Project Management

(Assignment 1)

Submitted Dr. Shyam Sunder

To Chitta
Submitted
Saptarshi Mukherjee
By
P.R.N 16021141097
 Cost and Budget estimation in Project Management

Cost budgeting is a tool to estimate the costs or necessary efforts for projects,
work packages or activities in project management. Cost budgeting includes
the estimation of costs, setting a fixed budget, and managing and controlling
the actual costs (compared to the estimated ones). The costs then have to be
allocated to the activities or work packages in a project. A carefully
implemented schedule and resource plan enables a more precise cost
budgeting.
Cost Estimate vs Budget
There are two processes within the cost knowledge area and planning process
group: Estimate Costs and Determine Budget. Both are required in order to
develop the project cost performance baseline.
Cost Estimate
The cost estimates are simply the costs associated with the work packages or
activities within the project schedule. Depending on the work package or
activity, the cost estimate may be determined using parametric, three-point, or
analogous estimating techniques.
It is important for all cost estimates to include any assumptions that were
made, where did the estimate originate, who provided the information, level
of confidence, etc.
Budget
The budget is built using the cost estimates and the project schedule. The
budget provides a view of how much the project is estimated to cost both from
a total and a periodic perspective. This budget feeds the cost performance
baseline which is then used as critical ingredient in performing earned value
analysis and other cost management variance analysis techniques.
The project budget must be in alignment with the organizations funding limits
in order to ensure the funding is available and has been appropriated.
Example
The bathroom remodeling project will include the following cost estimates:
Demolition $3,000: Week 1
Sheet rock $2,000: Week 2
Tile floor $3,500: Week 3
Fixture installation $1,500: Week 4
Painting $800: Week 4
Therefore the total budget is $10,800:
Week 1: $3,000
Week 2: $2,000
Week 3: $3,500
Week 4: $2,300
Both cost estimates and budget are needed in order to determine the cost
performance baseline and the project funding requirements.
Cost estimates are the estimated costs for each work package or activity,
whereas the budget allocates the costs over the life of the project to
determine the periodic and total funding requirements.
Estimating, Budgeting and Cost Control
1. Estimation
This typical process approach will provide a robust estimate based on previous
experience, recorded assumptions and a formula or analogy. Where possible it
should be supported by a stated rationale and be achieved by using a range to
match any project uncertainty. Additional estimating may then need to be
undertaken on areas of the project where wide cost ranges are identified.
Naturally the primary basis for the cost estimate is the projects technical
scope of work and as such every element of the projects WBS should be
reflected in the cost estimate. If the WBS does not allow the production of an
estimate to be made then it is not itself sufficiently detailed or the scope of
work is not fully matured on which to produce an accurate price estimate. The
technical scope should include information such as:
A detailed description of the work;
Any work not included in the scope but key to completion typically this could
cover preparation work, materials or even information performed or provided
by others
A description of any regulatory drivers, such as environmental, Health and
Safety and construction regulations;
Details of project deliverables, for example, for construction projects this may
be the completed project or just the building shell ready for equipment fit-out
by other parties.
Any constraints or special conditions on the project. Here a perfect example
would be the time constraints for sporting venues to be completed in time for
their programmed events or educational facilities which are required in
accordance with an academic timetable;
The Milestone progress dates and associated payments;
Project specific considerations such as site access and security for example,
both of which will have cost and time implications.
Plainly there are real project management benefits in having accurate
estimates of the costs associated with a project, however, the production of a
useful estimate takes time, resources and costs money to do well and provide
confidence on which to make investment decisions whether at the pre-bid
stage or in the execution of the project. It also needs to be recognized that
there are a number of common contributors & problems in cost estimating,
they are:-

Direct vs Indirect Cost

Direct Costs are those that can be measured and specifically tied to project
activities that produce the products or services. Most direct costs are also
classed as variable costs because the rate at which they are incurred will vary
depending on the rate at which work is being undertaken. Typically these
include the cost of labour, materials, equipment rentals and subcontractor
costs.
On the other hand, Indirect Costs are those which are incurred by the project
for common functions that benefit more than one project element or activity
and as such cannot be specifically identified with a single project element or
activity. Most indirect costs are incurred continuously, at a steady rate: they do
not depend on how much work is being performed. Thus they are also referred
to as fixed costs. Indirect costs are usually assigned to the individual activities
on a proportional basis of a function of the direct labour cost: area of space
used, for example. Typical categories of indirect costs are overhead, general
and administration costs and fringe benefits such as:
The salaries of the company directors and managers;
The costs of rent, rates, water, heating and lighting;
Cleaning and maintenance of plant and buildings costs;
Stationery, printing, communications;
Staff salaries in non-direct departments such as accounting, human
resources, marketing, office services and security.

