It has been our observations that estimating is still more of guesswork rather than using proper techniques and leading practices. Estimating is also directly related to the project management maturity of an organization. In the general context, estimating refer to process of developing cost and time estimates – a time estimate is also called a schedule. In this article, we focus on cost estimating.
Estimate Components
What makes a good cost estimate, regardless of its level or classification? The key components are:
- Direct costs: are all the costs required to perform the physical scope, such as installing hardware and the labor that goes into it.
- Indirect costs: these are costs related to supervision and management of the project.
- Overhead costs: usually these are the costs related to the corporate overhead of the performing organization.
- Depreciation costs: apply when using company assets in a project.
- Escalation/inflation: These are in two parts: (a) if the source of estimate data is past projects then these costs need to be updated to the time-frame of the estimate, and (b) expected inflation cost is applied from the estimate time to the expected time of expenditure.
- Technology allowance: if a project involves new and unproven technology, an additional allowance for the uncertainty that is associated with the new technology is appropriate. This is a form of contingency but should be independent of the regular contingency.
- Financing costs: Does the project require external financing? Then include the cost of money that will be borrowed. For projects in the construction industry with large cash flow requirements, project financing can be crucial and require special attention. Even if the project does not require external financing, the organization still needs to consider the cost of money.
- Exchange rate variations: this is a likely factor for large projects with significant capital investment since purchases from the global marketplace are the norm for major capital projects.
- Contingency: contingency is an allowance that should be included in every cost estimate to cover normal and expected variations in the project, in addition to accepted risks. Contingency does not cover changes to the objectives of the project. The contingency amount allocated is part of the project budget, and its management is the responsibility of the project manager.
- Management reserve: In some situations, where there are many uncertainties due to the nature of the project or its environment, such as political unrest or rapidly changing economic conditions, executive management may decide to budget an amount as a reserve against such potential project threats. Executive management, not the project manager, will control the reserve. Some organizations’ financial control system may include an allowance, commonly 10%, to cover such project over-expenditures. If the project cost is projected to exceed 110% of the approved budget, the organization will likely require an evaluation and subsequently a request for additional or supplemental funding.
Estimate and Project Management Maturity
We mentioned earlier that there is a link between proper estimating and project management maturity. In general, the link is not limited to estimating since the whole project management processes, particularly planning, are a function of the organizational project management maturity. Since this article is not about project management maturity we will not explain the links in details, but we will touch on key points.
Some of the factors that contribute to a higher level of project management maturity is a formalized project management organizational system, such as methodology, governance, processes, lessons learned, historical data and project records. The historical data and project records have a direct input on estimating and estimate accuracy since the estimating effort will use proper records and actual data instead of guesswork or use vendor quotations. Further, vendor quotations might not be possible during the early stages of the projects since vendors will need detailed design or specifications.
No, or weak organizational system, lack of historical data for cost and time, the absence of lessons learned, will all contribute to poor planning, unreliable project detailed plans, and funding decisions on questionable estimates. Moving on to implementation, poor planning will lead to numerous variances and unanticipated risks, which in turn result in the project management team spending too much time reacting to problems instead of pro-active management. In these situations, the outcome is almost certain – failed or challenged projects.