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How to create cost estimates?

The process of creating estimates involves the following:

  • Project Management Software

Project management software can help in speeding up the calculations required to estimate costs. These calculations could include direct, indirect, overhead, fixed cost calculations for several hundred activities.

  • Determining Resource Cost Rates

Resources can be internal human resources, vendors, consultants, suppliers, external technicians, among others. Project managers must have a know-how of the rate involved for the resource cost.

  • Reserve Analysis

Reserve analysis involves identification of activities which have significant risks and determination of the total efforts (time and money) required to manage these risks if they occur. There are two types of risks: Known and Unknown risks. Contingency reserves deal with known risks. Management reserves deal with unknown risks. Padding should be avoided when doing a reserve analysis.

  • Cost Of Quality

Quality efforts are required for the project. The amount of money added due to these efforts are bifurcated as Cost of Quality.

  • Accuracy Of Estimates

Estimation of Costs is an iterative process. Costs estimated during early stages of the project have lesser accuracy. Cost estimation should be made by the project manager in the form of ranges. Thus, the accuracy of estimates will be higher at the start of the project and will narrow down as the project progresses. There are different types of ranges for different scenarios i.e. for preliminary cost estimation, the range will vary, for cost estimation during the conceptualization stage the range will vary and similarly for feasibility and final estimation, the ranges will vary. The ranges will narrow down from broad level to lower levels.

  • Rough Order Of Magnitude (ROM) Estimate:

This estimate is generally made during project initiation phase. A typical range of estimates for ROM is +/- 50%, however, this percentage will vary depending on how much is known by the project team about the project when creating estimates.

  • Budget Estimates:

Done during the project planning stage. The ranges varies  from -10% to +25%.

  • Definitive Estimate:

It is a more refined project cost estimate. A few project managers use a range of +/- 10% and others use -5% to +10% of range from actual. When the Estimate Cost process is completed, it results into:

  1. Activity Cost Estimates with the explanation of how these costs were derived

  2. Changes or updates to other project management documents such as risk register, change control register, among others.

  • Determine Budget

In the process, the project manager determines the amount of funds the organization requires to have for the project by calculating the total cost of the project. This calculation leads to creation of a Budget. A project manager must perform risk management activities and include reserves (contingency and management) when estimating the total cost of the project. The cost budget is cost baseline plus management reserves. The cost budget indicates the total money the organization should have allocated for the project.

For the creation of a budget, the process of cost aggregation is used. In this concept, the activity costs are rolled up into work package costs, work package costs are then rolled up into control account costs and control account costs are finally rolled up into project costs. Contingency cost is added to the cost baseline. Management reserves are added as a final step.

Comparison of cost baseline and cost budget is done by the project manager to parametric estimates, expert judgment or historical records for a sanity check. If there are significant variances between the reference data and project estimates, the project manager needs to investigate and ensure that the estimates are correct.

Checking of the cash flow is the next thing to do. There could be situations where the funding is not available when it is required by the project. Hence, all the activities need to be planned in a time-phased manner and may be shown as an S-curve.

The next step is to identify any constraints in the project charter. A Project manager needs to reconcile the cost baseline and cost budget with these constraints. The reconciliation is done as a part of Integration Management process. If the project estimate exceeds the constraints, the project manager must meet the stakeholders and explain the reasons of exceeding the constraints and also share options to reduce project costs. Else, an unrealistic budget is made available and it is considered to be a project manager's fault.

The output of Determine Budget process is Cost Baseline. The efforts involved in determining budget process may lead to changes in other project management documents.

Control Costs

Control costs process is focused on controlling cost of the project as described in any other knowledge area in the control section. A few activities that could be helpful for controlling costs include:

Use of cost management plan:

A cost management plan helps the project manager plan for controlling cost of the project.

Use of Organizational process assets:

Organization policies, procedures, tools or reporting formats related to controlling costs can be used.

Prevention of unnecessary changes:

This is an important activity. Prevention process involves identification of the root-causes where high costs are involved.

Measure costs: 

Another important factor that the project manager must be completely involved in throughout the lifecycle of the project is measuring the project cost for variation from the baseline. This triggers either into corrective or preventive actions.

Progress Reporting

The project manager should avoid usage of guesstimates for reporting progress. One of the following techniques can be deployed by the project manager:

  1. 50/50 Rule: An activity is considered 50% complete when it begins and gets credit for the rest 50% only when it is completed.

  2. 20/80 Rule: An activity is considered 20% complete when it begins and gets credit for the rest 80% only when it is completed.

  3. 0/100 Rule: An activity is considered 0% complete when it begins and gets credit for the 100% only when it is completed.


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