You are on page 1of 72

Project Management

Estimating, Budgets, Cost


and Financial Management

Chalmers University BOM017


Phil Thomas

BOM017 Project Management


Lecture: Estimating, Budgets, Cost and Financial
Management
Workshop: Estimating and Budget
Book reference: Project Management:
A Systems Approach to Planning,
Scheduling and Controlling
Harold R Kertzner
Chapter 14 Pricing and Estimating
Chapter 15 Cost Control
Referenced Case Studies

Review of Previous Lectures

Project Management Overview


Strategic Project Management
Project organisation and Governance
The Triple Constraint
Work Breakdown Structures
Planning
Resources

Strategic Management
Process

Portfolio lifecycle

APM Body of Knowledge 6th edition. P30

Programme lifecycle

APM Body of Knowledge 6th edition. P28

Linear project lifecycle

APM Body of Knowledge 6th edition. P27

Integrated
Management of
Projects

Define the
Project

Seven logical steps for


scheduling a project

Break the work


down into
manageable
parts

Place the tasks


in a logical
sequence

Estimate
task
durations

4
Time
analysis:
critical path
and float

5
Schedule the
resources (if
necessary)

6
7

Assign tasks

The Triple Constraint


Time

Cost

Performance
Specification
or Scope

Estimating Accuracy
https://podio.com/site/budget-busters
Why do projects fail?
There are many reasons do your own
research
Over budget is one of the more common
failures.
Task: Find a suitable academic paper and
use for your essay

Estimating
Definition of Estimating
Estimating uses a range of tools and
techniques to produce estimates. An
estimate is an approximation of project time
and cost targets that is refined throughout
the project life cycle.

Estimate -v- Tender or Bid


An estimate is a reasonably accurate
calculation of the probable cost of
carrying out work.
A tender or bid is an offer to carry out
work for a stated price
To limit the extent of risk the contractor/
vendor/supplier will require a reasonably
accurate calculation of the probable cost

Tender/Bid Documents

For an external project:


Invitation to tender/bid
Instructions to tenderers/bidders
Form of tender; Appendix to the
form of tender
Conditions of contract
Drawings, Specification
Schedules of Quantities
For an internal project it will similar
with some amendments

What is in the tender or bid?


Subcontractors
Labour
Plant/Equipment
General expenses
Materials
Overheads and
Margin

A pre-tender/bid programme is required

for pricing of some work items


for pricing preliminaries / general expenses
for risk at tender/bid adjudication
to reconcile the cost estimate
basis for the master programme
may be required in tender/bid submission
for cost/value/expenditure/income profiles

Project phase

Five-year periods

1 Original concept
2 Feasibility study
3 Business plan
4 Risk assessment
5 Public enquiry
6 Authorization
7 Organization
8 Planning
9 Design
10 Procurement
11 Fulfilment
12 Test/commission
13 Handover
14 Economic life
15 Disposal

During the early project phases, cost estimates


provide the basis for a business case budget.

Project phase

Five-year periods

1 Original concept
2 Feasibility study
3 Business plan
4 Risk assessment
5 Public enquiry
6 Authorization
7 Organization
8 Planning
9 Design
10 Procurement
11 Fulfilment
12 Test/commission
13 Handover
14 Economic life
15 Disposal

In commercial fixed price projects, estimates made


during this time are the principal pricing factor.

Project phase

Five-year periods

1 Original concept
2 Feasibility study
3 Business plan
4 Risk assessment
5 Public enquiry
6 Authorization
7 Organization
8 Planning
9 Design
10 Procurement
11 Fulfilment
12 Test/commission
13 Handover
14 Economic life
15 Disposal

When the project is authorized, the cost


estimates convert to operating budgets

Project phase

Five-year periods

1 Original concept
2 Feasibility study
3 Business plan
4 Risk assessment
5 Public enquiry
6 Authorization
7 Organization
8 Planning
9 Design
10 Procurement
11 Fulfilment
12 Test/commission
13 Handover
14 Economic life
15 Disposal

Ball park

Recorded cost

Estimating accuracy will improve as


the project goes through its life cycle

Project phase

Five-year periods

1 Original concept
2 Feasibility study
3 Business plan
4 Risk assessment
5 Public enquiry
6 Authorization
7 Organization
8 Planning
9 Design
10 Procurement
11 Fulfilment
12 Test/commission
13 Handover
14 Economic life
15 Disposal

Ball park

Recorded cost

If cost estimates are continuously reviewed as


the project proceeds, they should finally
merge with the actual cost of the project.

