research-writing-services
4.8
research-writing-services
4.9
research-writing-services
4.7

Business Budget

Your team has already identified the details of the work schedule in a work breakdown structure and visualized these details in a Gantt chart with a critical path. You also used your stakeholder management plan to determine who needs to be informed of progress on the project and when. And you ve planned out responses to the risks you identified. Now, you must determine the cost to build and operate this store. You must also estimate the costs of the required inventory inside the store and the hiring and training of employees to begin operations. Read Project Cost Estimating and Project Procurement for help in answering this question.
For this project, your team only needs to research and provide high-level budget estimates for the various work packages or the higher-level work activities. For example, building the store itself might be broken down into design, site preparation (your company already owns the land), permit costs, plumbing, electrical, etc. Or, you may prefer to just use major categories such as design, build, and outfit. Consider other project procurements that may be required for your project. Develop your own project cost estimate template. While your research will yield material, labor, and overhead cost data in Brazilian real (BRL), for the purpose of this assignment, you will convert all cost figures to US dollars (USD).
When you have completed the project cost estimate, continue to the next step, where you will complete your project management plan.
Additional Info Provided:
Project Procurement
By Adrienne Watt and bpayne
The procurement effort on projects varies widely and depends on the type of project. Often the client organization will provide procurement services on less complex projects. In this case, the project team identifies the materials, equipment, and supplies needed by the project and provides product specifications and a detailed delivery schedule. When the procurement department of the parent organization provides procurement services, a liaison from the project can help the procurement team better understand the unique requirements of the project and the time-sensitive or critical items of the project schedule.
On larger, more complex projects, personnel are dedicated to procuring and managing the equipment, supplies, and materials needed by the project. Because of the temporary nature of projects, equipment, supplies, and materials are procured as part of the product of the project or for the execution of the project. For example, the bricks procured for a construction project would be procured for the product of the project, and the mortar mixer would be equipment procured for the execution of the project work. At the end of the project, equipment bought or rented for the execution of the work of the project are sold, returned to rental organizations, or disposed of some other way.
More complex projects will typically procure through different procurement and management methods. Commodities are common products that are purchased based on the lowest bid. Commodities include items like concrete for building projects, office supplies, or even lab equipment for a research project. The second type of procurement includes products that are specified for the project. Vendors who can produce these products bid for a contract. The awarding of a contract can include price, ability to meet the project schedule, the fit for purpose of the product, and other considerations important to the project.
Manufacturing a furnace for a new steel mill would be provided by a project vendor. Equipment especially designed and built for a research project is another example. These vendors performances become important parts of the project, and the project manager assigns resources to coordinate the work and schedule of the vendor. The third procurement approach is the development of one or more partners. A design firm that is awarded the design contract for a major part of the steel mill and a research firm that is conducting critical subparts of the research are examples of potential project partners. A partner contributes to and is integrated into the execution plan. Partners perform best when they share the project vision of success and are emotionally invested in the project. The project management team builds and implements a project procurement plan that recognizes the most efficient and effective procurement approach to support the project schedule and goals.
Early in the course of a project, the project manager must estimate the costs of goods, services, fees, permits, and any other expenses related to project completion. Estimated costs will need to align with the allocated budget on the project. As the project plan is executed, the project manager should monitor work to avoid cost overruns.
Throughout the course of a project, the project manager must ensure that necessary goods and services are procured so that a timely sequence of work can be planned and executed. Procurement will likely involve taking bids, drafting and executing contracts, and administering those contracts through completion.
Estimating and Managing Costs
An important part of a project manager s job is managing money. All types of organizations must manage their money well in order to fulfill their mission, including not-for-profit and government organizations. The tools and methods used to manage money on a project vary depending on the phase and complexity of the project. This chapter describes the methods used to estimate the cost of a project, create a budget, and manage the cost of activities while the project is being executed.
Estimating Costs
Estimating Costs to Compare and Select Projects
During the conceptual phase when project selection occurs, economic factors are an important consideration when choosing between competing projects. To compare the simple paybacks or internal rates of return between projects, an estimate of the cost of each project is made. The estimates must be accurate enough so that the comparisons are meaningful, but the amount of time and resources used to make the estimates should be appropriate to the size and complexity of the project. The methods used to estimate the cost of the project during the selection phase are generally faster and consume fewer resources than those used to create detailed estimates in later phases. They rely more on the expert judgment of experienced managers who can make accurate estimates with less detailed information. Estimates in the earliest stages of project selection are usually made using estimates based from previous projects that can be adjusted scaled to match the size and complexity of the current project or by applying standardized formulas.
Analogous Estimate
An estimate that is based on other project estimates is an analogous estimate. If a similar project costs a certain amount, then it is reasonable to assume that the current project will cost about the same. Few projects are exactly the same size and complexity, so the estimate must be adjusted upward or downward to account for the difference. The selection of projects that are similar and the amount of adjustment needed is up to the judgment of the person who makes the estimate. Normally, this judgment is based on many years of experience estimating projects, including incorrect estimates that were learning experiences for the expert.
