introduction
Cost Estimation is one of the 4 core components of project cost management and an integral part of the budgeting process.
Without proper Cost estimate >> it’s impossible to allocate and utilize funds properly and ensure that the team won’t experience cost overruns at some point throughout the course of project realization.
Overall, estimation is a significant prerequisite of a project’s long-term financial health, and it is essential to invest enough effort in performing this practice the right way.
The process of cost estimation determines an amount of resources required to accomplish project activities. It involves the approximation and development of costing alternatives to plan, perform and deliver the project. It focuses on finding and allocating optimal expenses for the job.
The process is vital to determining whether the project will be successful, whether the goals and objectives will be achieved and whether the deliverables will be produced. Considering this statement, the following definition of a successful project can be made: the project becomes successful if it meets the following success criteria.
- the scope is developed and on-budget and on-schedule;
- the quality expectation are met; and
- the expected benefits are received by stakeholders
Cost Estimate Concepts
Integrity
- Any cost estimate should be produced with a high standard of ethical integrity and by following an open and transparent process. Any uncertainties and vagueness associated with the estimate should be explained in an easy-to-understand manner and in laymen’s terms. This principle allows avoiding false precision and rash decisions by integrating all people involved in the process into a team which works as a single mechanism and uses the same sources of information.
information Accuracy and Relevance
- The development of cost estimates should be based only on the best information available. When a planner develops an estimate, engineering judgement and technical advice should be applied to any assumption made at that estimate. By following this principle, all information used for developing estimates can be thoroughly considered, filtered and refined in order to get the most accurate and relevant pieces of that information.
Uncertainty and Risk
- Any type of project cost should be identified and included in an estimate considering uncertainty and risk. For this purpose an exhaustive method of assessing and re-assessing project risks and uncertainties should be employed. A kind of cost estimation software can be used to associate each cost with potential risks or uncertainties surrounding the project. This software will also allow considering risks by producing accurate contingencies in cost estimates that may be used later on for developing a risk management plan.
Expert Team
- This principle assumes that only a skilled, interdisciplinary team should produce cost predictions and make calculations. Project cost estimation sheets should be developed utilizing a clearly defined statement of work. The expert team needs to use methodological tools and approaches to develop their expenditure forecasts. The team can be composed of project team members, experienced personnel of the performing organization, as well as experts from outside qualified agencies. Technical, managerial, and communication skills are required for the candidates. They should also be able to identify and evaluate critical issues and risks.
Validation
- The expert and unbiased team should validate cost predictions. First, the project manger develops initial estimates and submits them to the team for validation. A second independent judgment will help then make the estimates more correct and capture different perspectives on the estimating process. This principle becomes more important to complex projects which require producing large estimates.
Release and Use
- It assumes that while cost estimates might have been developed for a specific purpose, they can be used improperly by those people who do not understand the real context. Until the expert team has been thoroughly reviewed the estimates and validated their content, these estimates shouldn’t be released to the project team and stakeholders in order to avoid misuse and misunderstanding. This approach allows the estimates to be consistent with the project scope and accurate indicators of the real expenses.
What to cost ?
the following are subjected to cost estimate
- cost of quality effort
- cost of risk effort
- cost of project manager time and his team
- cost of project management activities
- direct cost to project , like material , tools , labor , training , computers ..etc
- expenses of offices and spaces used directly for project
- profit when applicable
- overhead cost like salaries of management
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Project Cost Types
All the costs of a project can be broken down into these three types:
Variable and Fixed
- Fixed Cost refers to as a cost which is not to be changed throughout the project lifecycle. It doesn’t change an increase or reduction of the work amount. Examples are setup cost, rental cost, cost for hiring of equipment, etc.
- Variable Cost refers to as any chargeable amount that can be changed with the amount of project work. An increase or reduction of project scope causes the respective change in variable cost. Examples are production materials expenses, remuneration of project team, cost of power and water.
Direct and Indirect
- Direct Cost is directly associated with particular tasks or/and activities. Examples are team wages and expense on materials used.
- Indirect Cost is expenses on overhead items (overheads). It doesn’t refer to as the project value. Examples are corporate tax, fringe benefit tax.
Opportunity
- Opportunity Cost is associated with an opportunity of a choice. When you select between two different projects, or activities within one project, you can consider opportunity expense of each project (activity) and then make your choice.
Estimate Cost Tools
Analogous Review
- This technique is also known as “Historical Data Analysis.” It assumes using the actual cost of previous or analogues projects as the foundation for estimating the cost of the current project. This technique is usually applied to separate segments of the project and in combination with other methods and tools.
