Lecture 7

Budgeting Projects

MN601 Network Project Management

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 Outline

Budgeting Projects
1. Introduction to Project Budgeting
2. Cost Management Planning
3. Purposes of the Cost Management Planning
4. Estimating Project Cost
5. Determining Project Budget
6. Establishing Project Cost Control
7. Conclusions
8. References

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 Introduction to Project
Budgeting
What it is a Budget?
• A budget is a plan that describes authorised
expenses for a project for specified period of time
• Budgets would often include:
– Start-up costs (fixed)
– Resources needed e.g., labor, materials (direct)
– Unit cost for resources (direct)
– Indirect costs
– Contingency reserve
– Management reserve
– Adds up to total project cost
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 Introduction to Project
Budgeting
• In order to develop a budget, we must:
– Forecast what resources the project will
require
– Determine the required quantity of each
– Decide when they will be needed
– Understand how much they will cost

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 Cost Management
Planning
“The process that establishes the policies, procedures,
and documentation for planning, managing, expending,
and controlling project costs.” PMBOK® Guide
– Involves developing a cost management plan for a
project
• For small projects 
– Ensure accurate cost estimates
– Secure the funding
– Develop cost reporting procedures
• For large projects 
– Develop and use accurate cash flow estimates
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 Cost Management
Planning
• The Cost Management Plan:
1. Defines how the costs on a project will be managed
throughout the project’s lifecycle
2. Sets the format and standards by which the project costs
are measured and controlled
3. Identifies who is responsible for managing costs
4. Identifies who has the authority to approve changes to
the project or its budget
5. Specifies how cost performance is quantitatively
measured and reported
6. Specifies report formats, frequency and to whom they
are presented
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 Purposes of the Cost
Management Planning
Purposes of the Cost Management Planning

– To present the costs and effort estimates of the

project

– To describe procedures that will be used to deal with

increases to the cost and effort

– How to develop and share relevant, accurate and

timely information for decision making

– Helps project stakeholders focus on schedule,

performance, and cost
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 Quiz

1. What are the different types of costs in any project?

2. What is the difference between cost management

planning for small and large projects?

3. What are the main steps involved in developing and

executing a cost management plan?

4. What is the main purpose of having a cost

management plan for any project?

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 Estimating Project Cost

• Cost estimating is the process of forecasting or

approximating the cost of completing project
deliverables
– Cost estimating is linked to scope, schedule, and
resource planning
– Never lie to yourself
• You must understand what the project costs really
are
– Never lie to anyone else
• Avoid shading the truth to secure necessary
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 Estimating Project Cost

Timing
Types of and
costs accuracy
of cost
estimates

Methods
used to Cost
estimate estimating
costs issues

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 Estimating Project Cost

Types of Costs

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 Estimating Project Cost

Fixed vs. Variable

• Fixed costs are those that do not change throughout
the life-cycle of a project
• Variable costs vary directly with volume of use
• Fixed and variable costs involve consideration of the
project scope
Example: For software development projects, the
physical development space and development
computers are fixed costs to the project

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 Estimating Project Cost

Fixed vs. Variable

Project cost and volume curve
– In general, cost of producing items grows fast to begin
with, then it plateaus out, rising sharply after some
volume. Details depend upon the individual project

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 Estimating Project Cost

Direct vs. Indirect

• Direct costs only occur because of the project
– Direct labor
– Other direct costs – material, travel, consultants,
subcontracts, purchased parts, computer time
• Indirect costs are necessary costs to keep the
organisation running but are not associated with one
specific project
– Support staff salaries, buildings, utilities, insurance,
clerical assistance
– Costs are allocated across projects
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 Estimating Project Cost

Direct vs. Indirect

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 Estimating Project Cost

Estimate vs. Reserve Costs

• Project estimates need to be aggressive, – some estimates
will run over, and some others will cost less
• Add a reserve to cover activities that run over aggressive
estimates
– Estimate – “A quantified assessment of the likely amount…It should
always include an indication of accuracy.” PMBOK® Guide
– Reserve – “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.” PMBOK® Guide

