Expert answer:Project Costs Final
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Answer the following essay questions. in a Word document. State your answers in
your own words, in complete sentences, and give complete answers/explanations with
examples where applicable.
Assignment…
1.
2.
Describe the most common cost elements to be included in a project cost estimate. (10 points)
Compare and contrast the advantages and disadvantages of analogous, parametric and bottom-up
estimating. (10 points)
3.
Discuss the reasons you would want to use a time-phased budget for a project. Note: The book may
not have enough information on this so please consider researching this for more details. (10 points)
4.
Identify five common project risk strategies employed to address threats that your project may
face. Give an example of each. (10 points)
5.
The quality revolution introduced many tools that can be used to improve the quality of project related
processes and outcomes. Identify three quality tools and briefly describe how you would use them to
improve project related processes and outcomes. (10 points)
CHAPTER
9
Budgeting Projects
CHAPTER
OBJECTIVES
After completing this
chapter, you should be
able to:
• Compare and contrast
analogous,
parametric, and
bottom-up methods
of estimating cost.
• Describe issues in
project cost
estimating and how to
deal with each.
• Create a time-phased,
bottom-up budget for
a project.
• Show both summary
and bottom-up
project budget
information with
cumulative costs
using MS Project.
244
© Diego Cervo/Shutterstock.com
• Define project cost
terms and tell how
each is used in
estimating project
cost.
I sold escalators and elevators for my first job out of business school. As part
of my training, before I was sent to the field, I would look over the estimates
made by the sales staff. This served to double-check their math so the
company had confidence in their estimates. It also served to teach me many
of the little nuances that more experienced estimators used. I had my training
manuals, lists of standards, main methods of calculation, and so forth, but
learning from others’ experience instead of making all my own mistakes
helped.
One of the last parts in my training was to spend eight weeks at the
Denver branch to get seasoned a little bit. Construction was booming in
Denver during the late 1970s. In fact, some days I needed to bid more than
one job. The first part of putting together a bid was to go the office where
the requests for proposals, plans, specifications, and the like were stored.
Then, armed with that information, I would put together an estimate. Finally,
Phase:
Selecting
Approval:
To Proceed
PMBOK® Guide
Topics:
• Plan Cost Management
• Estimate cost
• Determine budget
• Control cost
Initiating
Selection
Planning
Charter
Executing
Kickoff
Closing
Project
Result
Realizing
Administrative
Closure
Benefits
Realized
the actual bidding took place—usually over the phone. The problem was that
creating a detailed estimate would generally take at least half a day. If that
was my only duty (it was not), I would still have had a hard time when
multiple jobs were let for bid on the same day. Something had to give.
Every morning around 10 A.M., I met the construction superintendent for
coffee. We would discuss each bid that was due. What other job was it like?
How was it bigger or smaller than a recently completed job? What features
did it include more or less than a previous job? Did we make money on that
job? We used these questions to compare an upcoming job to other recently
completed jobs. We would also ask, “What do we think our competition will
bid?” By the end of the conversation, we had determined our strategy for
bidding the job. If we won the bid, we would complete a detailed cost
estimate to see if we were close.
After my training, I was transferred to Kansas City. Kansas City had less
construction than Denver. I had enough time to perform detailed cost
estimates before I submitted bids. Therefore, we were more certain that if
we got the bid, we would have a good chance of making money.
I worked for the same company in both cities. However, we used two very
different methods of estimating cost. Both made sense where they were used.
In Denver, if we wanted to bid every job (and you cannot win the job if you do
not bid on it), we needed a fast method. In Kansas City, we had the time to
develop detailed cost estimates, and so we took the time. There are many
methods of estimating project costs and each has its place.
Timothy J. Kloppenborg
245
246
Part 2 Planning Projects
9-1 Plan Cost Management
This chapter starts with estimating project costs. Once the overall cost is estimated, the
next step is to develop the budget by aggregating the costs and determining the project’s
cash flow needs. Project managers also need to establish a system to report and control
project costs. The final chapter section deals with how to use Microsoft Project to aid in
cost management activities.