Some cost estimate categories


(each company will have its own system)

Wild guess
Ball park
Informed guess
Comparative
Feasibility
Definitive
Final recorded cost

Increasing
accuracy

Some cost estimate categories


(each company will have its own system)

Intuitive, when there is


little time or very little
information: a few people
have a gift for being
surprisingly accurate.

Wild guess
Ball park
Informed guess
Comparative
Feasibility
Definitive
Final recorded cost

Some cost estimate categories


(each company will have its own system)

Wild guess
Ball park
Informed guess
Comparative
Feasibility
Definitive
Final recorded cost

The estimator looks for


cost records of similar
past projects and adapts
those to estimate the
current project cost.

Some cost estimate categories


(each company will have its own system)

Wild guess
Ball park
Informed guess
Comparative
Feasibility
Definitive
Final recorded cost

Conceptual design is
done and quotations
have been obtained for
major components and
materials.

Some cost estimate categories


(each company will have its own system)

Wild guess
Ball park
Informed guess
Comparative
Feasibility
Definitive
Final recorded cost

Design is complete, all


major purchases have
been made and the
project is well on the
way to completion.

Some cost estimate categories


(each company will have its own system)

Wild guess
Ball park
Informed guess
Comparative
Feasibility
Definitive
Final recorded cost

When the project is


finished, the cost
estimate should merge
with the final cost.
That depends on having
effective cost collection
and good accounting
procedures.

Some cost estimate categories


(each company will have its own system)

Wild guess
Ball park
Informed guess
Comparative
Feasibility
Definitive
Final recorded cost

If bad cost recording of


time, materials and
expenses is allowed . . .
. . . the true project cost
might never be known . . .
. . . and comparative
estimates for future
projects would be bad.

Top-down estimating
Considers
the
whole
project
first.
Greater
detail
might
not be
possible

The project

Intuitive
Probably ball-park
Useful when there is:
- little time available
- little information

Project prime cost


Builds up
in detail
from the
bottom
of the
task list
or work
breakdown
structure

Bottom-up estimating

Prime cost

The prime cost is the sum of all the direct


costs (labour, materials and expenses).
Direct costs are costs that can be measured
and charged directly to the project.
If this is a business change project, it is
probable that this prime cost will be used for
the business case and subsequent budgets.

Prime cost

If this is a project that is to be sold to a


customer for a budget or fixed price, then
additions must be made to the prime cost.

Prime cost

Overhead
Contingency (grey area)

Escalation
P C sums (if any)
Mark-up for profit
Selling price

Prime costs
Direct labour cost
Labour burden
Direct materials cost
Materials burden
Direct expenses

100 000
20 000
150 000
20 000
10 000

Estimated prime cost


Overheads at 66.67%

300 000
200 000

Estimated cost of sales

500 000

Below-the-line items
Escalation allowance 2%
Contingency 5%

10 000
25 000

Adjusted cost of sales


40% mark-up for profit

535 000
214 000

Proposed selling price

749 000

Provisional items

Typical items in a commercial project cost estimate

Add below
the line items
Estimates are
now budgets
Review / agree
the estimates
Make initial
estimates
List all the
cost items
Define and
code the WBS
Define
the project

Logical
stages for
a bottom-up

cost estimate

Budgets
Why do we need a budget?

Producing the Budget


where do we start?
The Tender or Bid or in-house calculation
Analysis
Price, cost, margin
The work elements of the cost calculation

Recasting the Tender/Bid as a


Project Budget
What are the problems in using the Tender/Bid?
Possible Late adjustments made before
submission of the tender/bid
Commercial adjustments in relation to bidding
strategy or market conditions
Basic errors or mistakes!
Outputs and methods used in the Tender/Bid may
require review by the Project Manager

The budget - what level of detail?


Too little detail = not enough control
Too much detail =

too much time taken to prepare


cost of preparation
information comes too late
difficult to focus action

WHAT is financial control? A definition


The regular process of ascertaining
actual earnings
actual costs

comparing them against


planned earnings
planned costs

and projecting any trends to the end of the


project

Successful financial control


To do this successfully both earnings and
costs must be

identified
classified
allocated
recorded

Control - a simple diagram


The Control Cycle
Plan

Measure

Action

Monitor

WHAT is financial control?


