 The budgeting process always involves forecasting

the level and type of resources needed to complete

the project.
 Many organizations will have well worn (and
reasonably accurate) methods for creating the initial
project estimate based on past experience.
 However - every project is unique
 So the estimating process always has some level of
uncertainty (and therefore RISK) associated with it.
 The PM must understand the organization’s
accounting practices to the extent that they are
imposed on the project budgeting and control
process.
 “Cost estimation is part science, part art.”
 There are many well defined processes within the cost estimating
discipline. There is also a subjective element to cost estimating
that makes the discipline an art form learned over time and
through experience.
 Cost estimating is not a “black box” process. The more
understanding and credibility we gain with our customers, the
more they will understand the structured process that cost
estimators follow and the disciplined process and tools used in an
estimate.
 The current perception that cost estimating is a “black box” can be
demystified by accurate, defensible, well-documented estimates
that are consistently presented and can be easily understood.
 NASA Cost Estimating Handbook
 What is a budget?

 A plan for allocating scarce resources to the

various endeavors of an organization
 A budget implies constraints
 Thus, it implies that managers will not get
everything they want or need
 The budget for an activity also implies management
support for that activity

 The higher the budget, relative to cost, the higher

the managerial support

 The budget is also a control mechanism

 Many organizations have controls in place that prohibit
exceeding the budget
 Comparisons are against the budget
 On most projects
 Material + Labor + Equipment + Capital +
Overhead + Profits = Bid
 In other words
 Resources + Profits = Bid

 So budgeting is in effect, the task of

forecasting resources
 Like any forecast, this includes some uncertainty
 There is uncertainty regarding usage and price
 Especially true for material and labor

 The more standardized the project and

components, the lower the uncertainty

 The more experienced the cost estimator, the lower

the uncertainty (and therefore the RISK)
1. There may not be as much historical data or none
at all
2. Even with similar projects, there may be significant
differences
3. Multiple people have input to the budget
4. Multiple people have some control over the budget
5. There is more “flexibility” regarding the estimates
of inputs (material and labor)
6. The accounting system may not be set up to track
project data
1. Top-down
2. Bottom-up
3. Negotiated
 The technique of developing a budget by comparing
this project to past ones using the judgment and
experience of management.
 Typically an overall budget is assigned to the
project to be distributed to the individual tasks.
 If the projects being used for comparison are similar
enough, this process can result in a fairly accurate
total number.
 The process of distributing the total can create a lot
of conflict among the management team.
ADVANTAGES DISADVANTAGES

 Overall project budgets can  More difficult to get buy in

be set/controlled very  Leads to low level
accurately competition for larger
 Management has more shares of budget
control over budgets
 Do not need to do as much
up-front planning
 The process of developing budgets by asking
the people who will perform the individual
tasks on the WBS for their estimates.
 These individual numbers are then rolled up
to a summary for presentation to
management.
ADVANTAGES DISADVANTAGES

 Greater buy in by low level  Need a good WBS

managers
 More likely to catch
unusual expenses
 Can lead to game playing
when individuals pad their
estimates in anticipation of
management cuts.
 Management has a
tendency to trim the
budget as they have not
originated it
 Using the bottom-up estimates, costs can be applied to
each WBS element.
 These are typically calculated by taking the labor hour
estimate and ‘dollarizing’ it using appropriate labor and
overhead rates.
 To be accurate, the estimator needs to understand the
relationship between the labor estimate and the actual
number of hours that will be charged to the project
because of personal time and inefficiencies.
 A similar process must be used if machine time or
other resources are charged to the project.
 Typically the budgeting process requires some negotiation
between the PM and senior management.
 This is because the PM will be better informed on the
technical details while management will know more about
the financial realities of the business.
 Together they need to discuss the project requirements and
life cycle.
 If the project is heavily dependent on testing and integration
at the end, then it’s important to not short change the
budget for the completion process.
 Organizations are use to budgeting (and collecting
data) by category
 These activities correspond to “line items” in the
budget
 Examples include phone, utilities, direct labor,…

 Projects need to accumulate data and control

expenses differently – by collecting project costs
according to the WBS
 This results in program or activity budgeting

Meredith & Mantel (2009) Project management: a managerial approach. 7th ed. Wiley.
Table 7-1
Table 7-2
 Inputs from a lot of areas are required to estimate a project
 May have a professional cost estimator to do the job
 Project manager will work closely with cost estimator when
planning a project
 Most projects are concerned only with estimating direct
costs rather than indirect costs (although the PM will need to
know which is required)
 PM must build contingencies into the process to account for
uncertainty. One way to do this is to use the process of
developing likely , optimistic and pessimistic estimates.
 Most firms add 5-10 percent for contingencies
 Projects are known for being over budget
 It is unlikely that this is due to deliberate underestimating
 There are two types of errors
 Random
 Systematic
 There is nothing we can do about random errors
 Want to eliminate systematic errors
 Studies and common sense have shown that as
people repeat a task they get better at it.
 This idea is formalized in the concept of the learning
curve, which states that each time the output
doubles the worker hours per unit decrease to a fixed
percentage of their previous value.
 This effect is important because the estimator must
determine the impact learning had on past projects
(and their rates) and predict its impact on the one
being estimated.
 Projects that involve new technologies or processes
are very difficult to estimate because past
performance is not a useful guide.

 An almost certain, immediate result of installing a

new cost-saving program is that costs rise
 May be resistance to change….or
 When we alter a system, we disturb its functioning and it
reacts in unpredictable ways
 Changes in resource costs due to factors like
inflation – PM must build in appropriate
contingencies – identifying areas of greatest
exposure
 Waste, spoilage, and labour turnover
 People, as resources are not freely
interchangeable with each other. The project
may require five people, but if they are not the
right people, the number available is irrelevant.
 Ideas based on work by Fred Brooks – The Mythical Man
Month

 Tendency to underestimate the time intellectual work will

take

 A lot of risk is involved in projects that consist of a series of

components, all of which must work for the project to
succeed
 We have a (mistaken) tendency to assume
that workers and time are interchangeable,
so adding more workers should reduce the
time taken
 Brooks asserts that: “adding manpower to a
late software project makes it later”

 Why?
 Data can be collected on the quality of project
estimates by using statistical techniques.
 The estimate is compared to the actual, and
statistics like the Mean Absolute Deviation (MAD),
the Mean Absolute Ratio (MAR) and the Tracking
Signal can be calculated.
 These are all used to detect bias or non-random
error in the estimate.
 Meredith & Mantel (2009) Project
management: a managerial approach. 7th ed.
Wiley.