight-
session class. From previous experience, you know that your firm follows an 85
percent learning rate. For this contract it appears the effort will be substantial,
running 50 hours for the first session. Your firm bills at the rate of $100/hour and
the overhead is expected to run a fixed $600 per session. The customer will pay
you a flat fixed rate per session. What will be the total bid price, the per session
price?
Example
• A former construction company executive just started a new company called
Cookie-Cutter Homes. The company only makes one home type, so as to
maximize the learning curve effect. The entrepreneur assumes that his company
will realize a 75 per cent learning curve effect. The first home took 200 days to
complete. How long will it take to produce the 5th home? How about the 10th
home? What about the 100th home? What about the 104th home?
Bottom-up Approaches for Estimating Project
Times and Costs
• Template Method: If the project is similar to past projects, the costs from past
projects can be used as a starting point for the new project.

• Differences in the new project can be noted and past times and costs adjusted to
reflect these differences.

• For example, a ship repair drydock firm has a set of standard repair projects (i.e.,
templates for overhaul, electrical, mechanical) that are used as starting points for
estimating the cost and duration of any new project.
Bottom-up Approaches for Estimating Project
Times and Costs
• Parametric Procedures Applied to Specific Tasks
• Just as parametric techniques such as cost per square foot can be the
source of top-down estimates, the same technique can be applied to
specific tasks.
• For example, as part of an MS Office conversion project, 36 different
computer workstations needed to be converted.
• Based on past conversion projects, the project manager determined
that on average one person could convert three workstations per day.
• Therefore the task of converting the 36 workstations would take three
technicians
 Bottom-up Approaches for Estimating Project
Times and Costs
• Range Estimating:
Range estimating
works best when
work packages
have significant
uncertainty
associated with
the time or cost to
complete.
Deciding Which Approach Is Right for Your
Project
• Ultimately, the decision of which approach is best for your project will
depend on the specific goals and resources available.
• If you have a clear vision and need to meet tight deadlines, a top-down
approach may be best for you.
• On the other hand, if you need to involve many stakeholders and
require flexibility in your project, then a bottom-up approach may be
most suitable for your needs.
• The top-down project management model is more appropriate when
projects have a clear goal and timeline.
• On the contrary, the bottom-up approach is a better fit for projects that
require collaboration and creativity.
Why Estimating Time and Cost Are Important
• To support good decisions.

• To schedule work.

• To determine how long the project should take and its cost.

• To determine whether the project is worth doing.

• To develop cash flow needs.

• To determine how well the project is progressing.

• To develop time-phased budgets and establish the project baseline.

Factors Influencing the Quality of Estimates
Developing Work Package Estimates
Common Sources of Project Cost
Labor • Labor costs are those associated with hiring and paying the various personnel involved in
developing the project.
• These costs can become complex, as a project requires the services of various
classifications of workers (skilled, semiskilled, laborers) over time.
• At a minimum, a project cost estimation must consider the personnel to be employed,
salary and hourly rates, and any overhead issues such as pension or health benefits.
Materials • Materials costs apply to the specific equipment and supplies the project team will require
to complete project tasks.
• For building projects, materials costs are quite large
• For many other projects, the actual materials costs may be relatively small, for example,
the purchase of a software package that allows rapid compiling of computer code.
Common Sources of Project Cost
Subcontractors • When subcontractors provide resources (and in the case of consultants, expertise) for
the project, their costs must be factored into the preliminary cost estimate for the
project and be reflected in its budget.
Equipment • Projects may be developed away from the firm’s home office, requiring members of
and facilities the project team to work offsite.
• Firms commonly include rental of equipment or office facilities as a charge against
the cost of the project.
• For example, oil companies routinely send four- or five-person site teams to work at
the headquarters of major subcontractors for extended periods.
• The rental of any equipment or facility space becomes a cost against the project.
Travel • If necessary, expenses that are related to business travel (car rentals, airfare, hotels,
and meals) can be applied to the project as an up-front charge.
Types of Cost