Analogous Estimate for John s Move
For example, John asked a friend for advice about the cost of moving. His friend replied, I moved from an apartment a little smaller than yours last year and the distance was about the same. I did it with a fourteen-foot truck. It cost about $575 for the truck rental, pads, hand truck, rope, boxes, and gas. Because of the similarity of the projects, John s initial estimate of the cost of the move was less than $700, and he decided that the cost would be affordable and the project could go forward.
Less experienced managers who are required to make analogous estimates can look through the documentation that is available from previous projects. If those projects were evaluated using the Darnall-Preston Complexity Index (DPCI), the manager can quickly identify projects that have similar profiles to the project under consideration even if those projects were managed by other people. Comparing the original estimates with the final project costs on several previous projects with the same DPCI ratings gives a less experienced manager the perspective that it would take many years to acquire by trial and error. It also provides references the manager can use to justify the estimate.
Parametric Estimate
If the project consists of activities that are common to many other projects, average costs are available per unit. For example, if you ask a construction company how much it would cost to build a standard office building, they will ask for the size of the building in square feet and the city in which the building will be built. From these two factors size and location the company s estimator can predict the cost of the building. Factors like size and location are parameters measurable factors that can be used in an equation to calculate a result. The estimator knows the average cost per square foot of a typical office building and adjustments for local labor costs. Other parameters such as quality of finishes are used to further refine the estimate. Estimates that are calculated by multiplying measured parameters by cost-per-unit values are parametric estimates.
Parametric Estimates for John s Move
To estimate the size of the truck needed for John s move, the parameter used by a truck rental company is the number of bedrooms, as shown below.
Moving Trucks
Truck size
Number of bedrooms
26
4+ bedrooms
24
3 4 bedrooms
17
2 3 bedrooms
14
1 2 bedrooms
10
apartment
The moving company assumes that the number of bedrooms is the important parameter in determining how big a truck is needed for a move. For John s move, he has a one-bedroom apartment, so he chooses the fourteen-foot truck. Once the size is determined, other parameters, such as distance and days, are used to estimate the cost of the truck rental.
Estimating Costs to Initiate Projects
Once the project is selected, more accurate estimates are often needed to raise funds and agree on contracts with vendors in the initiation phase.
Estimate During the Initiation Phase of John s Move
John recalled that his friend also told him how tiring it was to do all the packing, loading, and driving himself, and some items were damaged when the load shifted inside the truck during the trip. John decides to call in favors from two friends, Dion and Carlita, to help him pack in Chicago and to hire some of the skilled labor like that needed to load the truck properly.
Vendor Bid Analysis
If services or products will be provided by vendors, the cost of those services can be determined by issuing a request for proposal (RFP). The RFP describes the work, service, or product to be provided by the vendor and the quality level required. The RFP is sent to a list of vendors who are qualified meet standards of reliability and capability to perform this type of work. They respond with a proposal for completing the work described in the RFP, including an estimate of the cost. Some government organizations are required to use the qualified vendor with the lowest bid. Other organizations are not bound to take the lowest bid but are usually required to justify their reasons for not doing so.
Using RFPs to Make Estimates on John s Move
John wants to find out how much it would cost to hire a skilled crew to load and secure the furniture in the truck and then have another crew from the same company meet him in Atlanta to unload the truck and help him unpack. He is not sure if any companies offer this option, so he decides to ask three moving companies for bids. He also decides to ask for bids on a standard move that includes all phases of packing, loading, transportation, and unloading as a comparison to see if his cost-saving plan is worth the extra effort.
The project management team can review the responses by several vendors to the RFP to determine if their estimate of the cost of that aspect of the project is close to the estimate made during the project selection stage. If the estimates by the vendors are much higher than expected, and if the project cannot be completed for the cost that was used to select the project, the selection decision might have to be reconsidered. Reconsidering the selection of the project should take into consideration the economic ratings of the competing projects that were not chosen and who the project champions are for the projects that would be affected.
Some vendors may suggest an alternative way to meet the objective of the RFP in a more cost-effective manner that does not match the specifics of the RFP. Such alternatives can reduce costs if they are acceptable.
Bottom-Up Estimating
The most accurate and time-consuming estimating method is to identify the cost of each item in each activity of the schedule, including labor and materials. If you view the project schedule as a hierarchy where the general descriptions of tasks are at the top and the lower levels become more detailed, finding the price of each item at the lowest level and then summing them to determine the cost of higher levels is called bottom-up estimating.
Bottom-Up Estimate for John s Move
After evaluating the bids by the moving companies, John decides the savings are worth his time if he can get the packing done with the help of his friends. He decides to prepare a detailed estimate of costs for packing materials and use of a rental truck. He looks up the prices for packing materials and truck rental costs on company Web sites and prepares a detailed list of items, quantities, and costs, as shown below.