PLAN THE SPEND
SET the financial targets we want to achieve
MEASURE
the actual results as we go (regularly)
MONITOR
these against our targets (and project what will
happen)
ACT corrective action where necessary to

address variances.

RESULTS

STANDARDS

HOW do we do it? - a simple diagram


VALUE

TOTAL VALUE

PLANNED

COSTS

TOTAL COSTS

PROFITS

ACTUAL
COSTS

PROJECTED TOTAL
COSTS

ACTUAL

PROJECTED TOTAL

VALUE

VALUE

indicates

a projection

PROJECTED
ACTUAL
PROFITS

indicates a
comparison

WHO is involved?
Estimator sets cost/price in the first place
Financial or Commercial managers produce
budgets and codes
Production staff generate the data from the
project work executed
Project commercial team measure/monitor
Production staff implement any actions
required
In other words -just about everyone!

Cost Management

Some general principles of cost control

Before you can manage costs . . .

. . . you must know the different kinds of project costs . . .

. . . and how they combine to build the total project cost

Different kinds of project costs


Direct costs
Direct purchases
Materials
Fixed price contracts
Expenses
Direct labour
Own personnel
Temporary hired labour

Direct costs are costs that can be measured


and charged directly and wholly to projects

Different kinds of project costs


Direct costs (continued)
Direct purchases
Materials
Fixed price contracts
Expenses
Direct labour
Own personnel
Temporary hired labour

Most direct costs are also variable costs because


the rate at which they are incurred will vary
depending on the rate at which work is being done

Different kinds of project costs


Indirect costs, also known as overheads
Indirect costs are the general costs of running the
business that cannot generally be attributed to a
particular task or even to a particular project. All
projects will be charged the overhead %age
Most indirect costs are incurred continuously, at a
steady rate: they do not depend on how much work is
being done. Thus they are also fixed costs
Overheads
Indirect purchases
Indirect expenses
Indirect labour

Different kinds of project costs


Indirect costs (continued)
Indirect costs comprise expenses such as:
the salaries of directors and managers
rent, rates, water, heating and lighting
cleaning and maintenance of plant and buildings
stationery, printing, communications
staff salaries in departments like accounting, human
resources, marketing, office services and security
Overheads
Indirect purchases
Indirect expenses
Indirect labour

Different kinds of project costs


Summary
Direct purchases
Materials
Fixed price contracts
Expenses

Variable
costs

Fixed
costs

Direct labour
Own personnel
Temporary hired labour
Overheads
Indirect purchases
Indirect expenses
Indirect labour

Costs
committed with
each order

Costs
dependent
upon
progress
and time

Different kinds of project costs


This chart is critical to understanding cost control
Direct purchases
Materials
Fixed price contracts
Expenses

Variable
costs

Costs
committed with
each order

Direct labour
Own personnel
Costs
Temporary
hired in
labour
One of the biggest
factors
controlling the
dependent
costs of bought-out materials is to have upon
Overheads
efficient purchasing
procedures and control progress
the
and time
Fixed
Indirect
purchases
costs at or just
before
the time when each
costs
Indirect expenses
order is committed
Indirect labour

Different kinds of project costs


This chart is critical to understanding cost control
Staff motivation, teamworking, effective supervision,
Direct purchases
Costs
progress management
and the avoidance of changes
Materials
are key to controlling
costs
that depend oncommitted
progresswith
Fixed price
contracts
each order
and
Expenses
the passage of time
Variable
costs

Fixed
costs

Direct labour
Own personnel
Temporary hired labour
Overheads
Indirect purchases
Indirect expenses
Indirect labour

Costs
dependent
upon
progress
and time

Project costs against time: the effect of fixed costs


Cost overrun with time

000s

Planned finish date

500
400

Planned expenditure

300
Fixed cost element

200
100

10

Fixed costs:
add cost to the project but not value
accumulate remorselessly with time
can be the deciding profit or loss factor

