3.11. Cost Estimation/Budgeting

Ultimately, cost, the number management typically cares about most in a for-profit organization, is determined by the price. For many projects, knowing the exact cost of an endeavour is impossible until it is completed. Stakeholders can agree on the intended value of a project at the beginning, and that value has an expected cost associated with it. But you may not be able to pin down the cost more precisely until you’ve done some work on the project and learned more about it.

To estimate and manage costs effectively, it is important to understand the different types of costs:

• Direct Costs: “An expense that can be traced directly to (or identified with) a specific cost centre or cost object such as a department, process, or product” (Business Dictionary, n.d.). Examples of direct costs include labour, materials, and equipment. A direct cost changes proportionately as more work is accomplished.
• Direct Project Overhead Costs: Costs that are directly tied to specific resources in the organization that are being used in the project. Examples include the cost of lighting, heating, and cleaning the space where the project team works. Overhead does not vary with project work, so it is often considered a fixed cost.
• General and Administrative (G&A) Overhead Costs: The “indirect costs of running a business,” such as IT support, accounting, and marketing” (Tracy, n.d., para. 1).

Many contracts include both fixed-price and cost-plus features. For example, they might have a fixed price element for those parts of the contract that have low variability and are under the direct control of the project team (e.g., direct labour) but have variable cost elements for those aspects that have a high degree of uncertainty or are outside the direct control of the project team (e.g., fuel costs or market-driven consumables).

It is important to come up with detailed estimates for all the project costs. Once this is compiled, you add up the cost estimates into a budget plan. It is now possible to track the project according to that budget while the work is ongoing.

Often, when you come into a project, there is already an expectation of how much it will cost or how much time it will take. When you make an estimate early in the project without knowing much about it, that estimate is called a rough order-of-magnitude estimate (or a ballpark estimate). This estimate will become more refined as time goes on and you learn more about the project.

The project team will work through several processes to determine the overall estimate of a project’s cost. It will be your job to keep track of all of the documents supporting the estimate. That way, you will be able to support the assumptions made when the team creates their final estimate and develops a budget. We’ll learn more about document storage and organization in a later chapter, but knowing now that some of the bigger documents (budget, timeline, etc.) will have smaller supporting documents that need to be stored together will help you as you work to develop a document management system.

Estimating Costs to Compare and Select Projects

As an Office Administrator, it’s helpful to understand how project costs are estimated during the selection phase. Economic factors are important when choosing between projects. To compare projects, we need to estimate their costs accurately enough to make meaningful comparisons. However, the time and resources used for these estimates should match the project’s size and complexity.

Estimating Methods

During the selection phase, cost estimates are usually quicker and use fewer resources than detailed estimates made later. These early estimates rely on the expert judgment of experienced managers who can make accurate estimates with less detailed information. They often use information from previous projects, adjusted to match the current project’s size and complexity, or standardized formulas.

Analogous Estimate

An analogous estimate is based on the costs of similar projects. If a similar project costs a certain amount, it’s reasonable to assume the current project will cost about the same. Since no two projects are exactly alike, the estimate must be adjusted for differences in size and complexity. This adjustment is based on the estimator’s experience, including lessons learned from past projects.

Parametric Estimate

If the project consists of activities that are common to many other projects, average costs are available per unit. For example, if you ask a construction company how much it would cost to build a standard office building, the estimator will ask for the size of the building in square feet and the city in which the building will be built. From these two factors—size and location—the company’s estimator can predict the cost of the building. Factors like size and location are parameters—measurable factors that can be used in an equation to calculate a result. The estimator knows the average cost per square foot of a typical office building and adjustments for local labour costs. Other parameters, such as the quality of finishes, are used to refine the estimate further. Estimates that are calculated by multiplying measured parameters by cost-per-unit values are parametric estimates.

Activity-Based Estimates

An activity can have costs from multiple vendors and internal costs for labour and materials. Detailed estimates from all sources can be reorganized so those costs associated with a particular activity can be grouped by adding the activity code to the detailed estimate.  The detailed cost estimates can be sorted and then subtotalled by activity to determine the cost for each activity.

Figure 3.7 Detailed Costs Associated With Activities

“6.3. Cost Estimation” from Essentials of Project Management by Adam Farag is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 4.0 International License, except where otherwise noted.