Detailed Cost Estimate
Category
Description
Quantity
Unit price
Cost
Packing materials
Small boxes
10
$1.70
$17.00
Packing materials
Medium boxes
15
$2.35
$35.25
Packing materials
Large boxes
7
$3.00
$21.00
Packing materials
Extra large boxes
7
$3.75
$26.25
Packing materials
Short hanger boxes
3
$7.95
$23.85
Packing materials
Box tape
2
$3.85
$7.70
Packing materials
Markers
2
$1.50
$3.00
Packing materials
Mattress/Spring bags
2
$2.95
$5.90
Packing materials
Lift straps per pair
1
$24.95
$24.95
Packing materials
Bubble wrap
1
$19.95
$19.95
Packing materials
Furniture pads
4
$7.95
$31.80
Truck
Rental
$400.00
Truck
Gas at 10mpg
200
$2.25
$45.00
This type of estimate is typically more accurate than an analogous or parametric estimate. In this example, the sum of packing materials and truck expenses is estimated to be $661.25.
The detail can be rolled up subtotaled to display less detail. This process is made easier using computer software. On projects with low complexity, the cost estimates can be done on spreadsheet software.
For example, the subtotal feature could be used in Excel and collapsed to show the subtotals for the two categories of costs.On larger projects, software that manages schedules can also manage costs and display costs by activity and by category.
Activity-Based Estimates
An activity can have costs from more than one vendor plus costs for labor and materials from internal sources. Detailed estimates from all sources can be reorganized so those costs that are associated with a particular activity can be grouped by adding the activity code to the detailed estimate, as shown in the table below.
Detailed Costs Associated with Activities
Category
Description
Activity
Quantity
Unit price
Cost
Packing materials
Small boxes
2.1
10
$1.70
$17.00
Packing materials
Medium boxes
2.1
15
$2.35
$35.25
Packing materials
Large boxes
2.1
7
$3.00
$21.00
Packing materials
Extra large boxes
2.1
7
$3.75
$26.25
Packing materials
Short hanger boxes
2.1
3
$7.95
$23.85
Packing materials
Box tape
2.1
2
$3.85
$7.70
Packing materials
Markers
2.1
2
$1.50
$3.00
Packing materials
Mattress/Spring bags
2.1
2
$2.95
$5.90
Packing materials
Lift straps per pair
2.1
1
$24.95
$24.95
Packing materials
Bubble wrap
2.1
1
$19.95
$19.95
Packing materials
Furniture pads
2.1
4
$7.95
$31.80
Truck
Rental
2.2
$400.00
Truck
Gas at 10mpg
2.2
200
$2.25
$45.00
The detailed cost estimates can be sorted by activity and then subtotaled by activity to determine the cost for each activity.
Establishing a Budget
Once the cost of each activity is estimated, it is possible to determine how much money is needed for each group of tasks and for the whole project.
Cost of Tasks
The cost of each group of activities of the project can be estimated by summing the costs of the components of each activity in the group. This process of subtotaling costs by category or activity is called cost aggregation.
Budget Timeline
Because the costs are associated with activities and each activity has a start date and a duration, it is possible to calculate how much money needs to be spent by any particular date during the project. The money needed to pay for a project is usually transferred to the project account shortly before it is needed. These transfers must be timed so that the money is there to pay for each activity without causing a delay in the start of the activity. If the money is transferred too far in advance, the organization will lose the opportunity to use the money somewhere else, or they will have to pay unnecessary interest charges if the money is borrowed. A schedule of money transfers is created that should match the need to pay for the activities. The process of matching the schedule of transfers with the schedule of activity payments is called reconciliation. Refer to the table below, which shows the costs of ten major activities in a project. Funds are transferred into the project account four times. Notice that during most of the project, there were more funds available than were spent except at Activity 6 when all the available funds were spent.
Fund Transfers and Expenditures
Activity
1
2
3
4
5
6
7
8
9
10
Cost
50
200
50
300
500
200
100
400
300
500
Total spent
50
250
300
600
1,100
1,300
1,400
1,800
2,100
2,600
Transfers
400
900
700
600
Total funding
400
400
400
1,300
1,300
1,300
2,000
2,000
2,600
2,600
Cash in account
350
150
100
700
200

600
200
500

Line graph showing a rise from zero to 50 on day 1, a flat line to day 5, and a rise from day 5 to day 6 to PV 260, EV 160, and AC 160.
Total Funding and Expenditure per Activity
In the project budget profile shown in the table above, there is no margin for error if the total of the first six activities exceeds the amount of funding at that point in the project.
Contractual agreements with vendors often require partial payment of their costs during the project. Those contracts can be managed more conveniently if the unit of measure for partial completion is the same as that used for cost budgeting. For example, if a contractor is pouring concrete for a large project, their contract may call for partial payment after 25 percent of the total volume of concrete is poured as determined by cubic yards of concrete.
Key Points
Analogous estimating scales an estimate from a similar project to match the current project. Parametric estimating multiplies a standard cost-per-unit value by the number of units in the project. Bids from contractors can be compared to estimate costs. Bottom-up estimating determines the cost of each detail and aggregates them to determine activity cost estimates.
During the project selection and approval stage, rough estimates are used that are usually obtained using analogous and parametric methods. Vendor bid analysis and detailed bottom-up estimates are used in the initiation phase to estimate project costs.
Detailed estimates are associated with activities and aggregated during the planning phase to create an activity-based budget. Funding transfers are arranged to reconcile money spent to money from funding sources in a timely manner.
