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PMP Training Kit: Cost Management

Estimate Costs

The Estimate Costs process is a planning process that uses the cost management plan for guidance and takes the defined activities and work packages, and assigns a cost estimate for each one using a variety of tools and techniques. In order to easily track which estimates are for which particular work package, you can use the numbering systems from the work breakdown structure (WBS). This process is a highly iterative process that is repeated throughout the life of the project.

The Estimate Costs process covers the following domain task:

  • 2.3 Develop a budget plan based on the project scope using estimating techniques, in order to manage project cost.

In assessing the estimate for each activity, it is important to have a basic understanding of different types of costs that may be estimated.

  • Variable costs These are costs that change with the amount of production. The more you produce, the more costs you incur. For example, if you increase the amount of homes you are building, you will use more home building materials. If you use more electricity as a result of greater amounts of work, then your costs will increase.

  • Fixed costs These are costs that are fixed no matter how much you produce. For example, the rental you pay for your warehouse storage space is constant whether or not the warehouse is full or empty. Also, the costs you pay for any consents you require or equipment needed to complete the job are fixed costs.

  • Direct costs These are costs attributable directly to the actions of the project. For example, the materials you use on your project are direct costs.

  • Indirect costs These are costs that are not incurred directly by the project but which the project may have to account for. For example, the project may have to make provision for paying a share of corporate overheads such as office rental space and shared services. Your cost management plan may contain guidelines on what portion, if any, of indirect costs you must account for in your cost estimates. These are often referred to as overheads.

  • Sunk costs These are costs spent on the project to date that cannot be recovered if the project was to stop. For example, the money you have spent developing code for a new piece of software is sunk cost if you stop halfway through, because it has no recoverable value. Your cost management plan may contain guidelines on how sunk costs are treated in determining whether to continue on a troubled project.

All estimates are simply your best guess at the future, based on the information you have available to you. The better the information you have, the better the estimates will be. Thus, there is nearly always an element of uncertainty inherent in any estimate. It is often important to express this range of uncertainty inherent in any estimate. As a rule, the accuracy of cost estimates will improve as the project progresses, and your organization may have, as part of its organizational process assets, guidelines on the necessary level of accuracy required before proceeding. Table 5-3 shows the typical description of a variety of estimate ranges.

Table 5-3. Range of estimates

Estimate type

Estimate range

Order of Magnitude Estimate

-50% to +100%

Rough Order of Magnitude Estimate

-25% to +75%

Conceptual Estimate

-30% to +50%

Preliminary Estimate

-20% to +30%

Definitive Estimate

-15% to +20%

Control Estimate

-10% to +15%

Inputs

The Estimate Costs process uses some, or all, of the following seven inputs.

Cost management plan

The cost management plan is obviously a key input into the Estimate Costs process because it provides the guidance for how you are going to complete this process and, therefore, without it you would not be able to complete the process. The cost management plan is an output from the Develop Cost Management Plan process.

Human resource management plan

The human resource management plan is used as an input into the Estimate Costs process because it contains information about the project staff who will be working on the project and the chargeout rates, remuneration packages, and any other financial rewards to be paid to them. In order to develop the project cost, you will need to know this information. The human resource management plan is an output from the Plan Human Resource Management process.

Scope baseline

The scope baseline is composed of the project scope statement, the work breakdown structure (WBS), and the WBS dictionary, and it contains a full and detailed description of all the work to be done on the project. By using this information you can then attribute costs to each of the work packages and also the activities taken from the project schedule, and aggregate these costs into a total project cost estimate. The scope baseline is an output from the Create WBS process.

Project schedule

The project schedule is an important input into the Estimate Costs process because it gives an indication of when the work packages and activities are to be completed. The sequencing, timing, and duration of distinct project work packages and activities will affect the costs. The project schedule is an output from the Develop Project Schedule process, which in itself is the culmination of the other schedule management planning processes.

Risk register

The risk register is used as an input into the Estimate Costs process because it contains information around defined and documented uncertainty relating to specific work packages. This uncertainty is captured in the contingency reserve for each activity work package and needs to be taken into account in developing the project cost estimates. The risk register is an output from the Identify Risks process.

Enterprise environmental factors

The specific types of enterprise environmental factors that are useful as inputs into the Estimate Costs process are external market conditions that will affect the prices of products and services being procured for the project, and any published commercially available estimating data.

Organizational process assets

The specific types of organizational process assets that are useful as inputs into the Estimate Costs process are any relevant templates and processes useful in the development of project cost estimates, including any historical information and lessons learned owned by the organization.

Tools and techniques

The following 10 tools and techniques are used upon the inputs to deliver the process outputs.

Expert judgment

The use of experts is an acknowledged tool in the preparation of project cost estimates. It is the experts, or people working on the project, who have an intimate knowledge of the work to be done and the likely cost of that work. In addition to project team members with expert judgment on the work to be done, you may also choose to consult external experts, such as those involved in the quantity surveying profession, who can provide expert advice on the expected costs of materials and resources to be used.