Cost and schedule are closely related. Sometimes, the two move in the same direction.
For example, when a schedule calls for materials to be delivered, or for workers to
perform, money needs to be available to pay for the materials or workers. Sometimes,
they move in opposite directions. For example, if a project needs to be completed earlier
than planned, more money will probably need to be found to pay for overtime.
Plan cost management is “the process that establishes the policies, procedures, and
documentation for planning, managing, expending, and controlling project costs.”1 Cost
planning entails developing a cost management plan for your project. The cost management plan is “a component of the project management plan that describes how costs will
be planned, structured, and controlled.”2 On small projects, this can be as simple as
ensuring accurate estimates are made, securing the funding, and developing cost reporting procedures to ensure that the money is spent correctly. On large projects, each of
these processes can be much more involved; in addition, developing and using accurate
cash flow estimates become critical. A project cost management plan includes descriptions, procedures, and responsibilities for:
•
•
•
•
•
Costs included (such as internal and external, contingency, etc.),
Activity resource estimating,
Cost estimating,
Budget determination, and
Cost control, including metrics, reporting, and change approvals.
A project cost management plan needs to be consistent with the methods of
the parent organization. In many organizations, project managers are provided
with specific guidance on setting up their cost management plan. The plan provides
guidance to the project manager and other stakeholders in order to serve several
purposes:
•
•
•
•
First and most fundamentally, it shows how to develop and share relevant, accurate,
and timely information that the project manager, sponsor, and other stakeholders
can use to make intelligent and ethical decisions.
It provides feedback, thereby showing how the project’s success is linked to the
business objectives for which it was undertaken.
It provides information at a detailed level for those who need details and at
appropriate summary levels for those who need that.
It helps all project stakeholders focus appropriately on schedule and performance
as well as cost.3
9-2 Estimate Cost
Estimate cost is “the process of developing an approximation of the monetary resources
needed to complete project activities.”4 Cost estimating is linked closely with scope,
schedule, and resource planning. To understand cost well, a project manager needs to
understand what the work of the project includes, what schedule demands exist, and
what people and other resources can be used. As more of this detail becomes known,
the cost estimates can be more precise.
Chapter 9 Budgeting Projects
247
The first principle in dealing with project costs is for the project manager to never lie
to himself. Many times, in dealing with project costs, the project manager will need to
negotiate with sponsors, customers, and other stakeholders. If he does not understand
what the project costs really are, he is just trading meaningless numbers. That is neither
an effective nor an ethical method of establishing and committing to sensible budgets.
The second principle in dealing with project costs is for the project manager to never
lie to anyone else. Since sponsors, customers, and other stakeholders can often drive hard
bargains, it is sometimes tempting to shade the truth to secure necessary funding. This is
wrong on two counts. First, it is ethically wrong. Second, as a practical matter, a project
manager’s reputation goes a long way for good or for bad. People are more inclined to
work with project managers who are viewed as being honest and trustworthy.
To estimate project costs accurately, the project manager must understand the various
types of cost, the timing and accuracy of cost estimates, the different methods that can
be employed to estimate costs, and a variety of cost estimating issues.
9-2a Types of Cost
Costs can be better understood by considering various types of classifications such as
those shown in Exhibit 9.1.
FIXED VERSUS VARIABLE COSTS Cost can first be classified as either being fixed or variable. Fixed costs are those that remain the same regardless of the size or volume of work. For
example, if you need to buy a computer for your project, the cost is the same regardless of
how much you use it. Variable costs are those that vary directly with volume of use. For
example, if you were building a cement wall, the cost of the cement would vary directly
with the size of the wall. To understand the importance of fixed versus variable costs, a project manager ideally structures costs and the impact of changes on those costs. When a project
manager understands how big a project is likely to be, she will try to determine how to
complete all of the project work for the least cost. On many projects, there are choices of
how to perform certain activities. Some of these choices reflect a high-fixed-cost and lowvariable-cost alternative such as buying an expensive machine that can make parts with low
variable costs versus a more manual process of inexpensive machines but high labor costs.