Managing the Budget
Managing Cash Flow
If the total amount spent on a project is equal to or less than the amount budgeted, the project can still be in trouble if the funding for the project is not available when it is needed. There is a natural tension between the financial people in an organization, who do not want to pay for the use of money that is just sitting in a checking account, and the project manager, who wants to be sure that there is enough money available to pay for project expenses. The financial people prefer to keep the company s money working in other investments until the last moment before transferring it to the project account. The contractors and vendors have similar concerns, and they want to get paid as soon as possible so they can put the money to work in their own organizations. The project manager would like to have as much cash available as possible to use if activities exceed budget expectations.
Contingency Reserves
Most projects have something unexpected occur that increases costs above the original estimates. If estimates are rarely exceeded, the estimating method should be reviewed because the estimates are too high. It is not possible to predict which activities cost more than expected, but it is reasonable to assume that some of them will be. Estimating the likelihood of such events is part of risk analysis, which is discussed in more detail in a later chapter.
Instead of overestimating each cost, money is budgeted for dealing with unplanned but statistically predictable cost increases. Funds allocated for this purpose are called contingency reserves (Project Management Institute, Inc., 2008). Because it is likely that this money will be spent, it is part of the total budget for the project. If this fund is adequate to meet the unplanned expenses, then the project will complete within the budget.
Management Reserves
If something occurs during the project that requires a change in the project scope, money may be needed to deal with the situation before a change in scope can be negotiated with the project sponsor or client. It could be an opportunity as well as a challenge. Money can be made available to the project to be used at the discretion of the manager to meet needs that would change the scope of the project. These funds are called management reserves. Unlike contingency reserves, they are not likely to be spent and are not part of the project s budget baseline, but they can be included in the total project budget (Project Management Institute, Inc., 2008).
Evaluating the Budget During the Project
A project manager must regularly compare the amount of money spent with the budgeted amount and report this information to managers and stakeholders. It is necessary to establish an understanding of how this progress will be measured and reported.
Reporting Budget Progress on John s Move
In the John s move example, he estimated that the move would cost about $1,500 and take about sixteen days. Eight days into the project, John has spent $300. John tells his friends that the project is going well because he is halfway through the project but has only spent a fifth of his budget. John s friend Carlita points out that his report is not sufficient because he did not compare the amount spent to the budgeted amount for the activities that should be done by the eighth day.
As John s friend points out, a budget report must compare the amount spent with the amount that is expected to be spent by that point in the project. Basic measures such as percentage of activities completed, percentage of measurement units completed, and percentage of budget spent are adequate for less complex projects, but more sophisticated techniques are used for projects with higher complexity.
Earned Value Management
A method that is widely used for medium- and high-complexity projects is the earned value management (EVM) method. EVM is a method of comparing the budgeted and actual costs of a project periodically during the project. It combines the scheduled activities with detailed cost estimates of each activity. It allows for partial completion of an activity if some of the detailed costs associated with the activity have been paid but others have not. The earned value analysis method compares the anticipated cost of work that is scheduled to be done at a given point in time against what has been done and how much it actually cost.
The Budgeted Cost of Work and Planned Value
The budgeted cost of work scheduled (BCWS) comprises the detailed cost estimates for each activity in the project. The amount of work that should have been done by a particular date is the planned value (PV). These terms are used interchangeably by some sources, but the planned value term is used in formulas to refer to the sum of the budgeted cost of work up to a particular point in the project, so we will make that distinction in the definitions in this text for clarity.
Planned Value on Day Six of John s Move
On day six of the project, John should have taken his friends to lunch and purchased the packing materials. The portion of the BCWS that should have been done by that date (the planned value) is listed in the table below. This is the planned value for day six of the project.
Planned Value for Lunch and Packing Materials
Description
Quantity
Cost
Lunch
3
$45.00
Small boxes
10
$17.00
Medium boxes
15
$35.25
Large boxes
7
$21.00
Extra large boxes
7
$26.25
Short hanger boxes
3
$23.85
Box tape
2
$7.70
Markers
2
$3.00
Mattress/Spring bags
2
$5.90
Lift straps per pair
1
$24.95
Bubble wrap
1
$19.95
Furniture pads
4
$31.80
Total
$261.65
Budgeted Cost of Work Performed and Earned Value
The budgeted cost of work performed (BCWP) is the budgeted cost of work scheduled that has been done. If you sum the BCWP values up to that point in the project schedule, you have the earned value (EV).
Actual Cost
The amount spent on an item is often more or less than the estimated amount that was budgeted for that item. The actual cost (AC) is the sum of the amounts actually spent on the items.
Comparing PV, EV, and AC in John s Move on Day Six
Dion and Carlita were both trying to lose weight and just wanted a nice salad. Consequently, the lunch cost less than expected. John makes a stop at a store that sells moving supplies at discount rates. They do not have all the items he needs, but the prices are lower than those quoted by the moving company. They have a very good price on lifting straps so he decides to buy an extra pair. He returns with some of the items on his list, but this phase of the job is not complete by the end of day six. John bought half of the small boxes, all of five other items, twice as many lifting straps, and none of four other items. John is only six days into his project, and his costs and performance are starting to vary from the plan. Earned value analysis gives us a method for reporting that progress. Refer to the figure below.
