Cost Estimating and Budgeting

By

Dr. M. L. Mittal
Department of Mechanical Engineering
Malaviya National Institute of Technology Jaipur

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 Estimating

The process of forecasting or

approximating the time and cost of
completing project deliverables.

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 Why to estimate cost?
 To know how much it would cost

 To determine whether we should go for the project or

continue/discontinue already running current project
 An input to project planning e.g. resource planning
and scheduling
 Act as baseline for project monitoring and control

 Appropriate pricing for bidding external projects

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Factors affecting quality of estimates

Planning Horizon

Other (Non-project) Project

Factors Duration

Quality of
Organization Estimates People
Culture

Padding Project Structure

Estimates and Organization

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 Types of estimates
Macro or top-down estimates
– Based on judgment and upper levels of WBS
– Do not require detailed data
– Less accurate and requires less time and efforts
Micro or bottom-up estimates
– Based on detailed engineering analysis for elements in lower
levels of WBS
– More accurate and requires much more time and efforts

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When to use Macro/Micro estimates

Condition Macro Estimates Micro Estimates

Strategic decision making X

Cost and time important X
High uncertainty X
Internal, small project X
Fixed-price contract X
Customer wants details X
Unstable scope X

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 Methods of estimation
1. Expert opinion

2. Parametric estimates

3. Analogy estimates

4. Detailed cost analysis

5. Hybrid method

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 Expert opinion

Based on expert judgment and used when

– No similar project or data available for
comparison
– Project is poorly defined
Approaches
– Delphi technique
– Nominal Group Technique

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 Parametric estimates
Estimates derived from an empirical or mathematical
relationship.

The parameter could be physical features such as area,

volume, weight , capacity or performance features as
speed, rate of output, power or strength.

Mathematical expression can be developed by regression

model using least square technique. y = b1x1 + b2x2 + c

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 Analogy estimates
Developed by adjusting costs and times of
previous similar projects.

Adjustments may be made with respect to

– Location: US and India
– Time: 3 years earlier and 2 years later
– Size, scope, capacity or performance

The estimates may be prepared at any level

e.g. project, work package or task level by
using similar item for comparison
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 Detailed cost analysis
Cost and time are estimated for individual work
package or task level to get the final estimates.
Requires WBS with sufficient level of details
and categories of cost such as labor, material,
equipment etc.
Most accurate but consume lot of time and
requires considerable work for detailing

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An example: A project consists of five work packages
requiring three grades of labor. It also requires material,
equipment, and subcontractor work

Work Hours by labor grade Non labor cost

package 1 2 3 Mat. Equip. Subcont other

A 50 10 - 10000 - -
B 10 20 50 - 20000 -
C - 100 30 50000 - -
D - - - - - 150000
E 70 - - 60000 10000 -
Totalb given
This’ll 60 130 80 120000 30000 150000
Total labor cost = 200*60 + 150*130 + 100*50 = 36500

Total project cost = 36500+120000+30000+150000 = 336500

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 Types of costs
 Direct cost – Clearly chargeable to specific work
package. e.g. Labor, material, equipment
 Direct overhead cost – Costs that are directly
tied to an identifiable project deliverable or work
package. e.g. Salary, rents, supplies, specialized
machinery
 General and administrative overhead costs –
Overhead costs not directly linked to a specific
project. e.g. Senior management costs, advertising,
accounting, legal experts

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 Allocation of overheads
Overheads are generally charged as the
% of some direct cost

Method of allocation of overheads to

projects depend on company policy and
affects the costs of individual projects
even if the total cost of company
overheads remain same

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 Hybrid method
When details about later phases are not
available in the beginning the macro
estimates are developed which are
refined as more details become available

Generally used in high tech projects such

as aerospace, new technology
development, construction where design
is not complete
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Phase Estimating over Product Life Cycle

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 Standardizing estimation

Companies engaged in repetitive or

similar tasks such as construction develop
estimating manuals to prepare accurate
estimates in less time and effort.

But this standardization is not appropriate

for true one of a kind projects such as
R&D
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 Learning curves
Human performance usually improves when a task is
repeated and thus the direct labor cost is reduced .

From empirical evidence across all industries the

pattern of this improvement has been quantified as
learning curves.

Each time the output doubles, the worker hours per unit
decreases to a fixed % of their previous value. This
percentage is called the learning rate

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 An example
Suppose 16 prototype units are to be made and a total of
1000 labor hours are needed for the first time. Let the
improvement ratio is 70% then the times can be
calculated as
Number of units Labor hours
1 1000
2 (1000*0.7) = 700
4 (700*0.7) = 490
8 (490*0.7) = 343
16 (343*0.7) = 240.7

Note the diminishing reduction of cost

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700

600

500

400

300

200

100

0
0 10 20 30 40 50 60 70

Cumulative units of production

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 Estimating labor hours for nth unit

Tn = T1 nr

Where

Tn = the direct labor hours for nth unit

T1 = the direct labor hours for the first unit
n = the number of units produced
r = log (decimal learning rate) / log 2

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 An example
Consider a situation where the first unit
requires 812 hours and the company is
performing on a 75 % learning rate .
Determine the time to produce 250th unit.
Solution:
n = 250 T1 = 812 and
r = log 0.75 / log 2 = (-0.07085)/0.30102=- 0.415
Put values in the formula Tn = T1 nr
T250 = (812) (250) - 0.415 = 82 hours
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The cumulative average time (the average time for a
unit) can be approximated by

Ta = (T1 nr )/(1+ r)

The cumulative average time for the example

Ta = (812)(250)-0.415 /(1- 0.415) = 135 hours

The total time for producing 250 units

= 135*250 = 33,750 hours

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Sometimes companies do not know the
time for the first unit. In such a situation
assume some target time for nth unit and
then estimate the time for the first unit by
T1 = Tn n-r

Suppose target for 100th unit is 120 hours

then time for the first unit would be
T1 = (120) (100) 0.415 = 811 hours

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 Refining estimates
Reasons for adjusting estimates
– Interaction costs are hidden in estimates.
– Normal conditions do not apply.
– Things do not go as planned .
– Changes in project scope and plans.
Adjusting estimates
– Time and cost estimates of specific activities are
adjusted as the risks, resources, and situations
become more clearly defined.

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 Refining estimates (cont…)
Contingency Funds and Time Buffers
– Created independently to offset uncertainty.
– Reduce the likelihood of cost and completion time overruns
for a project.
– Can be added to the overall project or to specific activities
or work packages.
– Can be determined from previous similar projects.
Changing Baseline Schedule and Budget
– Unforeseen events may dictate a reformulation of the
budget and schedule.

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 Project budget
A budget is a plan for allocating resources
Based on cost estimates but estimates
are not budget until approved by
competent authority
Provides a basis of project control
Should be time-phased and should
indicate the cash flows and their timing

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 Estimating pitfalls
Misinterpretation of the statement of work
Omissions or improperly defined scope
Inaccurate work breakdown structure
Failure to account for risks
Failure to understand or account for cost
escalation and inflation
Failure to use correct estimating technique

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Thanks!

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