An Introduction to

Project Project Cost Estimation

Management & Budgeting
Pramod Kumar Singh
B Tech: IIT BHU Varanasi
MBA: IIM Calcutta
Ex-PwC, Ex-B&V
 Welcome to CEOs /
Future Leaders of
Industry
Project Management
Prof Pramod Kumar Singh
( B Tech – IIT, MBA – IIM Calcutta)

SVKM’s Narsee Monjee Institute of Management Studies

Mukesh Patel School of Technology Management & Engineering
Mumbai
 Introduction
B Tech ( IIT BHU Varanasi)
Studies

MBA ( IIM Calcutta)

Contract Law ( Harvard University)
Industry

BHEL, PwC, Abengoa SA, Black & Veatch, Various Start-ups

Value Chain

Marketing, Operations, ERP, Management Consulting, Finance, Projects &

Contracts

World Bank, ADB, JICA, DfID, Govt of India, Govt of MP, AP, Bihar,
Countries Clients

TNEB, NTPC, IOCL, ONGC, SEBs, NHAI, etc.

India, Sri Lanka, Bangladesh, Nepal, USA, Japan, UAE, Kuwait, Oman, Spain
 Today’s
Agenda

Project Cost Estimation & Budgeting

• Project cost elements,

• Cost estimation methods,
• Cost Accounting System,
• Cost Schedule & Forecast

4
Project Cost Management Definition

Project Cost Management includes

the processes involved in estimating,
budgeting, and controlling costs so that the
project can be completed within the
approved budget.
PMBoK® Guide, 4th Edition, Glossary

5
Types of Costs

Project Costs can be categorized into Variable or Fixed Costs

Type Definition Examples

Costs that change with the amount of

Variable Material, supplies, wages, etc
production or the amount of work.

Non-recurring costs that do not change as

Fixed Setup, rental, etc.
production changes.

Incurred Costs during a project are the result of Direct or Indirect charges
Type Definition Examples

Team travel, team wages,

Costs directly attributable to the work on
Direct recognition, costs of materials
the project
used on the project, etc.

Overhead items or costs incurred for the Taxes, fringe benefits, janitorial
Indirect
benefit of more than one project. services, etc.
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Cost Management Processes

Estimate Costs
Determine Budget
Control Costs

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 Estimate Costs Process

Project Management Process Groups

Knowledge Area
Initiating Planning Executing Monitoring & Controlling Closing

7.1
7. Project Cost Estimate Costs - 7.3 -
Management
- Control Costs
7.2
Determine Budget

13
Estimate Costs Terms

Estimate Type Margin Process Group

Rough Order of
-50% to +50% Initiating
Magnitude (ROM)

Budget or
-10% to +25% Planning
Preliminary
Monitoring &
Definitive or Detailed -10% to +10% Controlling

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Estimate Costs Tools and Techniques
Expert Obtaining one cost estimate per activity based on expert judgment, historical
Judgment information, or guessing.
Using the actual cost of previous, similar projects as the basis for estimating the
Analogous
cost of the current project. Suitable when there is limited amount of detail. Uses
Estimating
expert judgment. Less costly than other techniques, but also less accurate.
A technique that uses a statistical relationship between historical data and some
Parametric other variable to estimate the cost of an activity.
Estimating
For example: square footage in construction, lines of software code, etc.
Bottom-Up Estimating individual work packages and then summarizing them to a higher level of
Estimating generality. More accurate but also more costly; requires well-defined activities.

A technique that uses three cost estimates to represent the optimistic, most likely,
and pessimistic scenarios. Used to improve the accuracy of the estimates when the
Three Point
underlying activity or cost is uncertain or there is a considerable amount of risk to
Estimating
factor in. Often the estimates are combined by PERT* formula into one probable
estimate

*Note: PERT (Program Evaluation and Review Technique) is an estimating method that uses a weighted
average of three numbers to come up with a final estimate. One of the most used PERT equations
is calculated as (Optimistic + 4Most Likely + Pessimistic)/6, which “weighs” the most likely cost
most heavily, since it is weighted four times as much as the other two values.
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Estimate Costs Tools and Techniques (cont’d)
Many estimators include contingency reserves as costs in schedule activity cost
estimates. This has the problem of potentially overstating cost estimates.
Reserve Management Reserve: Extra money in the budget to cover the cost of unknown
7.1.2.6
Analysis events that might affect the project.
Contingency Reserve: Extra money in the budget to cover known risks
identified in Risk Management Plan.

The Cost of Quality (Section 8.1.2.2) may be used in the preparation of estimates, by
Cost of
7.1.2.7 showing that if thorough requirements, design and planning are not done, there may
Quality
be increased costs for rework due to lack in initial quality.

