project management c8 -cost_estimation_and_budgeting

The Importance of Project Cost Management

• Projects have a poor track record for meeting cost goals • Average cost overrun from 1995 CHAOS study was 189% of the

original estimates; improved to 145% in the 2001 study • The 2003 CHAOS studies showed the average cost overrun (the

additional percentage or dollar amount by which actual costs exceed estimates) was 43 percent.

• In 1995, cancelled projects cost i.e IT in the U.S. over $81 billion • U.S. lost $55 billion in projects i.e IT in 2002 from cancelled projects

and overruns compared to $140 billion in 1994.*

*The Standish Group, “Latest Standish Group CHAOS Report Shows

Project Success Rates Have Improved by 50%,” A Standish Group Research Note (3/25/03).

What is Cost and Project Cost Management?

Project Cost Management Processes

1. Resource planning: determining what resources and quantities of them should be used

2. Cost estimating: developing an estimate of the costs and resources needed to complete a project

3. Cost budgeting: allocating the overall cost estimate to individual work items to establish a baseline for measuring performance

4. Cost control: controlling changes to the project budget

Basic Principles of Cost Management

• Most CEOs and boards know a lot more about finance than technical/engineering, so technical project managers must speak their language

– Profits are revenues minus expenses

– Life cycle costing is estimating the cost of a project plus the maintenance costs of the products it produces

– Cash flow analysis is determining the estimated annual costs and benefits for a project

– Benefits and costs can be tangible or intangible, direct or indirect

– Sunk cost should not be a criteria in project selection

Example : Cost of Defects

When Defect is Detected Typical Cost of Correction

User Requirements $100-$1,000

Coding/Unit Testing $1,000 or more

System Testing $7,000 - $8,000

Acceptance Testing $1,000 - $100,000

After Implementation Up to millions of dollars

It is important to spend money up-front on projects to

avoid spending a lot more later.


1. Tangible costs – can easily measured.

2. Intangible costs – difficult to measure.

3. Direct costs - directly related to producing products and services.

4. Indirect costs - not directly related to the products or services of the project

5. Sunk cost - money that has been spent in the past


Quantity Produced

Un

it C

ost

When many items are produced repetitively, the unit cost of those items decreases in a regular pattern as more units are produced

http://www.google.com/url?sa=i&rct=j&q=&esrc=s&frm=1&source=images&cd=&cad=rja&docid=Gr0z4Am6mT242M&tbnid=PVwVvKFEduH-RM:&ved=0CAUQjRw&url=http://www.policonomics.com/lp-cost3-learning-curve/&ei=20glUvP4OcK3rgelvoHADw&bvm=bv.51495398,d.bmk&psig=AFQjCNFKvEJZ-lRFhs7kCZtd_XMaMPJhYQ&ust=1378261562002660

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Reserves are dollars included in a cost estimate to mitigate cost risk by allowing for future situations that are difficult to predict.

Contingency reserves allow for future situations that may be partially planned for (sometimes called known unknowns) and are included in the project cost baseline.

Management reserves allow for future situations that are unpredictable (sometimes called unknown unknowns).

Resource Planning

The nature of the project and the organization will affect resource planning

Some questions to consider: How difficult will it be to do specific tasks on the project?

Is there anything unique in this project’s scope statement that will affect resources?

What is the organization’s history in doing similar tasks?

Does the organization have or can they acquire the people, equipment, and materials that are capable and available for performing the work?

Cost Management Plan

• A cost management plan is a document that describes how the organization will manage cost variances on the project.

• A large percentage of total project costs are often labor costs, so project managers must develop and track estimates for labor.

Figure 7-1. Surveyor Pro Project Cost Estimate

Figure 7-2. Surveyor Pro Software Development Estimate

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall

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Common Sources of Project Cost

Labor

Materials

Subcontractors

Equipment & facilities

Travelling, Mileage, Allowances, Refreshments


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Name Hours Needed

Overhead Charge

Personal Time Rate

Hourly Rate

Total Direct Labor Cost

John 40 1.80 1.12 $21/hr. $1,693.44

Bill 40 1.80 1.12 $40/hr. 3,225.60

J.P. 60 1.35 1.05 $10/hr. 850.50

Sonny 25 1.80 1.12 $32/hr. 1,612.80

Total Direct Labor Cost =

$7,382.34

Eg: Labour Costs


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Cost Classifications

Direct Labor X X X X

Building Lease X X X X

Expedite X X X X

Material X X X X

No

n-r

ecu

rrin

g

Dir

ect

Ind

irec

t

Fixe

d

Rec

urr

ing

Var

iab

le

No

rmal

Exp

edit

ed

Costs

Cost Estimating

• An important output of project cost management is a cost estimate

• Several types of cost estimates and tools and techniques to help create them

• It is also important to develop a cost management plan that describes how cost variances will be managed on the project

VO = Variances Order


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Cost Estimation

Ballpark \ Yellow Pad \ Guesstimate 30%

Comparative 15%

Feasibility 10%

Definitive 5%

Types of Cost Estimates

Type of Estimate When Done Why Done How Accurate

Rough Order of

Magnitude (ROM)

Very early in the

project life cycle,

often 3–5 years

before project

completion

Provides rough

ballpark of cost for

selection decisions

–25%, +75%

Budgetary Early, 1–2 years out Puts dollars in the

budget plans

–10%, +25%

Definitive Later in the project, <

1 year out

Provides details for

purchases, estimate

actual costs

–5%, +10%

Cost Estimation Tools and Techniques

• 3 basic tools and techniques for cost estimates:

–analogous or top-down: use the actual cost of a previous, similar project as the basis for the new estimate

–bottom-up: estimate individual work items and sum them to get a total estimate

–parametric: use project characteristics in a mathematical model to estimate costs


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Problems with Cost Estimation

Low initial estimates

Unexpected technical difficulties

Lack of definition

Specification changes

External factors


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Creating a Project Budget

• Top-down

• Bottom-up

• Activity-based costing (ABC)

Project Plan

WBS

Scheduling Budgeting

The budget is a plan that identifies the resources, goals and schedule that allows a firm to achieve those goals


8-25

Activity-Based Costing

Projects use activities & activities use resources

1. Assign costs to activities that use resources

2. Identify cost drivers associated with this activity

3. Compute a cost rate per cost driver unit or transaction

4. Multiply the cost driver rate times the volume of cost driver units used by the project


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Months

Activity January February March April May Total by Activity

Survey 4,000 4,000

Design 5,000 3,000 8,000

Clear Site 4,000 4,000

Foundation 7,500 7,500

Framing 8,000 2,000 10,000

Plumb & Wire

1,000 4,000 5,000

Monthly Planned

4,000 9,000 10,500 9,000 6,000

Cumulative 4,000 13,000 23,500 32,500 38,500 38,500


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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

ABC VIDEO

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8-30

• Project Management Institute – home of the Project Management Body of Knowledge (PMBOK)

http://www.pmi.org/Pages/default.aspx

• NYS Project Management Guidebook Release 2 http://www.oft.state.ny.us/pmmp/guidebook2/index.htm

• FNS Handbook 901, Chapter 5 http://www.fns.usda.gov/apd/Handbook_901/V_1-2/Chapter_5.pdf

Booz Allen User

http://www.pmi.org/Pages/default.aspx

http://www.oft.state.ny.us/pmmp/guidebook2/index.htm

project management c8 -cost_estimation_and_budgeting

Education

cost management

project cost

resource planning

cost estimates

cost estimate

prentice hall

cost estimating

basic principles