PA 114 – PROJECT MANAGEMENT

MODULE
Roderick Tuling Olivar, MPA (CAR), CHRA

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 CHAPTER 7
Project Budgeting and Cost Estimation
Objectives:
At the end of this chapter, the learner will be able to:
Recognize the need for cost estimation and budget in project management;
Distinguish the various forms of project costs;
Value those factors that must be considered in improving the quality for project times and costs;
Differentiate among methods of estimating costs for a project;
Defend some issues that can influence the ability to carry out a sensible and accurate project cost
estimates;
Use the two ways of data gathering to obtain input data for the budget;
Develop processes that may assist in the estimation process.
A well-researched and planned cost estimation and budget is necessary for the successful
completion of any project. Project managers need to thoroughly scope the project in order to secure
sufficient funding Scoping involves estimating labor hours, materials, supplies and other miscellaneous
expenses Budgets and cost estimations are a work in progress and should contain room for change.
Cost Estimation and Budget in Project Management
Project budgeting and cost estimation and goes hand in hand. A project budget is a detailed, time-
phased estimate of all resource costs for a project. Typically a budget is developed in stages which are from
a preliminary rough estimate to a detailed estimate to a completed, approved project budget. On occasion,
approved budget may.
Cost estimating is the process of approximating a reasonable time phased budget by identifying
the cost of resources required in order to complete project activities. A good cost estimate is impartial. It
should be made by someone who would always be sensible in numbers, meaning no overestimate or
underestimate The cost estimate ought to clearly describe the purpose of the project what it will carry out
what assumptions are prepared, how long the estimate is legally binding and how much the project will
spend The estimate should be flexible, adapt at and provide a range of the costs involved Cost estimates
start out broad, and various stages are completed, they are more accurately defined.
The more precise the estimate of project cost is, the better competent the project manager handles
the project's budget. Hence, estimating a project's costs is important for several reasons:
1. It makes possible the project manager to consider probable benefits against estimated costs to
see whether the project is logical
2. It permits the project manager to distinguish whether the necessary funds are obtainable to stain
the project
3. It provides as a guideline to help ensure that there t adequate funds to finish the project.
Types of Project Costs
All projects acquire costs Project costing is a key input in formulating project decisions. Cost is an
important element in the success of a project. Among the various forms of project costs are those related to
type (direct or indirect) frequency of occurrence (recurring or nonrecurring); opportunity to be adjusted fied
or parsabile), and schedule (normal or expedited)

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1. Direct versus Indirect Costs – Direct costs are those costs directly related to the project like labour and
materials. Direct labour includes workers who were employed to work on the project. Other direct labour
consists of materials travel, consultants, contractors, purchased parts and computer time. On the other hand,
indirect costs are those necessary to keep the organization running, but not actually associated with any
specific project. Indirect costs are generally linked to two features namely overhead and selling general
administration Overhead costs comprise all indirect materials, utilities, taxes insurance, property and
repairs, depreciation of equipment, and health and retirement benefits for the labour force. Costs commonly
categorized under the selling and general administration are advertising, shipping, salaries, sales and
secretarial support, office space rent, general supplies, costs of furniture, fixtures, and equipment, sales
commission and other similar costs. Unlike direct costs, tracking indirect costs is not straightforward and
procedures used by organization differ. Some organizations charge a flat rate for all overhead costs relative
to the direct costs of the project. The most common range for such indirect multiplier rates ranges from
20% to 50% on top of direct costs.
2. Recurring versus Nonrecurring – Costs can also be estimated based on frequency with which they
occur and classified as recurring or nonrecurring. Recurring costs are those that normally continue to
operate over the project’s life cycle. Most labour, materials, logistics and sales costs are classified as
recurring since budgetary charge is applied to these costs during significant portions of the project
development cycle. Nonrecurring costs are those charges applied once at the start or end of the project like
preliminary marketing analyses personnel training or outplacement services.
3. Fixed versus Variable – Applying cost could also be in the form of fixed or variable costs. Fixed costs
are those that stay constant despite changes in the level of project activities. Some examples of fixed costs
are rent, insurance premiums, or loan payments. Variable costs are those that differ in direct proportion to
the changes in the level of project activities like hourly labour, cost of materials, cost of supply, fuel for
bulldozer and other similar costs.
4. Normal versus Expedited – Normal costs are those acquired in the regular process of working to finish
the according based on the original, planned schedule consented by all stakeholders at the start of the
project. Although there could be some changes as the project advances, still the costs are in accordance
with the baseline project plan. Expedited costs are these unplanned costs acquired to accelerate the
completion of the project. Among these costs are overtime, hiring additional temporary workers,
contracting with external sources for support, incurring high costs for transportation as well as logistics for
materials deliveries.
Factors Influencing the Quality of Estimates
A high probability of 95 % is the objective in project costs estimation. Among the factors that must
be considered in improving the quality for project times and costs are the following:
1. Past experience (historical data) - Similar past projects can be utilized as a reference or a template for the
current project's estimates in terms of time and costs if there are only minor variations. The current project's
estimates should make small adjustments reflecting those differences. This would aid project managers in
developing schedules and estimating costs faster with little possible deviations in the future.
2. Project uniqueness - The uniqueness of a project makes it more challenging for the project manager to
have a precise and actual estimate.
3. Project duration - Vagueness in project estimates are likely to amplify with the extent of the project.