Project
Management Tools, such as cost estimating software applications, computerized spreadsheets,
7.1.2.8
Estimating simulation and statistical tools, that can assist with cost estimating.
Software

By comparing multiple bids and using PERT analysis you can determine the most
likely cost for each deliverable, which will give you a more accurate project cost
Vendor Bid
7.1.2.9 estimate. Also understand that when using and managing outside vendors, additional
Analysis
work will be required to examine the prices and proposals of individual deliverables
and manage these vendors throughout the project.

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What is Cost and Project Cost Management?

• Cost is a resource sacrificed or foregone to

achieve a specific objective or something given
up in exchange
• Costs are usually measured in monetary units
like dollars
• Project cost management includes the
processes required to ensure that the project
is completed within an approved budget
Basic Principles of Cost Management
• Most CEOs and boards know a lot more
about finance than IT, so IT project
managers must speak their language
– Profits are revenues minus expenses
– Life cycle costing is estimating the cost of a project plus the
maintenance costs of the products it produces
– Cash flow analysis is determining the estimated annual costs
and benefits for a project
– Benefits and costs can be tangible or intangible, direct or
indirect
– Sunk cost should not be a criteria in project selection
Basic Principles of Cost Management
• Tangible costs or benefits are those costs or benefits that an
organization can easily measure in dollars.
• Intangible costs or benefits are costs or benefits that are difficult to
measure in monetary terms.
• Direct costs are costs that can be directly related to producing the
products and services of the project.
• Indirect costs are costs that are not directly related to the products or
services of the project, but are indirectly related to performing the
project.
• Sunk cost is money that has been spent in the past; when deciding
what projects to invest in or continue, you should not include sunk
costs.
Basic Principles of Cost Management
• Learning curve theory states that when many items are produced
repetitively, the unit cost of those items decreases in a regular
pattern as more units are produced.
• Reserves are dollars included in a cost estimate to mitigate cost
risk by allowing for future situations that are difficult to predict.
– Contingency reserves allow for future situations that may be
partially planned for (sometimes called known unknowns)
and are included in the project cost baseline.
– Management reserves allow for future situations that are
unpredictable (sometimes called unknown unknowns).
Types of Construction Costs:
❑ Capital Cost:
❑Expenses related to the initial establishment of
the facility:
• Land acquisition, including assembly, holding and improvement
• Planning and feasibility studies
• Architectural and engineering design
• Construction, including materials, equipment and labor
• Field supervision of construction
• Construction financing
• Insurance and taxes during construction
• Owner's general office overhead
• Equipment and furnishings not included in construction
• Inspection and testing
• Operating and Maintenance Cost:
– The operation and maintenance cost in subsequent years over the
project life cycle includes the following expenses:
• Land rent, if applicable
• Operating staff
• Labor and material for maintenance and repairs
• Periodic renovations
• Insurance and taxes
• Financing costs
• Utilities
• Owner's other expenses
• The magnitude of each of these cost components depends on the nature, size and
location of the project as well as the management organization, among many
considerations. The owner is interested in achieving the lowest possible overall
project cost that is consistent with its investment objectives.

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Contingencies provisions:
– In most construction budgets, there is an allowance for
contingencies or unexpected costs occurring during construction.
This contingency amount may be included within each cost item
or be included in a single category of construction contingency
– The amount of contingency is based on historical experience and
the expected difficulty of a particular construction project
– For example, one construction firm makes estimates of the
expected cost in five different areas:
• Design development changes,
• Schedule adjustments,
• General administration changes (such as wage rates),
• Differing site conditions for those expected, and
• Third party requirements imposed during construction, such as new
permits.
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 Project Cost Management

• Project Cost Management includes the processes involved in

planning, estimating, budgeting, and controlling costs so that the
project can be completed within the approved budget.
• Cost Estimating – developing an approximation of the costs of
the resources needed to complete project activities.
• Cost Budgeting – aggregating the estimated costs of individual
activities or work packages to establish a cost baseline.
• Cost Control – influencing the factors that create cost variances
and controlling changes to the project budget.
 Summary of Estimate Costs Methods
Analogous or Top-Down Parametric Modeling Bottom-Up

“If one application costs

“The last effort like this cost “Task A costs $200 & Task B
$100,000, then five
Example $9MM so this effort should costs $150, so project cost is
applications should cost
cost about $9MM.” $200+$150 = $350”
$500,000.”