Planned Value, Earned Value, and Actual Cost
Budgeted Cost of Work Scheduled (BCWS)
Budgeted Cost of Work Performed (BCWS)
Actual Cost (AC)
Description
Quantity
Cost
Quantity
Cost
Quantity
Cost
Lunch
3
$45.00
3
$45.00
3
$45.00
Small boxes
10
$17.00
5
$17.00
5
$17.00
Medium boxes
15
$35.25
15
$35.25
15
$35.25
Large boxes
7
$21.00
Extra large
7
$26.25
Short hanger
3
$23.85
Box tape
2
$7.70
2
$7.70
2
$7.70
Markers
2
$3.00
2
$3.00
2
$3.00
Mattress/Spring bags
2
$5.90
2
$5.90
2
$5.90
Lift straps per pair
1
$24.95
1
$24.95
2
$24.95
Bubble wrap
1
$19.95
Furniture pads
4
$31.80
4
$31.80
4
$28.50
Planned Value (PV)
$261.65
Earned Value (EV)
$162.10
Actual cost (AC)
$154.50
Note: The original schedule called for spending $261.65 (PV) by day six. The amount of work done was worth $162.10 (EV) according to the estimates, but the actual cost was only $154.50 (AC).
Schedule Variance
The project manager must know if the project is on schedule and within the budget. The difference between planned and actual progress is the variance. The schedule variance (SV) is the difference between the earned value (EV) and the planned value (PV). Expressed as a formula, SV = EV PV. If less value has been earned than was planned, the schedule variance is negative, which means the project is behind schedule.
Schedule Variance on John s Move
Planning for John s move calls for spending $261.65 by day six, which is the planned value (PV). The difference between the planned value and the earned value is the scheduled variance (SV). The formula is SV = EV PV. In this example, SV = $162.10 $261.65 = $(99.55) A negative SV indicates the project is behind schedule.
The difference between the earned value (EV) and the actual cost (AC) is the cost variance (CV). Expressed as a formula, CV = EV AC
Cost Variance on John s Move
The difference between the earned value of $162.10 and the actual cost of $154.50 is the cost variance (CV). The formula is CV = EV AC. In this example, CV = $162.10 $154.50 = $7.60.
A positive CV indicates the project is under budget.
Variance Indexes for Schedule and Cost
The schedule variance and the cost variance provide the amount by which the spending is behind (or ahead of) schedule and the amount by which a project is exceeding (or less than) its budget. They do not give an idea of how these amounts compare with the total budget.
The ratio of earned value to planned value gives an indication of how much of the project is completed. This ratio is the schedule performance index (SPI). The formula is SPI = EV/PV. In the John s move example, the SPI equals 0.62 (SPI = $162.10/$261.65 = 0.62) A SPI value less than one indicates the project is behind schedule.
The ratio of the earned value to the actual cost is the cost performance index (CPI). The formula is CPI = EV/AC.
Cost Performance Index of John s Move
In the John s move example, CPI = $162.10 / $154.50 = 1.05 A value greater than 1 indicates the project is under budget.
Line graph showing a rise from zero to 50 on day 1, a flat line to day 5, and a rise from day 5 to day 6 to PV 260, EV 160, and AC 160.
Schedule Variance and Cost Variance on Day Six
The cost variance of positive $7.60 and the CPI value of 1.05 tell John that he is getting more value for his money than planned for the tasks scheduled by day six. The schedule variance (SV) of negative $99.55 and the schedule performance index (SPI) of 0.62 tell him that he is behind schedule in adding value to the project.
During the project, the manager can evaluate the schedule using the schedule variance (SV) and the schedule performance index (SPI) and the budget using the cost variance (CV) and the cost performance index (CPI).
Estimated Cost to Complete the Project
Partway through the project, the manager evaluates the accuracy of the cost estimates for the activities that have taken place and uses that experience to predict how much money it will take to complete the unfinished activities of the project the estimate to complete (ETC).
Atypical Cost Variance
To calculate the ETC, the manager must decide if the cost variance observed in the estimates to that point are representative of the future. For example, if unusually bad weather causes increased cost during the first part of the project, it is not likely to have the same effect on the rest of the project. If the manager decides that the cost variance up to this point in the project is atypical not typical then the estimate to complete is the difference between the original budget for the entire project the budget at completion (BAC) and the earned value (EV) up to that point.
Expressed as a formula, ETC = BAC EV.
Estimate to Complete John s Move
In John s move, John was able to buy most of the items at a discount house that did not have a complete inventory and, he chose to buy an extra pair of lift straps. He knows that the planned values for packing materials were obtained from the price list at the moving company where he will have to buy the rest of the items, so those two factors are not likely to be typical of the remaining purchases. The reduced cost of lunch is unrelated to the future costs of packing materials, truck rentals, and hotel fees. John decides that the factors that caused the variances are atypical. He calculates that the estimate to complete (ETC) is the budget at completion ($1,534) minus the earned value at that point ($162.10), which equals $1,371.90. Expressed as a formula, ETC = $1,534 $162.10 = $1,371.90.
