Estimating the Cost
There are several types of budgeting. Many organizations use a
combination of the strategies, depending on where they are in the life cycle of
a project.
Top-down estimating (Analogous estimating)
This method is used when few details are known about a project. It
is often used in the early stages of a project and based on previous projects
of a similar nature.
Example, if a builder is building homes in a subdivision that
average $200,000 for a four-bedroom home, and $175,000 for a three-bedroom
home, an analogous estimate for a typical buyer of a four-bedroom home would be
$200,000.
It is usually less accurate, but it is cheaper to produce
analogous estimates. It is most reliable when previous projects are VERY
similar, and the preparers have expertise in building estimates.
Bottom-up estimating
This is used when most of the details are known about a project.
It is often used in the later stages of a project. Typically, estimators, or
the people who are doing the work, look at each activity and estimate the cost
of that activity. The costs are aggregated into an overall budget.
Example, when that same builder walks through a model home with a
potential buyer and the buyer selects all of the fixtures, lighting, floor
coverings, and so on, and identifies all of the requested options, he or she
can build a much more accurate budget. In most cases, this budget is much
higher. That $200,000 could easily grow into a $240,000 budget.
Bottom-up estimating is usually more reliable, but it costs more
to produce because these estimates take longer to create.
Fixed costs are costs that remain constant regardless of
the duration of a project or scale of business activity. For example, a
purchase of a crane or computer system is the same cost regardless of the
duration of the project.
Variable costs are costs that vary with time or resource
changes. For example, hourly labor costs are dependent on the number of hours.
When the project budget is set, it is then allocated across the
various work packages. For example, if the budget was set at $200,000 for the
model home, there may be $50,000 allocated to lighting fixtures, $50,000
allocated to fixtures and accessories, and $100,000 allocated to floor
coverings.
Earned
Value Analysis
Now that the budget has been set, and allocated across the work
packages, it is critical to monitor and control the budget throughout the
duration of the project. A tool PMs can use to manage projects is exception
reporting and calculating earned value. We use cost variance (CV), schedule
variance (SV), and indexes to help us focusing on the activities that are in
danger of not being met or going over budget.
- Cost Variance = BCWP - ACWP A negative result means that you are over budget.
- Schedule Variance = BCWP - BCWS A negative result means that you are behind schedule.
BCWS = Budgeted
Cost of Work Scheduled
ACWP = Actual Cost of Work Performed
BCWP = Budgeted Cost of Work Performed
If a project is reporting cost variances or schedule variances
that are too favorable, this
could be an indication that work is not being performed with high quality or
the efforts have been overestimated. If the project is reporting cost variances
or schedule variances that are too
negative, it means that the efforts have been underestimated. The sooner
the variances are reviewed, the quicker corrective action can be taken. Some
projects use variance levels as triggers to alert management to potential
oversight; too much variance in either direction should be closely reviewed.
Another way of calculating cost efficiency of the project is to
calculate the cost performance index (CPI). Similarly, the schedule efficiency
index (SPI) of the project can be calculated. In organizations that have
multiple projects, comparisons are made among projects to determine which
efficiencies are the best and worst among various project teams.
- CPI = BCWP/ACWP; A low ratio means the project is NOT cost efficient; a ratio of 1.0 is on budget, a ratio closer to 0 is very inefficient.
- SPI = BCWP/BCWS; A low ratio means the project is NOT time efficient; a ratio of 1.0 is on track, a ratio greater than 1.0 is very efficient.
Estimate
at Completion
The EAC computation is used to predict the total project budget
after the project has begun. This calculation is usually made when project
estimates have not been accurate.
- EAC = Actual to date + remaining project budget modified by a performance factor
- Used when current variances are seen as typical of future variances.
- EAC = Actual to date + a new estimate for all remaining work
- Used when original estimates are fundamentally flawed or no longer relevant due to changes in conditions.
- EAC = Actual to date + remaining budget
- Used when original estimates are expected to be accurate in the future.