✓ Moderately fast if model is simple ✓ Most accurate

✓ Fast/ Inexpensive to do
✓ With enough sophistication, the ✓ Force estimators to think twice
✓ Limited information needs
Benefits model can be reused for many about the work
✓ Gives PM an idea of types and sizes of similar ✓ Facilitates cost monitoring and
management’s expectations projects control later

Can be dangerously misleading Requires detailed

Generally less accurate
Only as good as the accuracy, understanding of the work
Only as good as the
detail, and comparability of the Time consuming
comparability of the projects
historical data used Harder to get management
Drawbacks Requires expertise to make
Requires quantifiable parameters buy-in to process
expert judgment on
comparability of projects Requires consideration of Project team may pad
“volume discounts” and “learning estimates if not sure of work
curves” required
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7.1 Estimate Costs Data Flow Diagram

PMBoK® Guide,4th Edition, p. 169

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 Determine Budget Process

Project Management Process Groups

Knowledge Area
Initiating Planning Executing Monitoring & Controlling Closing

7.1
7. Project Cost Estimate Costs - 7.3 -
Management
- Control Costs
7.2
Determine Budget

28
 Time-Phased Project Costs - “S-Curve Diagram”

Key Notes:
If Project Expenditures exceed the cost baseline, the project is over budget.
Project Funding Requirements need to be negotiated against available cash flow. If
cash flow is not available the project funding needs to be restructured; i.e., Project
Funding Reconciliation process.

29 PMBoK® Guide, 4th Edition, p. 178

7.2 Determine Budget Data Flow
Diagram

30 PMBoK® Guide, 4th Edition, p. 175

 Cost Estimating: Tools and Techniques
• Analogous Estimating: Using the actual cost of previous, similar projects as the
basis for estimating the cost of the current project.
– Analogous cost estimating uses expert judgment.
– Analogous cost estimating is frequently used to estimate costs when
there is a limited amount of detailed information about the project
– Generally less costly than other techniques
– Generally less accurate

• Determine Resource Cost Rates

– For each resource to estimate schedule activity costs.
– Standard rates with escalation factors can be included in the contract.
– Obtaining data from commercial databases and seller published price lists
is another source of cost rates.
– Gathering quotes
• Bottom-up Estimating
– This technique involves estimating the cost of individual work packages or
individual schedule activities with the lowest level of detail.
– The cost and accuracy of bottom-up cost estimating is typically motivated by
the size and complexity of the individual schedule activity or work package.
– Generally, activities with smaller associated effort increase the accuracy of the
schedule activity cost estimates.
• Parametric Estimating
– Parametric estimating is a technique that uses a statistical relationship
between historical data and other variables (e.g., square footage in
construction
– This technique can produce higher levels of accuracy depending upon the
sophistication, as well as the underlying resource quantity and cost data built
into the model.
– A cost-related example involves multiplying the planned quantity of work to be
performed by the historical cost per unit to obtain the estimated cost.
• Project Management Software
– Project management software, such as cost estimating software
applications, computerized spreadsheets, and simulation and statistical
tools, are widely used to assist with cost estimating.
• Vendor Bid Analysis
– Other cost estimating methods include vendor bid analysis and an
analysis of what the project should cost.
– In cases where projects are won under competitive processes,
additional cost estimating work can be required of the project team to
examine the price of individual deliverables, and derive a cost that
supports the final total project cost.
• Reserve Analysis
– Many cost estimators include reserves, also called contingency
allowances, as costs in many schedule activity cost estimates. This has
the inherent problem of potentially overstating the cost estimate for the
schedule activity.
 Cost Budgeting:
• Cost budgeting involves aggregating the estimated costs of individual
schedule activities or work packages to establish a total cost baseline for
measuring project performance.
• Cost Aggregation
– Schedule activity cost estimates are aggregated by work packages in
accordance with the WBS.
• Reserve Analysis
– Reserve analysis establishes contingency reserves, such as the
management contingency reserve, that are allowances for unplanned,
but potentially required, changes. Such changes may result from risks
identified in the risk register.
• Funding Limit Reconciliation
– Large variations in the periodic expenditure of funds are usually
undesirable for organizational operations. Therefore, the expenditure of
funds is reconciled with the funding limits set by the customer or
performing organization on the disbursement of funds for the project.
 Cost Budgeting: Outputs
• Cost Baseline
– The cost baseline is a time-phased budget
that is used as a basis against which to
measure, monitor, and control overall
cost performance on the project.
• Project Funding Requirements
– Funding requirements, total and periodic
(e.g., annual or quarterly), are derived
from the cost baseline and can be
established to exceed, usually by a
margin, to allow for either early progress
or cost overruns.
– Funding usually occurs in incremental
amounts that are not continuous, and,
therefore, appears as a step function.
• Cost Control
– Project cost control includes:
– Influencing the factors that create changes to the cost baseline
– Ensuring requested changes are agreed upon
– Managing the actual changes when and as they occur
– Assuring that potential cost overruns do not exceed the authorized
funding periodically and in total for the project
– Monitoring cost performance to detect and understand variances from
the cost baseline
– Recording all appropriate changes accurately against the cost baseline
– Preventing incorrect, inappropriate, or unapproved changes from being
included in the reported cost or resource usage
– Informing appropriate stakeholders of approved changes
– Acting to bring expected cost overruns within acceptable limits.
 Cost Control Inputs:
• Cost Baseline
• Project Funding Requirements
• Performance Reports
• Work Performance Information
• Approved Change Requests
• Project Management Plan
Cost Control: Tools and Techniques
• Cost Change Control System
– A cost change control system, documented in the cost management
plan, defines the procedures by which the cost baseline can be
changed.
• Performance Measurement Analysis
– Performance measurement techniques help to assess the magnitude
of any variances that will invariably occur.
– The earned value technique (EVT) compares the cumulative value of
the budgeted cost of work performed (earned) at the original
allocated budget amount to both the budgeted cost of work
scheduled (planned) and to the actual cost of work performed
(actual).
– This technique is especially useful for cost control, resource
management, and production.
 Cost Control Tools:

• Cost Change Control System

– A cost change control system, documented in the cost
management plan, defines the procedures by which the
cost baseline can be changed. It includes the forms,
documentation, tracking systems, and approval levels
necessary for authorizing changes.

• Performance Measurement Analysis

– Performance measurement techniques help to assess the
magnitude of any variances that will invariably occur. The
earned value technique (EVT) compares the cumulative
value of the budgeted cost of work performed (earned) at
the original allocated budget amount to both the budgeted
cost of work scheduled (planned) and to the actual cost of
work performed (actual). This technique is especially useful
for cost control, resource management, and production.
– Unit Cost Method of Estimation

– If the design technology for a facility has been specified, the

project can be decomposed into elements at various levels of
detail for the purpose of cost estimation.

– The unit cost for each element in the bill of quantities must be
assessed in order to compute the total construction cost. This
concept is applicable to both design estimates and bid
estimates, although different elements may be selected in the
decomposition.

– For design estimates, the unit cost method is commonly used

when the project is decomposed into elements at various levels
of a hierarchy as follows:
– Preliminary Estimates. The project is decomposed into
major structural systems or production equipment items, e.g.
the entire floor of a building or a cooling system for a processing
plant.

– Detailed Estimates. The project is decomposed into

components of various major systems, i.e., a single floor panel
for a building or a heat exchanger for a cooling system.

– Engineer's Estimates. The project is decomposed into

detailed items of various components as warranted by the
available cost data. Examples of detailed items are slabs and
beams in a floor panel, or the piping and connections for a heat
exchanger.
 Computer Aided Cost Estimation
• Some of the common features of computer aided cost estimation software include:

• Databases for unit cost items such as worker wage rates, equipment rental or
material prices. These databases can be used for any cost estimate required. If
these rates change, cost estimates can be rapidly re-computed after the databases
are updated.

• Databases of expected productivity for different components types, equipment and

construction processes.

• Import utilities from computer aided design software for automatic quantity-take-
off of components. Alternatively, special user interfaces may exist to enter
geometric descriptions of components to allow automatic quantity-take-off.

• Export utilities to send estimates to cost control and scheduling software. This is
very helpful to begin the management of costs during construction.
• Version control to allow simulation of different construction
processes or design changes for the purpose of tracking changes
in expected costs.

• Provisions for manual review, over-ride and editing of any cost

element resulting from the cost estimation system

• Flexible reporting formats, including provisions for electronic

reporting rather than simply printing cost estimates on paper.

• Archives of past projects to allow rapid cost-estimate updating

or modification for similar designs.
Components of Project Cost Estimates for Major Projects

• Preliminary Engineering. This is the cost to

prepare the construction documents.

• Right-of-Way. This is the cost to research and

acquire right-of-way for the project, including
easements. Include right-of-way costs for storm
water management, wetland mitigation, and
other work outside the roadway prism.

• External Third Party (e.g. Utilities and Railroad

Adjustments). Perhaps the most difficult costs to
estimate are those that are associated with third
parties, such as utilities and railroads.
 Using Software to Assist in Cost
Management
• Spreadsheets are a common tool for resource planning, cost
estimating, cost budgeting, and cost control.

• Many companies use more sophisticated and centralized

financial applications software for cost information.

• Project management software has many cost-related features,

especially enterprise PM software.
Project Cost
 Let’s connect

Contact Me
Let me know about your Project Management Moment !

PKSINGH
B Tech IIT BHU Varanasi
MBA IIM Calcutta

99303 44085

[email protected]

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Thank you
Pramod Kumar Singh: An IIT +IIM Faculty