Parametric Model
- It allows using historical and statistical data to make a model of activity parameters (like scope, budget and duration). It may provide a higher degree of accuracy depending on the data included in the parametric model. The technique can be used separately as well as in combination with other approaches and tools.
Bottom-up Analysis
- This analysis supports the idea that the individual cost of each activity or entire work package is of prime importance. By using the method, individual scheduled activities, or a work package, can be estimated to the smallest detail. All estimates are grouped and sorted by categories, and then gathered into a summary table that is used for tracking, control and reporting purposes.
Top-down Analysis
- This technique is opposite to Bottom-up Analysis. It assumes that the overall budget is determined at the project’s beginning and the expert team needs to identify the costs of each work item (task or job). The technique allows determining the number of required activities and tasks referring to the WBS (Work Breakdown Structure) which reflects the necessary work items and work packages. By using the WBS, the expert team can determine the quantity of the work items that can be delivered within the fixed budget. They may decide to add or remove certain items in the WBS in order to fit the fixed budget.
Reserve Estimating
- Since Quality Assurance and Quality Control are integrated parts of the cost estimation process, this technique is used to deal with uncertainties (which may overstate or understate project costs) by making reviews. It assumes that costs may include reserves (or contingency allowances) which can be used for mitigating uncertainties and responding to threats. Reserves should be estimated and then added to cost estimates in order to allow applying the critical chain method and risk mitigation strategies.
Cost Estimate : Inputs -Techniques - Outputs
Inputs
- cost management plan
- HR management plan
- scope baseline
- project schedule
- risk register
- OPA
- EEF
Techniques
- expert judgment
- analogous estimating
- parametric estimating
- three-point estimating
- bottom-up estimating
- reserve analysis
- cost of quality
- project management software
- vendor bid analysis
- group decision-making techniques
Outputs
- activity cost estimate
- basis of estimaing
- update project documents
Cost Estimate : Inputs
Project Management Plan
The specific guidelines that affect this process are:
- Units of measure–this will be in dollars or the base currency of whatever country the project is being done in
- Level of precision–how will the cost estimates be rounded up or down
- Level of accuracy–what is the acceptable range, usually expressed in terms of plus or minus percentage, for determining realistic cost estimates.
Scope baseline
there are three separate documents that comprise the scope baseline, which are
1- Project scope statement
- breaks down the scope from the requirements to the deliverables needed to fulfill those requirements; may contain some overall financial assumptions and constraints that will affect the budget
2- WBS (Work Breakdown Structure)
- –the scope is broken down further from the deliverables to the level of work packages, which then are broken down to the level of the activities needed to complete each work package.
3- WBS Dictionary
- contains information on the work packages, and will be updated with the cost estimate of the work package during the course of this process
Quality management plan–information on cost of quality contained in this management plan may be used to evaluate the cost impact of quality-related activities on the project.
Project Documents
These are listed according to the knowledge area they pertain to.
1- Integration Knowledge Area
- Lessons learned register–this will be updated as a result of this process if there are any lessons learned during the cost estimating process that will be helpful to improve the accuracy and precision of the cost estimates
2- Schedule Knowledge Area
- Project schedule–this is the output of process 6.5 Develop Schedule. The duration estimates of each work package or activity (an output of process 6.4 Estimate Activity Durations), combined with the information on the resources needed (see resource requirements document below), will be used to create the cost estimates, especially if those resources are charged per unit of time.
3- Resource Knowledge Area
- Resource requirements–this identifies the types and quantities of resources required for each work package or activity. This, combined with the information contained in the project schedule of the duration estimates of each work package or activity (an output of process 6.4 Estimate Activity Durations), will be used to create the cost estimates during this process.
4- Risk Knowledge Area
- Risk register–the risk register (an output of process 11.2 Identify Risks, and updated in every risk management planning process that follows it) contains information that can be used to estimate costs, especially when obtaining three-point estimates that include optimistic and pessimistic assumptions.
Enterprise Environmental Factors
- Market conditions–these will determine the standard costs for resources that may be used on the project
- Published commercial information–for any particular application area, there may be databases that contain standard human resource costs and standard costs for material and equipment that may be used on the project.
Organizational Process Assets
- Historical information and lessons learned repository, especially from similar projects to the one being done at present
- Cost estimating policies and templates (should be included in the Cost Management Plan)
With these inputs, we are ready to discuss the tools and techniques of this process. Some of these are “generic” tools and techniques used in any planning process, such as expert judgment, decision making, and the Project Management Information System (the software program such as Microsoft Project). However, there are some that are specific to the duration and cost estimating processes, such as
- analogous estimating
- parametric estimating
- bottom-up estimating
- three-point estimating
- data analysis techniques such as alternatives analysis, reserve analysis, and cost of quality
Cost Estimate : Techniques
Expert Judgement
- While estimating the project cost, the first step is to take the comments from the experts. The experts are the people who have prior knowledge on similar kind of projects. So they can suggest valuable insight based on their experience. You can also take their advice on various tools and techniques that can be used to estimate similar kind of project.