12

14

16

Months

Some general principles of cost control

Start with a logical work breakdown and budgets

Control costs before they are committed

Control progress: remember, time is money

Control and restrict changes

Follow good commercial practice:


issue invoices on time and avoid errors
purchase against competitive tenders
check all suppliers invoices before approval
pursue debtors
dont pay bills too early

Procedures in the remainder of this presentation:

can measure what has been spent


can measure cost performance
can predict what will be spent

but cost control needs management action

Three different methods for


measuring and collating direct
materials costs are compared on
the of
following
slides
achievementthree
and costs

Analysis and prediction

000s
350
Total materials budget

300
250
200

150
100

A: Job costing

50
2

10

12

14

16

Months

Job costing is the method commonly used by cost


accountants. Materials are issued from stores for work
against authorized requisitions. The cost office processes
data from those requisitions to calculate job (and project)
direct materials costs

000s
350
Total materials budget

300
250

B: Invoices

200

150
100

A: Job costing

50
2

10

12

14

16

Months

Provided that purchases were made specifically for the project,


the accounts office could compile the direct materials costs by
adding the amounts paid against all the relevant suppliers
invoices.

000s
350
Total materials budget

300
250

C: Orders

200

B: Invoices

150
100

A: Job costing

50
2

10

12

14

16

Months

Provided that purchases are made specifically for the project,


the purchasing department can add the costs of all relevant
orders when they are issued (when the costs are committed).
This gives the project manager the direct materials cost data
very early, when there might be time to correct overspending

Project phase

Five-year periods

1 Original concept
2 Feasibility study
3 Business plan
4 Risk assessment
5 Public enquiry
6 Authorization
7 Organization
8 Planning
9 Design
10 Procurement
11 Fulfilment
12 Test/commission
13 Handover
14 Economic life
15 Disposal

The following slides show some of the different ways in which


measured project costs can be compared against the cost budget
as the project goes through the most active part of its life cycle

Cost comparison method 1: linear budget graph


000s
Planned finish date
700
600

Total budget

500
400

Linear timed budget

300
200
100

Plot of actual costs


2

10

12

14

16 Months

This has no practical use because the actual cost graph bears no time
relation to the linear budget graph the budget could never be spent
at a linear rate but always follows an S curve (see the next slide)

Cost comparison method 2: cash outflow schedule


000s
Planned finish date
700
600

Total budget

500
400
Scheduled cash outflows

300
200
100

Plot of actual costs


2

10

12

14

16 Months

The budget graph has been plotted from the project cash outflow schedule.
The plot of actual costs should follow that graph but here they are below
budget. That might signify an insufficient rate of working but the graph is
meaningless unless we know what has been achieved for the money spent

Cost comparison method 3: project milestones


000s

Planned finish date

700
600

Total budget

500

Scheduled
cash outflows

400
300
200

100
2

10

12

14

16 Months

Step 1: Before the project starts, prepare a timed-budget curve as in the


previous method, using the cash outflow schedule as the data source

Cost comparison method 3: project milestones


000s

Planned finish date


M6

700
600

M5

Total budget

M4

500
M3

400
M2

300
M1

200

100
2

10

12

14

16 Months

Step 2: identify milestones in the project plan, find their time and cost
details from the cash outflow schedule, and plot them at their relevant
positions on the graph. They will all lie on the cash outflow curve.

Cost comparison method 3: project milestones


000s

Planned finish date


M6

700
600

M5

Total budget

M4

500
M3

Milestone M3 achieved 50,000 over


budget and almost two months late

400
M2

300

Milestone M2 achieved on
budget but three weeks late

M1

200
Milestone M1 achieved
below budget but late

100

Low early costs indicate a late, slow project start

10

12

14

16 Months

Step 3: this is not actually a step, but a continuous process of plotting


the actual costs curve and marking on it the place where each milestone
is achieved

Cost comparison method 3: project milestones


000s

Planned finish date


M6

700
600

M5

Total budget

M4

500
M3

Milestone M3 achieved 50 000 over


budget and almost two months late

400
M2

300

Milestone M2 achieved on
budget but three weeks late

M1

200
Milestone M1 achieved
below budget but late

100
2

10

12

14

16 Months

Summary

Estimating
Budgets
Cost Control
Financial Management
Project managers need to understand all the
above in order to successfully manage their
projects.

Workshop

Preparing the Estimate


Strategic Project Brief
Working in Teams
Communication
Leadership

End of Lecture 4