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 Estimating Project Cost

Management reserve vs. Contingency reserve

• Management reserve is the cost reserve that is used to
manage the unidentified risks
– Management reserve is not an estimated reserve; it is a
random (guessed) figure, which is defined according to the
organisation’s policy

• Contingency reserve is the estimated cost reserve that

is used to manage identified risks that are accepted
and for which contingent or mitigating responses are
developed
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 Estimating Project Cost

Accrual vs. Cash Accounting

• Cash accounting where receipts are recorded during the period they
are received, and expenses are recorded in the period in which they
are actually paid
– For example, if you send an invoice on Tuesday, and don't receive the
payment in your account until Thursday, you record the income against
Thursday's date in your books
• Accrual accounting, where revenue and expenses are recorded
when they are incurred (actioned)
– For example, if you're a builder and have sent an invoice for a project
you've completed, you record the sale in your books even though you
haven't received payment yet
• Cash accounting is more frequently used on projects

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 Estimating Project Cost
Accuracy and Timing of Cost Estimates

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 Estimating Project Cost
Accuracy and Timing of Cost Estimates

• Costs in Project Initiation

– Necessary for project charter approval
– Estimates are only approximate

• Costs in Project Planning

– Cost estimates are more precise

• Cost estimates should be documented

• The level of confidence in the cost estimate should be
described

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 Estimating Project Cost

Project Cost Estimate Comparisons

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 Estimating Project Cost

Estimate Names
• Order of Magnitude ( is it 1000s; 10,000s; 100,000s or Millions)
– Often used to seek initial charter approval
– Created when limited project details are available
– Ball park, conceptual, initial, or level one estimates
– Enough information for “go” or “no go” decision

• Budget and Definitive

– More accurate cost estimates at each stage

• Rolling wave planning

– Allows planning in waves of ‘accuracy in estimation’
– Start with rough estimates and high-level milestones
– Make the estimate and Milestones more specific later in the project

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 Estimating Project Cost

Methods of estimating costs

• As more details of a project are known,
more detailed estimating methods may be
used, these are called:
– Analogous estimating
– Parametric estimating
– Bottom-up estimating

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 Estimating Project Cost

Methods of estimating costs

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 Estimating Project Cost

Methods of estimating costs

• Analogous estimating also called top-down
estimating – “a technique for estimating the duration
or cost of an activity or a project using historical data
from a similar project.” PMBOK® Guide
– A similar project  a starting point for cost estimation
– Requires experience performing similar projects and
Actual costs of similar projects
– Knowledge of how project differs
– It is considered a combination of historical information and
expert judgment
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 Estimating Project Cost

Methods of estimating
costs
• Key considerations for
Analogous estimating are:
– How does the project differ
from that of the historical data
– What adjustment can be
made to the formula for those
differences
– How accurate is the historical
data

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 Estimating Project Cost

Methods of estimating costs

Parametric Estimating
“An estimating technique in which an
algorithm is used to calculate Cost or
Duration based on historical data and
project parameters.” PMBOK® Guide
Process:
1. Involves finding more information regarding
the project
2. Is often based on average known rates,
such as square meterage for construction
or software lines of code for software
projects etc.
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 Estimating Project Cost

Methods of estimating costs

Bottom-Up Estimating
• “Method of estimating project duration or
cost by aggregating the estimates of the
lower-level components of the WBS.”
PMBOK® Guide
– Most detailed –specifications need to be
very clear
– Time consuming
– Most accurate form of estimating
– Ensure every item is included
– Estimate accuracy relies on level of detail
known
– Can cost considerable amount of money
just to produce the estimate
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 Estimating Project Cost

Sample Cost Estimate

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 Estimating Project Cost

Comparing methods of estimating costs

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 Quiz

1. Give examples of fixed and variable costs in a network

development project
2. Suddenly there is a funding shortage for your project.
Would you try to save on direct or indirect costs? Explain
with an example
3. What is the difference between contingency reserve and
management reserve?
4. How do the three methods of estimating costs (analogous,
parametric, and bottom-up) compare vis-a-vis required
information and time, and the accuracy obtained