Analogous estimating

Analogous estimating is a quick means of estimating what a likely cost is to be for a particular material or resource by comparing your current requirements with the requirements of a previous project that you have information on, and then looking at the similarities between the two instances to determine what your current estimate will be. For example, if on a previous project you used a particular amount of concrete and it cost you $1,500, and on this project you expect to use twice as much, you would assume that your cost estimate is $3,000, by using analogous estimating. Because you are using an analogy from previous experience, there is a certain degree of expected inaccuracy in this form of estimating.

Parametric estimating

Parametric estimating is generally considered to be more accurate than analogous estimating because it uses known quantities of materials for resources and multiplies them by known financial rates. For example, you may know that you require 50 hours of work to be done by a business analyst, and that a business analyst costs $80 an hour; therefore, multiplying 50 hours by $80 an hour, you will arrive at a cost estimate of $4,000 by using parametric estimating.

Bottom-up estimating

Bottom-up estimating is generally considered to be quite an accurate form of estimating, because what you are doing is taking cost estimates from lower-level information—for example, the bottom level of the WBS—and then adding up, or rolling up, to higher levels and aggregating those costs to report a total cost.

Three-point estimating

You saw the use of three-point estimating in Chapter 4, “Time Management,” in the discussion of the Estimate Activity Durations process from the Schedule Management knowledge area. Here it is used again as a method of determining an estimate where there is a most likely (cM), optimistic (cO), and pessimistic (cP) cost estimate for an activity.

To get a simple average you take these three figures and add them together and divide by three. However, if you want to get a weighted average that gives greater weight to the most likely (cM) figure, then the formula to use is

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For example, if you have an optimistic cost estimate of $10, a most likely cost estimate of $16, and a pessimistic cost estimate of $25, then the weighted average using three-point estimating is $16.50.

You can also calculate the standard deviation which indicates how far from the average the optimistic and pessimistic figures are. A smaller standard deviation means they are closer to the average than a larger standard deviation. The formula for standard deviation is

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For example, using the numbers from the previous example, the standard deviation would be $2.50.

After you have determined the standard deviation, you can then express your certainty about a cost estimate range. You express this certainty as a confidence interval where one standard deviation either side of the mean represents a confidence interval of 68 percent, two standard deviations either side of the mean gives a confidence interval of 95 percent, and three standard deviations either side of the mean gives a confidence interval of 99.7 percent.

For example, using the numbers from the previous example, you could say that you have a 95 percent certainty that the cost for the activity will be between $11.50 and $21.50.

Reserve analysis

Reserve analysis looks at the contingency reserves, or contingency allowances, provided for in the project cost estimates. The contingency reserve is an amount that reflects and allows for identified uncertainty in estimating particular costs. It is commonly known as “accounting for the known unknowns” in any project and is usually calculated during quantitative risk analysis performed as part of the Risk Management knowledge area. For example, you may determine that a particular activity has a 10 percent chance of experiencing a $1,750 cost overrun, and therefore you would allow a $175 figure ($1750 x 10 percent) in the contingency reserve. By aggregating, or adding up, all of the individual amounts allowed for in the contingency reserve analysis, you will arrive at a total contingency reserve for the entire project.

The management reserve for unknown unknowns is also able to be calculated during risk assessment, or by expressing the range of uncertainty in your estimates as a total amount. The management reserve is controlled by senior managers, and the project manager must apply to use it; it is not part of the approved budget.

Cost of quality

As part of the preparation of your quality management plan, you will consider the issue of cost of quality, because any decisions made about what this means to you will affect cost on the project immediately, and for the organization after the project is handed over. Cost of quality refers to the quality attributes of the project and the product over the life of the product. For example, you may need to take into account the cost of future product returns or warranty claims because of decisions made to manufacture lower quality to lower the project costs.

Project management software

Project management software should be considered essential for any large and complex projects because trying to collect and aggregate many cost estimates manually is simply not possible.

Vendor bid analysis

The vendor bid analysis process is a way of double-checking the bids received from vendors to make sure that they are neither overinflated nor underinflated. You can think of vendor bid analysis as your quality check on the prices people are submitting to you.

Group decision-making techniques

Good cost estimates are prepared by people familiar with the activities being estimated, and when you get a group of these people together you are going to need some effective group decision-making techniques to make sense of the expert opinions supplied. These techniques are also used when estimating elements of the project schedule and include brainstorming, nominal group techniques, and the Delphi technique.

Outputs

The Estimate Costs process produces some, or all, of the following outputs.

Activity cost estimates

The activity cost estimates are the individual estimates for each activity identified. They are the entire focus of this process and will be used to put together your cost baseline. The activity cost estimates are used as an input into the Determine Budget process.

Basis of estimates

The basis of estimates is a useful document, because it outlines the assumptions made, the type of estimating technique used, any known constraints, and an indication of the range of uncertainty and of the confidence level of the final estimates for each activity, and indeed the entire project. The basis of estimates is used as an input into the Determine Budget process.

Project documents updates

The specific project documents that may be updated as a result of estimating costs will include such things as the statement of work, which may be updated as a result of the cost estimates, and elements of the risk register that are refined and updated as a result of specific cost estimates.