The final estimate will therefore include both direct and indirect costs
associated with a project and should detail a negotiating margin, the minimum
selling price, the profit and the ideal selling price.
Methods of Estimating
It is important to note that the estimating method used needs to reflect the
maturity of the project and, as the scope of the work is better defined and the
data availability increases, more detailed and reliable estimating methods can,
and should, be used. The estimating method used to develop the estimate
needs to be known by the project manager because the method will indicate
the relative accuracy of the estimate and will reflect how well the project has
been defined. In addition, it will also highlight how much data is available on
which to build the cost estimate. Producing an estimate could in practice use
more than one method depending on which part of the estimate is better
served by a particular approach. There are a number of methods of estimating
as listed below:
Analogy;

Parametric;

Expert opinion;

Wideband Delphi;

Range estimating;

Activity based (bottom-up).

Each of these estimating methods is now discussed.

Analogy
Analogy estimates utilize statistical analysis including regression analysis to
find correlation between costs and performances. An analogy assessment
requires assessment of the differences in project elements or technical
features and adjustments necessary to accommodate differences, that is, it
uses similar projects as a base for the estimate. This can be adjusted for the
actual project or actual costs by a factor based upon:
Comparative complexity and design;

Known differences;

Geographical and inflation data.

Analogy estimates need to recognize that the process is assumed but
substantially unknown, very little of the technical data or design is available
and relies on either reliable estimates or on actual costs from previous projects
for comparison.
Parametric
Parametric estimates rely on the development of Cost Estimating Relationships
(CER), based on the characteristics of the project. This relationship is based on
an analysis of previously completed projects that are similar to the proposed
project in scope, function or materials and so on. This method requires
accurate historical data based on similar projects and uses a formula to the
driving parameter, for example, cost per square metre, cost per cubic metre of
concrete. This requires a meaningful CER to be used with real up-to-date data.
For this method to be of maximum value it is important to capture the actual
costs from each project that the construction company undertakes in order to
update the database as this cost information will improve future CERs and any
overall estimates produced in this way.
Expert Opinion
Expert opinion can be used to developed estimates where the opinion will say
what the object or task will cost. However, this method is only accurate to the
extent that the expert is truly up-to-date in both the subject matter and
costing from a wide range of experience of the type of project being
considered. Expert opinion estimates tend to become more accurate as more
experts are consulted, however some caution is required in raising project
funds based solely on this approach.
Wideband Delphi
Wideband Delphi uses the perception of a group of experts to determine an
overall consensus estimate. This method combines the expert opinions
anonymously in order to avoid group think and any dominant personality
from effectively shouting others down. As this requires no face to face contact,
the technique works well with email. After the initial briefing on the estimates
required and sharing the background materials, the individual experts estimate
independently; the coordinator gathers the estimates, collates them and sends
them to all of the other expert members for their views. Each expert considers
the assumptions, analogies or parameter values and formula used by their
peers and either reasserts their original value or incorporates those
components of the other peoples estimates that they agree with. Using this
approach, estimates converge on one or more consensus views each
accompanied by the supporting assumptions. The project benefits from
understanding which factors are affecting its schedule and cost from all
participants. The use of this technique may be restricted to those areas of the
project with greatest visibility or political importance, greatest technical or
even those areas with third-party risk or the largest impact on dependent
activities or groups.
Range Estimating
Range estimating is a method which can be used when there is some, but
limited, technical data, the scope of work is poorly defined for at least one
phase or there is some historical data or project experience on similar
undertakings. This method uses a range of estimates to capture the
uncertainty in the estimates. The scope of work or the WBS elements are
evaluated to determine either:
The effort required and a degree of confidence (%) for each; or

A three-point estimate of the most optimistic, the most pessimistic and

the most likely estimates for each element,. It is important that the
estimate also describes or explains the rationale, for example, for
explaining the reason for the optimistic estimate and in respect to the
pessimistic estimate, what could go wrong.