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 Determining Project
Budget
• “The process of aggregating (combining) the
estimated costs of individual activities or work
packages to establish an authorised cost
baseline.” – PMBOK
1. Aggregating costs

2. Analysing reserve needs

3. Determining cash flow

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 Determining Project
Budget
Aggregating costs:
• Direct and indirect costs add up to the cost
baseline
• The cost baseline can only be changed through a
formal change management process
– Cost performance baseline – “A specific version of
a time-phased budget used to compare actual
expenditures to planned expenditures to determine if
preventive or corrective action is needed to meet the
project objectives.” – PMBOK

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 Determining Project
Budget
Aggregating costs:

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 Determining Project
Budget
Analysing reserve needs

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 Determining Project
Budget
Analysing reserve needs
• Known knowns are discovered during planning
and can be estimated directly
• Known unknowns are discovered during risk
identification
• Unknown unknowns (unk unks) are totally
unexpected occurrences that cause an increase
in cost and/or schedule
– The money used to cover unk unks is called
management reserve

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 Determining Project
Budget
Analysing reserve needs
• The amount placed into contingency reserve is calculated
during risk analysis
• The amount placed into management reserve is determined
by how much uncertainty management feels exists in the
project
• The cost baseline + contingency reserve + management
reserve are used to determine if sufficient funds are
available

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 Determining Project
Budget
• Project budget is the sum of project cost
base line and the management reserve;

Cost Baseline = Cost + Contingency Reserve

Project Budget = Cost Baseline + Management
Reserve

• Management Reserve is not a part of the cost

baseline but it is a part of the project budget
• Contingency Reserve is a part of cost baseline
as well as project budget
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 Determining Project
Budget
Determining Cash Flow
• Expenses are applied to individual
activities in the schedule to see when cash
is needed
• Cash may be supplied through
organisation budgets on a periodic basis
• The cumulative amount of cash coming in
to the project must meet or exceed
demands for cash payouts
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 Determining Project
Budget
Determining Cash Flow
• Project Cumulative Cash and Revenue

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 Establishing Project Cost
Control
• Control cost – “the process of monitoring the status
of the project to update the project costs and
managing changes to the cost baseline.” PMBOK®
Guide
– Approved project budget serves as a baseline for
project control
– Milestones are used as a typical measuring point
– Use cash flow projections to determine how much
funding is expected to reach each milestone
– Create enough milestones to keep track of progress
without creating an administrative burden
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 Establishing Project Cost
Control
Cost Control Benefits
• To complete projects on budget to achieve financial
objectives
• Applying cost control techniques effectively can
ensure that projects stay within projected budgets or
are allowed to exceed budgets in a controlled way
for specific reasons
• When project control is implemented appropriately it
reduces risk and receives the full benefits
anticipated from project completion
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 Quiz

1. What are main three steps in creating a project

budget?
2. When analysing reserve needs, what are the type of
items one has to consider? Explain each with an
example.
3. What is a cost baseline? How can a cost baseline be
modified?
4. What additional costs need to be considered over and
above the cost baseline?
5. What are the main Benefits of having a good Cost
Control mechanism?

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 Conclusions

• Budgeting is an important aspect that must be done

before the project starts
• Cost Management Planning is essential to complete
the project successfully and within budget
• Estimating Project Cost can be done at as:
– Order of Magnitude to determine Go or No Go for the project
– Definitive and budgeted for each stage of the project
– Rolling wave planning that starts with rough estimates and then
is improved with time
– Estimates can be Analogous, Parametric, or Bottom-up
• Budget is created by aggregating all the costs
• Cost Control ensure that the project remains within
budget or exceed budgets in a controlled way
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 References
Acknowledgement: Some of the text in this lecture is taken almost verbatim
from the following references:
• Kloppenborg, T.J. Contemporary Project Management: Organize, Plan and Perform,
South-Western Cengage Learning, (2012).

• Gray, C., & Larson, E. (2011). Project management – The managerial process (Fifth edn).
NY: McGraw-Hill.

• Fuller, Mark A., Valacich, Joseph S., and George, Joey F. (2008), Information Systems
Project Management: A Process and Team Approach, Pearson Education Inc. Upper
Saddle River, New Jersey, 07458.

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