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4. People - People factor can also introduce errors in estimation of time and costs. The knowledge and skill
of task estimators, the well-matched of their skills with the task requirements, the competence of the project
members in working jointly as an efficient team, the turnover rate, and dedication are all vital human factors
that seriously have pressure on project estimates
5. Planning range - The quality of estimates declines as the planning possibility of future events raises,
Estimates made at the initiation phase of the project are normally around 50% percent from the actual.
Estimates made during the planning phase are budget estimates which are in the range of 10% to 2% from
the actual estimated value. At the late planning or early execution phase of the project, estimates become
more perfect and would be in the range of 10 % from the actual.
6. Organizational structure - The organizational structure also influences com and time estimates. In the
projected form, the team is entirely committed on the project and is working full time which makes work
delivery faster an additional cost. Conversely in the matrix form, the personnel are common across several
projects, saving cost but demanding more time to synchronize among all the projects' activities.
7. Padding estimates-In order to reduce the risk of being late most people when asked to estimate an activity
tend to add little padding. The project schedule or budget becomes unbelievable and unrealistic if estimates
are padded. This situation would gravely affect negatively the reputation and integrity of the project
management profession. Padding is actually a sign of poor project management practice. In order to lessen
padding, the project manager should make available all the information that stakeholders require for their
estimations. Any uncertainties must be treated as risks to be handled with cautions as an element of the risk
management process.
8. Organizational culture – The culture of the organization greatly influenced project estimating. Several
organizations support estimate padding while others promote greater precision. Some cultures consider it
is unattainable to forecast the future. Thus, it would be a squander of time formulating comprehensive
estimates. Others believe correctness of estimates is the key input for an effectual project management
practice.
9. Non-project factors - Delays in equipment delivery, vacations, holidays, priorities, politics, visa
consultant issuance issues, and legal affairs are all cases of non-project factors that can significantly adjust
time estimates.
Methods of Estimating Cost
There are a number of ways to use in estimating costs for a project. A project manager may use a
combination of these cost estimating methods.
1. Analogous estimating - This is an estimating technique that uses costs along with measures of scale like
size, weight or complexity from the previous project to estimate cost for similar future project.
2. Parametric estimating- This is an estimating technique that uses a statistical relationship between
historical data and other variables (example: square footage in construction or lines of code in software
development) to calculate an estimate for activity factors like scope, cost, budget, and duration costs for
project completion.
3. Bottom-up estimating It is the method of constructing estimates by decomposing the work into more
detail. An estimate is planned based on the requirements of each of the lower, more detailed pieces of work
and then later are combined into a total quantity for the project. For this method the work breakdown
structure (WBS) necessitates to be broken down to the most detailed level with very clear specifications.

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4. Top down estimating-It is based on the collective judgments and experiences of top and middle
management and available past data concerning similar activities.

