5/17/2021

Chapter 8
Cost Estimating and Budgeting

Project Management for Business,

Engineering, and Technology

Intro to Cost Estimation

1
 5/17/2021

Systems Development Cycle

Phase A: Conception phase Phase B: Definition phase
Initiation stage System definition
Feasibility stage User and system
Proposal preparation requirements
Project definition

◼ Phase D:
Project Operation
plan shouldphase Phase C: Execution
answer the following phase
questions about
System maintenance Design stage
the project:
and evaluation Production/build stage
1. What? Fabrication
Project Scope Statement / SOW
How?
2. System Testing
System
Work Breakdown Structure
Implementation stage
Improvement
Who? termination
Responsibility Assignment
3.
TrainingMatrix
AcceptanceSchedule
tests of
4. When, how long, and in what order?
(To Phase A: Activities
Installation
5. How much?
repeat cycle)
Cost Estimation
Termination
6. How well?
7. What if?

Cost Overruns on Infrastructure Projects

300

200
Cost overrun %

100

-100

1910 1930 1950 1970 1990

1920 1940 1960 1980 2000
Year of decision to build
Projects versus Percent Cost Overrun (Flyvbjerg, B., Bruzelius, N., & Rothengatter, W., Megaprojects and Risk: An Anatomy of Ambition.
Cambridge:Cambridge University Press, 2003, p. 17. With permission.)

2
 5/17/2021

Sources of Cost Escalation and Overruns

◼ Is the problem that costs go up due to project
mismanagement (execution failures)?
◼ Or are estimates too low and understate costs
(planning failures)?

Sources of Cost Escalation and Overruns

◼ Uncertainty and Lack of Accurate Information
◼ Changes in Requirements, Scope, or Design
◼ Economic and Social Factors (inflation)
◼ Inefficiency, Poor Communication, and Lack of
Control
◼ Ego Involvement of the Estimator
◼ Project Contract (fixed price and cost-plus)
◼ Moral Hazard

3
 5/17/2021

Cost Estimating and the System

Development Life Cycle

System Life Cycle Costs

Life cycle costs (LCC)
◼ All costs of a system throughout its full
cradle-to-grave life cycle, i.e.:
❑ all costs incurred during the project life cycle
phases of Definition and Execution
◼ PLUS
❑ all costs associated with the Operations
phase of the system and the eventual
disposal of the system

4
 5/17/2021

1:5:200 Rule1 (construction industry)

◼ There is a rule of thumb stating that:

❑ If the initial construction costs of a building is 1,

❑ then its maintenance and operating costs over the
years is 5,
❑ and the business operating costs (salary of
people working in that building) is 200.

1. Evans, R., Haryott, R., Haste, N. and Jones, A. (1998) The Long Term Costs of Owning and Using Buildings, London, Royal
Academy of Engineering.

System Life Cycle Costs

Purpose of life cycle cost analysis
◼ To anticipate the realities of operating,
maintaining, and (ultimately) disposing
of the end-item system
◼ To establish target costs for operating,
maintaining, and disposing of the end-
item system.
◼ To design the system so it will meet
those target costs.

5
 5/17/2021

Summarizing with Q&A

Cost Estimation Process

6
 5/17/2021

Estimating Process
Estimate versus Target or Goal
◼ Estimate: a realistic assessment based upon known
facts about the work, required resources, constraints,
and the environment, derived from estimating methods
◼ Target or goal: a desired outcome, commitment, or
promise.

◼ Don’t confuse estimates with goals. The estimating

process should be directed at producing accurate and
precise estimates, not restating targets or goals.

Estimating Process
Estimating Methods
1. Expert opinion
2. Analogy + compensation for differences
3. Parametric: Formula or Cost Function, e.g.,
0.7

( )
Thrust, engine A
Cost, engine A = (Cost, engine B)
Thrust, engine B

Cost, cabling = 150 (total area + 10%)

+ 300 (number of rooms)
+ 125 (number of floors)

7
 5/17/2021

Estimating Methods (cont’d)

4. Cost engineering
Detailed cost breakdown of labor, materials,
etc. at the work package or task level.
Example below

Total, L1 = 60
Total, L2 = 30

8
 5/17/2021

Total = $26,500

Read Example 8.6 for more details

Estimating Process

◼ Any of these methods can be used in any area

of a project
◼ Note that parametric (top down) estimates may
be more difficult to adjust for particular
conditions than engineering costs (bottom up)
◼ Parametric and cost engineering methods are
often used together, parametric estimating in the
early stages, cost engineering later

9
 5/17/2021

Summarizing with Q&A

Steps toward Cost

Estimation

10
 5/17/2021

Estimation Process
Procedure for larger projects
Project Management
WBS 1. (PM)
information

Functional Management
2.
(FM)

3.
Work Team Leads

Estimation Process
Procedure for larger projects, steps 1-3

1. PM: Uses WBS to identify work packages

2. FM: Subdivides work packages into identifiable
tasks; determines labor, material, facilities, and
resource requirements for each
3. Supervisors/team leads: Estimate number of
labor hours and quantities of materials needed
Project Management
WBS 1.
information

Functional Management
2.