These choices require both some fixed and some variable costs. Ideally, the cost curve for
EXHIBIT 9.1
COMPARISON OF COST TERMS
Fixed
Variable
Direct
Indirect
Recurring
Nonrecurring
Regular
Expedited
Internal
External
Lease
Purchase
Labor
Material
Estimate
Reserve
Source: Adapted from Kim LaScola Needy and Kimberly Sarnowski, “Keeping the Lid on Project Costs,” in David I. Cleland, ed.,
Field Guide to Project Management, 2nd ed. (Hoboken, NJ: John Wiley & Sons, 2004): 145–147.
248
Part 2 Planning Projects
E X H I B I T 9. 2
PROJECT COST AND VOLUME CURVE
Expected project volume
Total
cost
Volume
the expected project volume appears as shown in Exhibit 9.2. This reflects the lowest possible
total cost at the size the project is expected to be. Unfortunately, problems may occur if the
volume of the project work is substantially larger or smaller than first expected. If the volume
drops a little bit, the total costs may drop very little. If the volume expands a little, the costs
may go up significantly. Therefore, when considering fixed and variable cost choices, it is
important to understand the project scope.
DIRECT VERSUS INDIRECT COSTS A second classification divides project costs into
direct and indirect costs. Direct costs are those that only occur because of the project
and are often classified as either direct labor or other direct costs. For example, direct
labor includes workers who are hired specifically to work on the project and who will
be either assigned to a new project or released when the project is complete. Other direct
costs may include such items as materials, travel, consultants, subcontracts, purchased
parts, and computer time.
Indirect costs are those that are necessary to keep the organization running, but are
not associated with one specific project. The salaries of the company executives and
the cost of company buildings, utilities, insurance, and clerical assistance are examples.
These costs are allocated among all of the projects and other work that benefit from
them. The methods of allocating these costs have evolved in recent years thanks to
activity-based costing, as described in the cost estimating issues section. Exhibit 9.3
shows both direct and indirect costs for a work package.
RECURRING VERSUS NONRECURRING COSTS The third cost comparison is recurring versus nonrecurring costs. Recurring costs are those that repeat as the project work
continues, such as the cost of writing code or laying bricks. Nonrecurring costs are those
that happen only once during a project, such as developing a design that, once approved,
guides the project team. Nonrecurring costs tend to occur during project planning and
closing, while recurring costs tend to occur during project execution.
REGULAR VERSUS EXPEDITED COSTS A fourth cost comparison is regular or
expedited. Regular costs are preferred and occur when progress can be made by normal
work hours and purchasing agreements. Expedited costs occur when the project must be
conducted faster than normal and overtime for workers and/or extra charges for rapid
Chapter 9 Budgeting Projects
249
EXHIBIT 9.3
DIRECT AND INDIRECT COSTS IN A WORK PACKAGE
PROJECT: ACCOUNTS PAYABLE
REFINEMENT
WORK PACKAGE: INSTALL MODULE 1
Description:
Install accounts payable refinement
application and related hardware.
Deliverable(s):
Installed and functioning accounts payable module.
Cost Categories
Quantity
Total
Direct Labor
Programmer
120 hrs @ $ 75/hr
9,000
Systems Analyst
40 hrs @ $ 100/hr
4,000
Systems Architect
20 hrs @ $ 120/hr
2,400
Other Direct
Hardware
20,000
Software
8,400
Consultant Services
12,000
Direct Overhead (.6 * DL)
9,240
Total
65,040
Source: Kevin P. Grant, University of Texas, San Antonio. Adapted with permission.
delivery from suppliers are necessary. The comparison of these costs shows why it is vital
to understand schedule pressures and resource demands as costs are estimated.
OTHER COST CLASSIFICATIONS The next several cost comparisons require little
explanation. They are helpful to understand both in structuring the cost estimates and as
checklists to help remember items that may be forgotten. One comparison is costs internal
to the parent organization versus those external to it. Major external cost items such as equipment can be either leased or purchased. Direct cost items are often labor or materials.
