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Project Cost Estimation is Project Management

Project Cost Management is defined as the process of planning and controlling the project cost and budget effectively and efficiently. It defines what costs are required for each deliverable of the project. It includes various functions of Project management like estimation, job controls, field data collection, scheduling, accounting, design etc.

The cost of the project can be estimated from various process sources:

  • Creating Work Breakdown Structure (WBS)

  • Develop Schedule

  • Plan human resources

  • Identifying risks

Project Cost Estimation

Project Cost Estimation is defined as the process of approximating the total expenditure of the project. The accuracy of the cost estimation and budgeting in project management depends on the accuracy and details of the project scope, which is the scope baseline. The scope will also define any constraints like date, resources or budget. The risk register will help to calculate estimate types of costs, the expenses made behind the contingent action and the expenses made to cope with risks.

To estimate the cost of project you have to categorize various cost types into categories like:

  • Labor cost

  • Equipment cost

  • Cost of supplies

  • Travel cost

  • Training cost

  • Overhead cost, etc.

While cost management overall is a very complicated process and a critical project management knowledge area, we can break it down into four processes:

1. Resource planning

While resource management is in place to plan, allocate, and schedule the resources needed for each stage of a project, resource planning looks specifically at the costs associated with each of these resources. Because of the complexity of this process, a work breakdown structure (WBS) can help to simplify and provide clarity. Using your resource planning software, identify what resources will be used to complete each item in the WBS, determine the associated costs, and perform a cost-benefit analysis.

2. Cost estimation

Cost estimation is the process of approximating the costs associated with each of the resources required for all scheduled activities. Cost estimating forecasts the cost of completing a project within a defined scope. Given that scope tends to shift throughout the life of a project, cost estimation is not a one time process. Effective cost management requires project managers to iterate on cost estimations whenever scope changes or change requests are approved. These estimations provide a summation of all costs involved in successfully finishing a project, from inception to completion.

To get a good estimate at the costs, you can use one of the following techniques:

  • Analogous estimating: estimates are based on past projects. It uses actual costs from a similar finished project to estimate the costs of the new project. The accuracy of these estimates will depend on the similarities between the new project and the old project.

  • Parametric modeling: estimates are based on mathematical formulas, typically following a Regression Analysis or Learning Curve model. The accuracy of these estimates depends on the assumptions made.

  • Bottom-up estimating: estimates are based on individual work item cost and duration estimates. This involves estimating the smallest activities and then adding them up to create an estimate for the whole project.

3. Cost budget

Cost estimations lead directly into the cost budgets. In this step, you will determine the cost baseline and the funding requirements for the project. A good project budget will help you make key decisions with respect to the project schedule and resource allocation constraints. Combine individual activity cost estimates into a total project cost, establish the timing of the costs, and measure the progress of the project against the approximated baseline costs. These budgets should account for everything from direct labor costs, to material costs, factory costs, equipment costs, administrative costs, and software costs.

To determine the cost budget, consider the following techniques:

  • Cost aggregation: requires you to aggregate or combine costs from an activity level to a work package level. The final sum of the cost estimates is applied to the cost baseline.

  • Reserve analysis: requires you to create a buffer or reserve to protect against cost overruns. The degree of protection should be equivalent to the risk foreseen in the project. The buffer is part of the project budget, but not included in the project baseline.

  • Historical data: requires you to think about estimates from closed projects to determine the budget of the new project. This is very similar to analogous estimation described earlier.

  • Funding limit reconciliation: requires you to adhere to the constraints imposed by the funding limit. The funding limit is based on the limited amount of cash dedicated to your project. To avoid large variations in the expenditure of project funds, you may need to revise the project schedule or the use of project resources.

4. Cost control

Good project managers will carefully monitor the cost of their projects to prevent scope creep. This includes watching to see where actual cost has varied from estimated cost. Cost control also involves informing the stakeholders of cost discrepancies that vary too much from the budgeted cost.

Controlling the budget requires being aware of the original budget, approved costs, forecasted costs, actual costs, and committed costs. If there are any changes to scope or if unforeseen risks have an impact on the approved budgets, the project manager will need to review the level of impact and take corrective action as needed.

To effectively control project costs, consider these tools and techniques:

  • Earned value management: uses a set of formulas to help measure the progress of a project against the plan.

  • Forecasting: uses the current financial situation to project future costs. The forecast is based on budgeted cost, total estimated cost, cost commitments, cost to date, and any over or under budgeted costs.

  • To-complete performance index (TCPI): represents the level of project performance that future work needs to be implemented to meet the budget.

  • Variance analysis: involves analyzing the difference or variance between the budgeted costs and the actual costs to indicate whether the project is on budget.

  • Performance reviews: used to check the health of a project. Includes an analysis of project costs, schedule, scope, quality, and team morale. By learning how to estimate costs, determine budgets, and control costs, you can be a better project manager and leader. Effective cost management will help you get projects done on time and under budget, the golden ticket for any successful project manager.

Techniques used to estimate project cost

There are some techniques used to estimate a project cost like: Expert Judgement, Three-Point Estimation, Reserve Analysis and Cost of Quality.

However, to estimate project cost, formally there are few main methods (techniques) used as follows:

1. Analogous Estimating

This estimating technique is based on expert judgments and information based on similar previous projects. Where previously done similar project cost is considered with plus or minus of 20% for existing project.

2. Parametric estimating

Past data or record is used to estimate cost for the current project.

3. Bottom-up estimating

Once you have defined the scope of the project, it is the most reliable form of technique. In this technique, based on WBS, you estimate the cost for each resource or deliverables.

Likewise, there are other methods (techniques) which could be useful for estimating cost like PERT estimating, vendor bid analysis, etc.

Benefits of Cost Management in Project Management

  1. It controls the costs of the specific processes/ activities which in turn helps in gaining control over the complete business cost.

  2. With proper cost management, you will be able to accurately estimate the future expenses and thus put your efforts towards generating the expected revenues.

  3. Cost management helps in predefining the expenses of all the project activities which are then maintained as business records.

  4. It prevents the over expenditure on any one business components and thus maintains the budget balance.

  5. It helps you in prioritizing your project tasks by strictly limiting the financial flow. Because of this, you will focus more on the activities that are actually needed in the project.

  6. It also reduces the extra expenses as all the expenses need to be approved by the manager before they are actually made.

Challenges of Project Cost Management

1. Lack of resources: If a project budget is too small, it can be difficult to secure the required labor, materials, etc., to complete the project successfully.

2. Inaccurate estimation: Poor forecasting can occur when a manager is inexperienced or doesn’t fully understand the scope of the project. This can lead to cost overruns and affect overall profitability.

3. Outdated technology: Project managers need access to intuitive, up-to-date technology and tools to manage costs accurately.

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