Example of three-point estimate for delivery of materials to site

 Activity Based
Activity-based estimates/activity-based costing (ABC) is commonly called bottom-
up costing and is widely used on large-scale projects. Activity-based estimates
use a detailed project design to list all materials and labour required to
undertaken the project. The cost of materials is estimated at the greatest level of
detail and then summed up through the various levels of the WBS. Activities
associated with installing material and equipment are estimated using detailed
cost estimating relationships for each activity. This method requires the WBS to
identify the lowest levels of individually measurable and quantifiable activities on
which to build a cost estimate. The project design should be sufficient to establish
detailed material take-offs, the methods of performance and any constraints of
the activities. It should be noted that the accuracy of the WBS, the design and the
historical data directly correlate to the accuracy of the cost estimate using this
technique.

2. Budgeting and Cost Management

Budgeting covers the understanding of what costs will be incurred, when and
why, and clearly follows on from the estimating activities and the award of the
project. Cost management on the other hand covers knowing what costs have
been incurred by the project, when this expenditure happened and what future
costs are planned. This is not just a simple administrative monitoring task, as cost
management involves ensuring that the sums spent and invoiced are in
accordance with the budget, that the timing of each transaction is appropriate
and taking necessary action to ensure that any corrective project actions are
taken as and when required. In general there are a number of key elements of
cost management which need to be produced in addition to good project and
subcontract management:
Identified deliverables for a measured outcome;

Realistic budgets and plans;

A work authorization system;

An accurate cost collection and reporting system;

An ongoing review and action process;

An appropriate change control system.

Managing the cost plan begins with defining and planning the work in a formal
and structured way. In addition to the normal steps associated with planning
work, the cost plan management will require the development of the
measurement methods for the types of work to be performed. This step is critical
to assure that the comparisons are valid and reliable. From planning, the process
moves to actually utilizing the plan, collecting measurement data, assessing it and
taking any necessary corrective actions; this process can be seen to use the same
closed-loop feedback approach This is the point in the cost management process
where the projects cost and schedule performance are obtained and reports
generated both for the project team and externally for the stakeholders and
customers. One final, but critical, part of the process is the need for continuing
maintenance and control of the cost plan. It should be noted that changes to the
cost plan can invalidate the measurement process unless these changes are
understood and they truly represent a difference from that of the original scope
of work.
When assembling a cost plan it will be important to identify when certain costs
will accrue. Failing to do this can result in apparent variances of significant sizes,
which might be explained simply as cash flow. Whilst the purchase of materials
usually impacts the account in one large sum, the cost of a project should ideally
be matched to the income. In addition actual project cash flow also needs to be
considered.
The term cash flow refers to the money that goes in and out of the project. Cash
inflow is a positive amount typically from achieving progress or payment
milestones on construction activities. Cash outflow by contrast is a negative
amount arising from the payment of suppliers, materials, equipment and so on.
The difference between the positive cash flow (income) and negative cash flow
(outturn) is known as net cash flow.
In general, cash flow at the project level contains a full list of expenses and all
amounts earned during the project implementation phase. The items covered in
cash outturn are likely to include: the costs of the contract management, cost of
preliminary design work, materials and supplies, equipment and rental charges,
payment for subcontractors, workers and any additional costs. The cash income
which influences the cash flow throughout the project life cycle includes, for
instance, the time (delay) in receipt of payments from the client organization, the
time of payment on behalf of the subcontractors, crediting conditions, and any
equipment rental conditions and so on.
The cost profile is likely to feature as part of the contract negotiations
especially on long-term and/or high-value projects and may include provision
for payments and income as shown in Many construction projects are
described in terms of negative values of cash flow during the construction
works and this situation may change after pre-payment of sums made by the
client and after the final settlement of the project. The project cash flow is
shown in, the profile of the cash flow for the initial investment, that is, the
construction activities would be improved if milestone payments were
included as part of the contractual agreement. It should be noted that the cash
flow profile in this figure accurately reflects the PPP arrangements where the
initial investment is not recovered until typically two-thirds through a projects
life, in many PPP projects the break-even point is not reached until 15 years
after the construction is complete and the cash recover period begins.
 3. Cost Control
Money is one of the most important resources in business and often prompts
the expression that Cash is King and not least so on construction projects.
Many businesses have gone bankrupt not through lack of work but as a result
of improper management of its cash flow. In the context of the needs and
analysis of the real conditions of the business environment, many methods of
cash flow management have been devised. Cost control is therefore concerned
with:
Influencing the factors that create changes to the cost plan and ensuring
that changes are agreed upon;

Determining that the cost plan has changed;

Managing the actual cost changes as and when they occur;

Monitoring cost performance to detect and understand variances from

the cost plan;

Ensuring that all appropriate changes are recorded accurately in the cost
plan;

Preventing incorrect, inappropriate or any unauthorized changes from

being included in the cost plan;

Taking actions to bring expected costs within acceptable limits.