Typical Cost Variance
If the manager decides that the cost variance is caused by factors that will affect the remaining activities, such as higher labor and material costs, then the estimate to complete (ETC) needs to be adjusted by dividing it by the cost performance index (CPI). For example, if labor costs on the first part of a project are estimated at $80,000 (EV) and they actually cost $85,000 (AC), the cost variance will be 0.94. (Recall that the cost variance = EV AC).
To calculate the estimate to complete (ETC) assuming the cost variance on known activities is typical of future cost, the formula is ETC = (BAC EV)/CPI. If the budget at completion (BAC) of the project is $800,000, the estimate to complete is ($800,000 $80,000) / 0.94 = $766,000.
Estimate Final Project Cost
If the costs of the activities up to the present vary from the original estimates, it will affect the total estimate for the project cost. The new estimate of the project cost is the estimate at completion (EAC). To calculate the EAC, the estimate to complete (ETC) is added to the actual cost (AC) of the activities already performed. Expressed as a formula, EAC = AC + ETC.
Estimate at Completion for John s Move
The revised estimate at completion (EAC) for John s move at this point in the process is EAC = $154.50 + $1,371.90 = $1,526.40.
Refer to the table below for a summary of terms and formulas.
Summary of Terms and Formulas for Earned Value Analysis
Term
Acronym
Description
Formula
John s Move
Actual cost
AC
The money actually spent on projects up to the present
$154.50
Budget at completion
BAC
Original budget for the project (same as BCWS)
$1,534.00
Cost performance index
CPI
Ratio of earned value to actual cost
CPI = EV / AC
1.05
Cost variance
CV
Difference between earned value and actual cost
CV = EV AC
$7.60
Earned value
EV
Sum of estimates for work actually done up to the present
$162.10
Estimate at completion
EAC
Revised estimate of total project cost
EAC = AC + ETC
$1,526.40
Estimate to complete
ETC
Money to complete the project if early cost variance is typical
ETC = BAC EV
$1,371.90
Estimate to complete
ETC
Money to complete the project if early cost variance is atypical
ETC = (BAC- EV) / CPI
N/A
Planned value
PV
Sum of the estimates for work done up to the present
$261.65
Schedule performance index
SPI
Ratio of earned value to planned value
SPI = EV / PV
.62
Schedule variance
SV
Difference between earned value and planned value
SV = EV PV
$(99.55)
Key Points
Extra money is allocated in a contingency fund to deal with activities where costs exceed estimates. Funds are allocated in a management reserves in case a significant opportunity or challenge occurs that requires change of scope but funds are needed immediately before a scope change can typically be negotiated.
Schedule variance is the difference between the part of the budget that has been done so far (EV) versus the part that was planned to be completed by now (PV). Similarly, the cost variance is the difference between the EV and the actual cost (AC).
The schedule performance index (SPI) is the ratio of the earned value and the planned value. The cost performance index (CPI) is the ratio of the earned value (EV) to the actual cost (AC).
The formula used to calculate the amount of money needed to complete the project (ETC) depends on whether or not the cost variance to this point is expected to continue (typical) or not (atypical). If the cost variance is atypical, the ETC is simply the original total budget (BAC) minus the earned value (EV). If they are typical of future cost variances, the ETC is adjusted by dividing the difference between BAC and EV by the CPI.
The final budget is the actual cost (AC) to this point plus the estimate to complete (ETC).
Cost Estimating
Cost estimating is the process of determining the likely cost of performing a defined scope of work at a future time. As with any attempt to predict the future, it is unreasonable to expect a cost estimate to be 100 percent correct. The estimating process should be focused on determining a reasonably accurate estimate based on defined assumptions for a reasonable expenditure of effort. The estimate should be supported by appropriate risk management strategies and management reserves based on an appreciation of the likely levels of variability and uncertainty inherent in the estimate.
The core stages in developing a pragmatic and reasonable process for cost estimating are as follows:
Plan the estimating strategy based on available estimating resources and available budget for preparing the estimate.
Determine the most appropriate approaches to develop the estimate. Select the most appropriate methodology consistent with the organization s culture and objectives.
Consider any estimating inputs to the project delivery strategy, such as assessing the cost effectiveness of alternative methodologies and strategies.
Develop systems to ensure the estimate covers 100 percent of the scope (this is nearly impossible, but essential). In particular ensure potential future suppliers and subcontractors have included within their submitted price all of the scope of work you expect them to price.
Determine the appropriate estimating technique to use. In most projects, a combination of these options are used to obtain the best estimate:
analogous comparing the current project with a similar completed project and making appropriate adjustments. This is relatively quick but requires expert knowledge. It is generally seen as the least accurate approach and this depends on the degree of knowledge and expertise. In most situations the degree of accuracy associated with an analogous estimate is considered to be a rough order of magnitude (ROM) estimate, with a range of -25 percent to +75 percent.
parametric using adjusted historical data to price defined elements of the project such as the cost per function point in software development and the cost per square (10 square miles) in domestic construction work.
bottom-up (or detailed) estimating the cost of each resource used in the project is determined and multiplied by the quantity required. This is the most expensive estimating process and the most accurate. A detained engineering estimate can be as accurate as -5 percent to +15 percent.
vendor bid analysis where prices for different components of the project are obtained from the market and compiled to generate the cost of the overall project.