Analogous Estimation
- Normally, at the early stages of your project, you do not have much detail, so taking into account of similar projects previously completed by your organization, the cost of the project can be estimated. Analogous estimation technique uses the parameters such as scope, budget, duration, size, weight and complexity of previous projects having similar nature of works. It measures the current project on that basis and does the estimation
- The technique is less costly and less time-consuming. But the accuracy of this estimation is lower than the other estimation techniques as it is purely based on historical data. It can be applied to the whole project or some part of the project in combination with other techniques.
- For example, if the budget of a particular activity in the previous project has X amount, and by measuring the same activity in your current project looks identical, then the same X amount can be applied to that.
Parametric Estimation
- This technique uses an algorithm to calculate the cost of the activity considering the historical data and other project variables. A statistical relationship needs to be evaluated between the historical data and other variables. This technique can be used for the complete project or for some
- of the activities in conjunction with other estimation techniques. This is one of the most accurate techniques to estimate the cost of the project.
Bottom-Up Estimation
- Bottom-up estimation technique starts with the estimation from the lower level i.e. the work package level created as per WBS and then rolled up to higher-level. The accuracy of this estimation technique is high as you are doing the estimation from granular level
Three-Point Estimation
- To deal with uncertainties and risk, you need to take the help of three-point estimation which is also referred as PERT- Program Evaluation and Review Technique.
The Program Evaluation and Review Technique use three types of estimations:
- M – Most Likely: The realistic or ideal situation, all the required resources will be assigned and can achieve the expected productivity
- O – Optimistic: Estimation based on best case scenario
- P – Pessimistic: Estimation based on worst case scenario
Based on the above assumptions, the expected duration can be calculated using two basic formulas.
- Triangular Distribution – (O+M+P)/3
- Beta distribution – (O+4M+P)/6
Reserve Analysis
- To deal with uncertainty, you need to allocate some funds called as the contingency reserve. That is the part of the cost baseline to mitigate the identified and accepted risks. Also for unknown risks, an amount needs to be estimated which is called management reserve. This is not included in the cost baseline but part of the overall project budget. It is important to keep the reserve budget to deal with uncertain events. The contingency reserve is under the project manager authority, while to use the management reserve the project manager need to take approval from the sponsors.
Cost of Quality
- Basically, two types of costs are there to ensure the quality, one is called the cost of conformance which is the budget required for prevention and appraisals, and another one is cost of non-conformance that may be used up due to internal and external failures. Cost of quality means estimating the cost of both conformance and non-conformance expenses.
Project Management Software
- There are some tools which can be used to perform the project cost estimation, such as cost estimating software application, spreadsheets, simulation and statistical tools.
Vendor Analysis
- This is another technique to estimate the cost by comparing the various bids proposed by the vendors. There may be differences in their bids but you can get an idea considering the average bid values.
Group Decision Making Techniques
- This technique emphasizes the involvement of a group of people who are going to perform the technical work. By involving those you will gain more details on the work and thus helpful to estimate more accurately. Also, it develops a commitment from the people who are involved in the discussion to complete the work as estimated.
- Depending upon the nature of your project, either you can apply these techniques together or in combinations of few techniques to estimate the project cost. Also, keep in mind that the estimations are never drawn to an exact figure; it is always in the probable ranges. In the initial phases, the preliminary estimate ranges between -15% to +50%, while the rough order of magnitude estimates in between -25% to +75%. And the budget estimate falls in -10% to +25% ranges.
Cost Estimate : outputs
One of the outputs of the Estimate Costs process is activity cost estimates. These are quantitative amounts—usually stated in monetary units—that reflect the cost of the resources needed to complete the project activities. The tools and techniques I just described help you derive these estimates. Resources in this case include human resources, material, equipment, information technology needs, and so on, as well as any contingency reserve amounts and inflation factors (if you’re using them).
The remaining outputs of the Estimate Costs process are basis of estimates and project document updates. Basis of estimates is the supporting detail for the activity cost estimates and includes any information that describes how the estimates were developed, what assumptions were made during the Estimate Costs process, and any other details you think are needed. According to the PMBOK® Guide, the basis of estimates should include at least the following:
- A description of how the estimate was developed or the basis for the estimate.
- A description of the assumptions made about the estimates or the method used to determine them.
- A description of the constraints.
- A range of possible results. You should state the cost estimates within ranges such as $5000 ± 10%.
- The confidence level regarding the final estimates.