From the above list, cost control can be seen to include examining and
understanding the reasons for both positive and negative cost variances. It is
often integrated with other control processes such as scope change control,
schedule control, quality control and so on and requires the following tools:
A cost plan for the project agreed with the client and key stakeholders;

Performance reports which provide information on the project scope and

cost performance such as which budgets have been met and which have
not

A change request process to capture any changes which occur in many

forms: oral and written, direct and indirect, externally or internally
initiated, and legally mandated or optional. The changes may require
increasing the budget or may even allow it to be reduced in the event of a
revised scope of work. A cost change control system defines the
procedures by which the cost baseline may be changed and typically
includes the paperwork, tracking systems and approval levels necessary for
authorizing budget or expenditure changes. The cost change system should
also be integrated with the functional or physical change control system.

Tools and Techniques for Cost Control

The available techniques of cost management and forecasting differ with regard
to the level of detail and preciseness of the assessment of the actual state and
forecasts. In reality, many factors operating during the project lifecycle, such as
the time delays, exceeding of costs, changes of orders (and the associated cost
changes) influence the real cash flow in the project. The basic problem of
forecasting and managing cash flow is the issue of taking into account these
factors in order to obtain accurate control. Furthermore, a second challenge is
assessing the actual monetary values associated with the project implementation,
such as time delays, cost deviations and so on in the context of the work value.
Often assimilating all of these factors is very difficult and, sometimes it has to be
said, even impossible. Consequently, cost control typically uses detailed plans and
schedules which were devised at the early stage of the project life cycle.
Typical S type budget-planned cost curves shows the time now position and the
cost value of the work done compared to the budgeted expenditure and the
actual costs incurred.
At the time now point, the planned costs are not exceeded by the actual project
costs. This position would suggest that while the project is not exceeding the
planned rate of spend, it is also not achieving the expected progress for the costs
incurred at this time. By conducting a series of regular project reviews it is
possible to predict the project cost overrun in time and overspend in monetary
terms and then examine options to rectify the situation. The variance the
difference between the planned and the actual performance may be significant
and if so will need to be addressed.

The outputs from cost control include the following:

Revised cost estimates where modifications to the cost information can

be used to manage the project. Appropriate stakeholders will need to be
notified as appropriate cost estimates may or may not require
adjustments to other aspects of the project plan.

Budget updates which are a special category of revised cost estimates as

changes to an approved costs baseline. These are generally revised only in
response to changes in the scope of work. In some cases, cost variances
may be so severe that re-baselining the project programme is needed to
provide a realistic measure of performance.

Corrective actions are anything done to bring the expected or planned

future project performance in line with the desired project plan.
 An Estimate at Completion (EAC) is a forecast of most likely total project
costs based on project performance and risk quantification. The most
common forecasting techniques are some variation of the following
methods:

o The actual cost to date plus the estimate for all remaining work.
This approach is most often used when past performance shows
that the original assumptions were fundamentally flawed, or that
they are no longer relevant due to a change in conditions. The
formula for this is EAC = AC + ETC.

o Actual cost to date plus remaining budget. This cost calculation is

most often used when current variances are seen as atypical and
the project management team expectations are that similar
variances will not occur in the future. The formula for this is EAC =
AC + BAC EV.

o EAC = Actual cost to date plus remaining budget modified by a

performance factor, often the cumulative CPI. This approach is most
often used when current variances are seen as typical of future
variances. Finally, the formula here is EAC = (AC + (BAC EV) / CPI).

Each of these approaches may be the correct approach for any given project
and will provide the project management team with a signal if the EAC
forecasts go beyond acceptable tolerances. EAC is an extrapolation from
current fact and as such it needs to be remembered that this is just an
approximation. Care needs to be taken that the results reflect the real project
dynamics that exist underneath the snapshot of the cost and expenditure
figures. One way to deal with the approximation issue is to compute several
EACs to show a range of project outcomes. As covered under Estimating in this
chapter, this could be derived from recent experience, expert judgment or the
use of various performance factors.