Project Cost Estimating Issues

There are several issues that can really influence the ability to carry out a sensible and accurate
project cost estimates. Highly complex projects are really not easy to estimate in terms of costs. Although,
in reality even construction projects which are customarily viewed as highly structured are not exempted
from harmfully expensive costs overruns. Here are some common problems with cost estimation:
1. Short initial estimates - This is caused by inadequate awareness of the project scope. In addition, there
could also be some failures in considering the project in relation to other organizational activities.
Organizational culture that rewards underestimation could also be the reason for low estimates. Starting
with low initial cost estimates during project initiation may create either willingness (due to the belief that
top management will not fund an expensive project) or unwillingness (through simple error) to continue
with the project.
2. Unpredicted technical difficulties - The assumption that technical problems would be minimal is also a
common problem in costs estimates. The impact of this issue could be lost of significant amount of money
or worst and more tragic is the loss of life.
3. Lack of definition - Poor initial scope development results in poorly defined features, goals and purpose
of the project. Lack of clear view of the project is the outcome of poor scoping which can immediately spill
over to inadequately realized cost estimates. A comprehensive scope statement and work breakdown
structure (WBS) are necessary for the process of cost estimation and project budgeting.
4. Specification changes - Many projects cannot avoid midcourse specification changes. A lot of projects
overrun their initial cost estimates due to serious changes to scope or project specification. This situation
makes the initial com estimates basically meaningless and useless.
5. External factors - In most cases inflation and other economic impacts cas cause a project to overrun its
estimates seriously.
Creating a Project Budget
The forecast on what resources the project will, the required quantity of each when they will be
needed and how they will cost are necessary to develop a projec budget. In addition, the effects of potential
price inflation should not be taken for granted. Uncertainty is always an element of forecast, some maybe
less but others could be more.
There are two ways of data gathering to obtain input data for the budget which are top-down
budgeting and bottom-up budgeting.
1. Top-down budgeting - This is a strategy of seeking first the opinion and experiences of top management
regarding estimated project costs. The assumption is that senor management is more experienced with past
projects and is in position to offer precise feedback and estimates for future project ventures. They initiate
the estimation of the overall costs of a project and its major work packages. Their projections are given to
the functional department levels where supplementary, more definite information is gathered. The projet is
broken down into detailed pieces at the functional departments. Later the project personnel who is assigned
the task eventually supply input on costs on a task-by-task basis.

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2. Bottom-up budgeting – This strategy starts inductively from the work breakdown structure (WBS) to
apply direct and indirect costs. Each project manager is required to prepare a project budget that names
project activities and indicates funds requested to support these tasks. The functional managers develop
their own documented budgets with requirements of the firm's projects and their own departmental needs
in mind.
Eventually, the best and most effective is a blend of these two project management techniques.
With the strength of each, each step could be aligned in order meet the requirements of the project. The
needs of the project could be decided at the top, and the lower levels are allowed to answer the
accountability This combination fuses the vision of top management and the skills of lower level allows an
organization to optimally use the best of what its employees have to employees. With this combination the
project is completed more efficiently, and offer.
Ways to improve the Process of Cost Estimation and Budgeting
Estimating is defined as an informed assessment of an uncertain event. For project managers,
accurate estimates are the foundation for effective project planning and execution. There are many
processes that have been developed to assist in the estimation process. Without proper estimating of project
duration, cost resources, risks and other parameters, it is impossible to implement proper alternatives and
ultimately make timely and sound decisions.
There are two fundamentally different ways to manage the risks associated with the chance events
that take place on every project:
1. The most familiar is to create an allowance for contingencies which are usually 5% or 10%.
2. Another is when the forecaster chooses "most likely, optimistic, and pessimistic" estimates.
With so many factors that could possible cause estimate inaccuracies, what can be done to make
project estimates the most accurate?
1. Teach the project team and organization on estimating and entail the fitting project team members
set up the approximate associated with their scope aspect of the project.
2. Contact for an expert with experience for scenarios
3. Include peer reviews and estimate valilation processes into the product life cycle (PLC).
4. Integrate risk management and contingency assessment throughout the PLC
5. Promote estimate review and validation after each phase of the PLC.
6. Precise and well-timed documentation of change requests.
7. Do research regarding historical data on the project effort, schedule, cost, risk and resources for
lessons learned and make suitable adjustments. Statistical baselines should be and modify
occasionally.
8. Use mock ups, trial runs field studies or other simulations as a direct.
9. Sufficiently identify work scope and truthfully track time against each task

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