❖Direct Vs. Indirect

❖Direct: clearly assigned
❖Indirect: overhead, administration, marketing

❖Recurring Vs. Nonrecurring

❖Fixed Vs. Variable

❖Normal Vs. Expedited

Types of Cost

❖Direct Vs. Indirect

❖Direct: clearly assigned
❖Indirect: overhead, administration, marketing

❖Recurring Vs. Nonrecurring

❖Fixed Vs. Variable

❖Normal Vs. Expedited

Direct Vs. Indirect
Direct Cost Indirect Cost
• Direct costs are those clearly assigned to the • Indirect costs, on the other hand, generally
aspect of the project that generated the cost. are linked to two features: overhead, and
• Labor and materials may be the best selling and general administration.
examples. • Overhead costs are perhaps the most
• All labor costs associated with the workers common form of indirect costs and can be
who build a house are considered direct costs. some of the more complex ones to estimate.
• The formula for determining total direct labor • Overhead costs include all sources of indirect
costs for a project is straightforward: materials, utilities, taxes, insurance, property
• Total direct labor costs = (Direct labor and repairs, depreciation on equipment, and
rate)(Total labor hours) health and retirement benefits for the labor
force.
Project Price Breakdown
Types of Cost

❖Direct Vs. Indirect

❖Direct: clearly assigned
❖Indirect: overhead, administration, marketing

❖Recurring Vs. Nonrecurring

❖Fixed Vs. Variable

❖Normal Vs. Expedited

 Recurring Vs. Nonrecurring
• Costs can also be examined in terms of the frequency with which they occur; they can be
recurring or nonrecurring.
• In budget management and cost estimation, it is necessary to highlight recurring versus
nonrecurring charges.

Nonrecurring Cost Recurring Cost

• Nonrecurring costs might be those associated with • Recurring costs are those that typically continue to
charges applied once at the beginning or end of the operate over the project’s life cycle.
project, such as preliminary marketing analysis, • Most labor, material, logistics, and sales costs are
personnel training, or outplacement services. considered recurring because some budgetary
• In budget management and cost estimation, it is charge is applied against them throughout
necessary to highlight recurring versus significant portions of the project development
nonrecurring charges. cycle.
Types of Cost

❖Direct Vs. Indirect

❖Direct: clearly assigned
❖Indirect: overhead, administration, marketing

❖Recurring Vs. Nonrecurring

❖Fixed Vs. Variable

❖Normal Vs. Expedited

 Fixed Vs. Variable
Fixed Cost Variable Cost
• Fixed costs, as their title suggests, do not vary with • Variable costs are those that accelerate or increase
respect to their usage. through usage; that is, the cost is in direct proportion
• For example, when leasing capital equipment or to the usage level.
other project hardware, the leasing price is likely not • Suppose, for example, we used an expensive piece of
to go up or down with the amount of usage the drilling equipment for a mining operation.
equipment receives. • The equipment degrades significantly because of use
• Whether a machine is used for 5 hours or 50, the cost in a particularly difficult geographical location.
of its rental is the same. • In this case, the variable costs of the machinery are in
• When entering fixed-rate contracts for equipment, a direct proportion to its use.
common decision point for managers is whether the
equipment will be used sufficiently to justify its cost.
Types of Cost
❖Direct Vs. Indirect
❖Direct: clearly assigned
❖Indirect: overhead, administration, marketing

❖Recurring Vs. Nonrecurring

❖Fixed Vs. Variable

❖Normal Vs. Expedited

 Normal Vs. Expedited
Normal Cost Expedited Cost
• Normal costs refer to those incurred in the routine • Expedited costs are unplanned costs incurred when
process of working to complete the project per the steps are taken to speed up the project’s completion.
original, planned schedule agreed to by all project For example, suppose the project has fallen behind
stakeholders at the beginning of the project. schedule and the decision is made to “crash” certain
• Certainly, this planned schedule may be very project activities in the hopes of regaining lost time.
aggressive, involving extensive overtime charges to • Among the crashing costs could be expanded use of
meet the accelerated schedule; nevertheless, these overtime, hiring additional temporary workers,
costs are based on the baseline project plan. contracting with external resources or organizations
for support, and incurring higher costs for
transportation or logistics in speeding up materials
deliveries.
Cost Classifications
Cost Classifications
 Creating a Project Budget
• The process of developing a project budget is an interesting mix of estimation,
analysis, intuition, and repetitive work.
• The central goal of a budget is the need to support rather than conflict with the
project’s and the organization’s goals.
• The project budget is a plan that identifies the allocated resources, the project’s
goals, and the schedule that allows an organization to achieve those goals.
• Effective budgeting always seeks to integrate corporate-level goals with
department-specific objectives, short-term requirements with long-term plans, and
broader, strategic missions with concise, needs-based issues
Creating a Project Budget
Statement The budget is a plan
of WBS
Work that identifies the
resources, goals and
Project schedule that allows a
Plan firm to achieve those
Scheduling Budgeting goals