3.
Work team

11
 5/17/2021

Estimation Process
Project Management
6. Labor and cost
estimates

Functional Management
4., 5.

Work team

Project Management

Estimation Process WBS

information
6.

Functional Management 4., 5.

Procedure for larger projects, steps 4-6

Work team

4. FM: check and aggregate time and material

estimates
5. FM: convert time estimates into costs
6. PM: checks over and approves all estimates
aggregates costs; adds in overhead costs:

Project cost = ∑direct costs + ∑ overhead costs

12
 5/17/2021

Estimation Process
Project Management 7., 8.

WBS
information

Functional Management

Work team

Estimating Process (cont’d) WBS

Project Management 7., 8..

information
Procedure for larger projects, steps 7-8
Functional Management

7. PM: Adds in contingency amounts.

Work team

Two possible contingencies

1. Base estimate = Σ (WP estimates + WP contingency)

(to handle known-unknowns)

2. Final estimate = Base estimate + overheads + project contingency

(to handle unknown unknowns; PM controls this)

8. PM: Compares bottom-up estimates to top-down targets

or goals. Reconciles differences.

13
 5/17/2021

Elements of Typical Budget

I. Direct Costs
Direct Labor (DL)
Charges for labor working directly on project 50,000.00
Direct Overhead on Labor (% of DL) E.g., 40% 20,000.00
Labor support: benefits, etc.

Direct Nonlabor and Materials (M) 10,000.00

Subcontractors, consultants, travel, telephone, materials,
purchased parts, etc.
Direct Overhead on Nonlabor and Materials (% of M) 3,333.33
Shipping, insurance, security, etc. E.g., 33.33%
Direct Total 83,333.33
II. General & Administrative (% of Direct Total) E.g., 20%
(Indirect overhead)
Corporate overhead: proposals, publicity, president, etc. 16,667.00
Budget Amount 100,000.00

Summarizing with Q&A

14
 5/17/2021

Project Budget

Project Budget
◼ Once approved, the estimate becomes the
budget.
◼ Specific for each project

◼ Subdivided into Control Accounts, one for each

work package

◼ Each cost account is a portion of the project total

budget

15
 5/17/2021

Project Budget

◼ Integrated project budgets are loaded to the

project network to allow cost tracking and work
performed to be tracked against time

◼ Example:

16
 5/17/2021

Control (Cost) Account

◼ The project budget is subdivided into smaller
budgets called control accounts or cost
accounts.
◼ Each control account includes:
❑ A work description
❑ A time schedule
❑ Who is responsible
❑ Material, labor, and equipment required
❑ A time-phased budget.

Cost Summaries

17
 5/17/2021

Cost Summaries

Summarizing with Q&A

18
 5/17/2021

Project Cost Accounting

System

Project Cost Accounting System

◼ Enables budget, progress, and actual cost
information to be aggregated or
disaggregated according to work packages
or functional areas or any combination of
work packages the PM wants to monitor and
track.

19
 5/17/2021

Project Cost Accounting System;

Cost Monitoring
◼ Weekly Expense and Cumulative Expense
Profiles.
❑ Created from work package budgets, actual reported
costs and the project schedule

❑ Assumes expenses occur uniformly throughout work

package duration

Project Cost Accounting System;

Cost Monitoring
◼ Weekly expense profile
❑ Similar to resource loading profile

◼ Example:

20
 5/17/2021

Compute uniform per-week cost (analogous to weekly resource requirement)

50

40 2. Sum per-week costs across all tasks

according to schedule.
30

20 Weekly expense profile

10

Plot showing expected per work expenses based on scheduled activities and
per-week costs of each.

21
 5/17/2021

Project Cost Accounting System;

Cost Monitoring

◼ The Cumulative expense profile shows the

Budgeted Cost of the Work Scheduled (BCWS),
which is the planned expenditure trajectory
throughout the project. It is based on the Budget
loaded to the project network.

◼ Example:

Early start times

50

40

30

20

10

Cumulative budget profile

BCWS

22
 5/17/2021

Project Cost Accounting System;

Cost Monitoring
◼ Planning and Control
❑ The weekly and cumulative budget and expense
profiles may be used to adjust schedules to
accommodate cash-flow and working capital
constraints or other resource limitations
❑ Example

Late start times

L Q

50

40
Maximum required
30 Working capital

Weekly expense profile, late start

20

10

Cumulative budget
profile, early start

Cumulative budget
profile, late start of L and Q

23
 5/17/2021

Summarizing with Q&A

24