Consider a staged approach to estimating, if possible. Near-term work can be estimated more accurately then far-term, but many projects need an overall estimate. Approaches such as rolling wave can be very useful.
Determine the allocation of organizational overheads to the project costs and how these will be applied.
Determine which costs are fixed (occurring only once regardless of the actual project outcomes) and which are variable (change in relation to changes in the project s work or time). Generally, small savings or errors on variable costs that occur every week will add up to a lot more than a larger one-off saving (or error) on a fixed cost. Focus most effort onto the costs that have the biggest effect overall.
Develop or adjust estimating rates for work to be priced internally. These rates should account for the following:
loaded hourly cost rates
loaded cost per unit or element (parametric estimates)
balancing the allocation of costs between project overheads and loaded cost rates
Assess the likely levels of estimating error to develop contingencies and reserves, accounting for the following:
variability in estimated costs and rates (there will always be a level of variability)
estimating errors (e.g., omissions and duplications)
external events and changes in the market (e.g., suppliers ceasing to trade)
assess future cost movements (e.g., inflation)
Understand the intensity of the work. Costs are minimized if the optimum crew sizes are applied to the work and it takes a normal time to complete. High intensity work associated with a crashed schedule generally causes increased inefficiencies and drives up costs.
Identify estimating and other risks and link to the project s risk management processes. The way the estimate has been developed is itself a risk issue, plus there will be identified risks arising from interaction with suppliers, contractors, and others.
Link estimating to procurement to minimize risk exposure from suppliers and subcontractors.
Once the estimating process is properly planned, the actual work of developing the estimate can be undertaken with the final output the expected cost of the work and a recommended level of management reserves. The US Government Accountability Office has developed a comprehensive guide to developing credible cost estimates and then managing the budget for a project using earned value. The GAO Cost Estimating and Assessment Guide is particularly useful for major projects.
Cost Estimating versus Pricing
The cost estimate is the net cost of completing the scope of work. The price charged to a client for the work should consist of the following elements:
estimated cost
reasonable level of management reserves (contingency) to cover both the expected level of variability in the cost price and an allowance for identified risk events
amount of profit to reward the organization for the risks involved in undertaking the work and to compensate for the use of the organization s capital to undertake the work. This would normally exceed the amount received from a safe investment (e.g., a bank deposit).
The final price is always a subjective management decision based on the defined items above, an assessment of the market and what is likely to be an acceptable price, and views on the level of competition from others, combined with the organization s level of desire to win the work.
The above factors are focused on a competitive estimate to win work by a commercial bid or tender. If the work is internal to the organization, the expected benefits to be realised define an acceptable price.
Cost Estimating & Risk Minimization
Estimating what something will cost in the future is a risk. It is impossible to forecast what the element of work will actually cost. The estimating processes need to balance the mutually exclusive options of seeking the lowest practical cost estimate and minimizing risk. Risk is reduced if the estimated values are inflated but the unnecessarily high cost estimates tend to make competitive bids too expensive to win work and internal projects too expensive to undertake. Decision need to be made to balance cost and risk within the risk tolerance levels of the organization s management. Some of the decisions that need to be made include the following:
In-house resources or subcontract?
Direct in-house resources are subject to more control, direction, and motivation, but any estimating errors in the quantum of effort needed to accomplish the work are a direct cost to the project (as are supervision, quality defects, etc.).
Subcontractors can be expected to carry the consequences of their estimating errors and perform the work for the agreed price. However, there is a loss of direct control and the need to manage contracts. At least some of the risk is transferred to the subcontractor.
Low price or safe suppliers and subcontractors?
Low bids from suppliers and subcontractors allow the overall estimate to be lower, increasing your competitive advantage. The low bid may be due to a competitive advantage held by the supplier or subcontractor.
The low bid contractor may have made an error in its estimating processes. In this circumstance the contractor may refuse to take on the work or chose to take on the work with the intention of making claims to recover its loss or delivering a lower-quality product.
Firm fixed price or cost reimbursable contacts?
A fixed price offers no insight into the way the contractor calculated its bid and tends to make the price changes expensive (there is no base for comparison).
Cost reimbursable contracts allow insight into the pricing process but require additional estimating to determine the cost.
The combination of options that provides the best (lowest) cost outcome within an acceptable risk parameter requires careful judgement within the organization s overall governance processes.
Major contractors divide the work between suppliers and subcontractors (i.e., their supply chain). The art of managing the estimating process is to ensure all of the work is portioned out to trade packages and there are no duplications. The art of estimating is to ensure 100 percent of the work is priced but only once! In addition, the accepted prices used in the estimate have been risk assessed on the likelihood of the quoted price being achieved by the supplier.