• Top-down budgeting
• Bottom-up budgeting
 Project Budget
Template
https://www.wallstreetmojo.com/project-
budget-template/

https://www.spreadsheet.com/template/project-
budget
Top-down vs Bottom up budgeting
• Top-down budgeting refers to a budgeting method where senior management prepares a high-
level budget for the company. The company’s senior management prepares the budget based
on its objectives and then passes it on to department managers for implementation.
Budget Contingencies
The allocation of extra funds to cover uncertainties and improve the
chance of finishing on time.

Contingencies are needed because

❑Project scope may change

❑Murphy’s Law is present
❑Cost estimation must anticipate interaction costs
❑Normal conditions are rarely encountered
Activity-based costing (ABC)
• Activity-based costing (ABC) a method of assigning overhead
and indirect costs—such as salaries and utilities—to products
and services.

• Activity-based costing consists of four steps:

1. Identify the activities that consume resources and assign costs to them, as is done in
a bottom-up budgeting process.
2. Identify the cost drivers associated with the activity. Resources in the form of project
personnel and materials are key cost drivers.
3. Compute a cost rate per cost driver unit or transaction. Labor, for example, is
commonly simply the cost of labor per hour, given as: 𝐶𝑜𝑠𝑡 𝑟𝑎𝑡𝑒/𝑢𝑛𝑖𝑡 → $𝐶𝑜𝑠𝑡/ℎ𝑜𝑢𝑟
4. Assign costs to projects by multiplying the cost driver rate times the volume of cost
driver units consumed by the project. For example, assume the cost of a senior
software programmer is $40/hour and that she is to work on the project for a total of
80 hours. The cost to the project would be:
($40/hr)(80 hours) = $3,200.00
Cost Estimates

➢Ballpark (order of magnitude)

➢Comparative

➢Feasibility

➢Definitive
Ballpark • Sometimes referred to as order of magnitude estimates, ballpark estimates are
estimate typically used when either information or time is scarce.
• Companies often use them as preliminary estimates for resource requirements or
to determine if a competitive bid can be attempted for a project contract.
• The unofficial rule of thumb for ballpark estimates is to aim for an accuracy of
±30%
Comparative • Comparative estimates assume that historical data can be used as a frame of
estimates reference for current estimates on similar projects.
• For example, Boeing Corporation routinely employs a process known as
parametric estimation, in which managers develop detailed estimates of current
projects by taking older work and inserting a multiplier to account for the impact
of inflation, labor and materials increases, and other reasonable direct costs.
• comparative cost estimation cannot achieve a degree of accuracy closer than ±15%
Feasibility • These estimates are based on real numbers or figures derived after the completion
estimates
of the preliminary project design work
• Feasibility estimates are routinely used for construction projects, where there are
published materials cost tables that can give reasonably accurate cost estimates for a
wide range of project activities based on an estimate of the quantities involved.
• Because they are developed farther down the life cycle, feasibility estimates are
often expressed in terms of a degree of accuracy of ±10%.
Definitive • These estimates can be given only upon the completion of most design work, at a
estimates
point when the scope and capabilities of the project are quite well understood.
• At this point all major purchase orders have been submitted based on known prices
and availabilities, there is little or no wiggle room in the project’s specifications, and
the steps to project completion have been identified and a comprehensive project
plan put in place. Definitive estimates can be expected to have an accuracy of ±5%.