Estimate versus reserve costs form the next comparison. The estimate is “a quantified
assessment of the likely amount… It should always include an indication of accuracy.”5
The reserve is “a provision in the project management plan to mitigate cost and/or
schedule risk. Often used with a modifier (e.g., management reserve, contingency
reserve) to provide further detail on what types of risk are meant to be mitigated.”6
Management reserve is “an amount of the project budget withheld for management
control purposes… for unforeseen work that is within the scope.”7 By contrast, contingency reserve is “budget within the cost baseline that is allocated for identified risks that
are accepted and for which contingent or mitigating responses are developed.”8
Just as uncertainly exists when estimating how long an activity will take, there is
uncertainty regarding how much an activity will cost. Some activities are easy to estimate with
precision. Other less familiar activities have many uncertainties, and estimating their cost is
more like guessing. If one were to estimate conservatively on each uncertain activity, the
total estimate for the project would likely be too high to be approved. To overcome this problem,
project managers are encouraged to estimate at least a bit more aggressively. That means some
activities will run over their estimates, while others will cost less. Project managers frequently
add contingency reserve to cover the activities that run over their aggressive estimates.
250
Part 2 Planning Projects
9-2b Accuracy and Timing of Cost Estimates
Project managers need to understand when cost estimates should be developed, how
accurate they need to be, and how they will be used. During project initiation, many
project managers need to develop cost estimates to have their project charters approved. At
this point, very little detail is understood regarding the project, so the estimates are only
approximate. However, as the scope becomes well defined in the work breakdown structure
(WBS), schedules are planned, and specific resources are assigned, the project manager
knows much more and can estimate more precisely. Many organizations have specific
names and guidance for their estimates and these vary widely. Normally, estimates should
be documented, and the level of confidence in the estimate should be described. Exhibit 9.4
shows several points regarding different types of project cost estimates.
ORDER OF MAGNITUDE ESTIMATES Several things should be noted from these comparisons. First, estimates go by several different names. For example, order of magnitude
estimates that are often used to seek initial charter approval are also sometimes called “ball
park,” “conceptual,” “initial,” or “level-one” estimates. These early estimates are often created
during the project initiating stage when very little detail is known about the project. At this
point, a very rough order of magnitude estimate that could underestimate the project by as
much as 100 percent (that is, the final cost could be double the initial estimate) may be
the only possible estimate. There is no way to really know how accurate an estimate is
until the project has been completed, but with less detailed knowledge concerning the project
in the initiating stage, there is likely to be a larger margin of error. Order of magnitude cost
estimates and the parallel high-level looks at each of the other planning areas can quickly give
enough information to decide whether to approve the project charter and begin to invest time
and money into detailed planning.
E X H I B I T 9. 4
PROJECT COST ESTIMATE COMPARISONS
Level of
Effort
Stage
Approval
Initiating
Planning
Charter
Executing
Project
Plan
Estimate
Name
Order of
Budget
Magnitude
Definitive
Accuracy
Level
−40% to
+100%
−10% to
+15%
Possible
Method
Analogous Parametric Bottom-Up
−30% to
+50%
Rolling Wave
Closing
Project
Result
Admin.
Closure
Chapter 9 Budgeting Projects
251
BUDGET AND DEFINITIVE ESTIMATES Once a project manager enters into the more
detailed planning stage, it is generally possible to create a more accurate cost estimate. This
is the same thought that goes into creating a more detailed project schedule, resource
estimates, risk profiles, quality plans, and communications plans. Depending on the complexity and size of their projects and organizational norms, some project managers can proceed
directly to definitive cost estimates at this point. Others may still need to look at one or more
intermediate levels of detail before they have enough detailed knowledge to create cost
estimates with accuracy. At the end of project planning, cost estimates should have a small
enough margin of error that they can be used to create a project budget, show cash flow
needs, and be used as a basis for controlling the project. Most project organizations want an
accuracy level of no more than plus or minus 10 to 15 percent, and some require considerably better, such as plus or minus 5 percent.
Especially on complex projects such as research and development of major new
products, project managers may use rolling wave planning to estimate costs. They do
this by creating a defini …
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