Appropriate Levels of Detail
Adding detail to an estimate will not automatically improve accuracy. Accuracy is only improved if improved knowledge or insight is achieved. Processes such as estimating the cost of individual efforts against work on scheduled activities can only add value if the information being used is based on new and enhanced information, preferably gathered from the person actually involved in the work (or from knowledge of the specific person). This type of estimating is appropriate for short-term work, but is pointless for tasks scheduled months in the future, where the precise scope of work is not known, and the people who will be doing the work are not defined.
Adding unnecessary detail increases costs, increases the workload, reduces visibility, and reduces flexibility. Superficial detail will also change expectations of more senior managers, who may believe the information is valid and therefore believe it is safe to reduce contingencies.
Guideline for Creating a Good Estimate
Estimators forecast the future, attempting to predict the time and money required to produce a product or service. Predicting the future is never an easy task, and it becomes increasingly difficult the more unique the project. However, knowing and applying the golden rules of estimating, listed below will provide greater opportunity for a successful forecast.
Find the Right Estimator
Estimators familiar with the work and estimating methods are key. There are many estimating techniques, including phased, top-down, analogous, parametric, and bottom-up. Regardless of the estimating method, the person making the estimate should have an understanding of the work to be done, and of the techniques and goals of estimating. He or she needs to understand that the goal is to predict the most likely outcome.
Estimate Based on Experience
All projects are unique, but they often have similarities with other historical projects. Data from past projects can be helpful in estimating future ones past performance data improves the accuracy of any of the discussed estimating techniques. Formal data is best, but if it is unavailable, people s personal experiences and recollections are valid, but need confirmation.
Avoid Negotiating Estimates
Though the tendency of management is to request estimate changes to reduce time and cost, this move should be resisted by demonstrating that the estimate was created from project specifications and represents a realistic balance of cost, schedule, and risk. Also, demonstrate that the estimate is linked to product specifications and the work breakdown structure. Further, highlight that the only way to reduce an accurate estimate is by changing the product scope or worker productivity.
Linking Cost Estimates with the Schedule
Apart from very small short-term projects (three to six months and under $200,000), attempting to directly integrate the cost estimating process with the scheduling process is fraught with difficulty. Even on these smaller projects, direct linking is not really feasible unless the primary source of all costs is staff directly employed on the work.
Most normal projects require a degree of integration between cost and schedule. This is usually achieved by developing a WBS and integrating time, cost, scope, risk, and quality at either the work-package level or the control-account level.
Dealing with Objections
It is not uncommon in internal projects and negotiations, that your carefully prepared project estimates have to be justified or defended if the client or sponsor thinks the numbers are too high. If you have done the estimating properly, reducing the price or time in the face of an objection simply creates a bigger problem later when the project overruns its reduced costs or time.
Information is the key to validating your work. You should be able to defend the estimate by demonstrating the following components:
your understanding of the work
estimating techniques you used
estimate of the effort hours, duration, and cost
detailed estimating information in case the sponsor would like to review
estimating assumptions
level of uncertainty as reflected in the estimating range
This level of information gives you the facts to respond to the challenge, and it will stop many challenges because people will have difficulty disputing your facts. The keys to this part of discussion are your credibility and the quality of the information you have presented.
Once the credibility of your estimate is accepted based on your estimating rigor, the discussion can then proceed to alternatives. If the sponsor still thinks the numbers are too high, or cannot afford the solution at that cost, there are a few alternative options:
Determine if the client has any additional information that would allow you to revise your assumptions and perhaps revise the estimate. For instance, if a critical end date now has some flexibility, perhaps the estimate can be revised based on this new information.
Determine whether high-level requirements and functionality can be scaled back. In many cases, the original set of features and functions is more of a wish list. After seeing a price tag, it is very possible that the client can live without certain features.
If you included a high contingency to reflect a high estimating risk, ask the client for more time to gather more detail for the estimate, which may result in less uncertainty and risk and allow you to reflect this as a smaller contingency.
No estimate is perfect. Sensible sponsors and clients are seeking reassurance that you have done the best job possible in the circumstances, and the costs are realistic. This reassurance requires that they believe you are skilled and credible and your estimating processes were rigorous and effective.
Managing the Estimate Lessons Learned
Estimating normally precedes the start of a project, or is completed in the early concept and planning phases. While the estimate may go through several iterations as its final scope is firmed up, the normal expectation is the estimate should be converted to the cost baseline before the main execution phase begins.
The cost baseline provides one of the key foundations for the ongoing management of the project work. The cause of any variance from the baseline should be identified, and options developed to lock in gains and mitigate losses. This is the domain of project controls, cost engineering, earned value management, and project administration.
Estimating processes are used for price variations and occasionally to re-estimate the project if the original cost baseline is found to be invalid. However, numerous surveys have shown that in most circumstances, re-estimating the project costs is less accurate then applying earned value calculations. The exception is where major changes in the structure of the project team or management have occurred.
Upon the completion of the project, and occasionally during the execution of the project, it is important to undertake an effective lessons learned study to determine the voracity of the estimating process and identify areas for improvement. A major advantage of retained organizational experience is the capability to accurately price work in a particular domain and understacixnd and manage the associated risks.

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