CS-411W – Budgeting, Costing, and Pricing VIII

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CS-411W
VIII – Budgeting, Costing, and Pricing
Definitions
• Cost - the value of inputs that have been used to
produce something. Inputs are typically
investment dollars, labor costs, materials costs,
subcontract costs, overhead expenses etc.
• Price - the amount of payment or compensation
established for a good, service or asset.
• Profit – the difference between Price and Cost
• Loss – occurs when Cost is greater than Price
Definitions (cont)
Operating at a Profit
Cost Profit Price
Operating at a Loss
Price
Cost
Profit
(Loss)
Definitions (cont)
• Cost Estimate - an assessment, approximation,
or estimate of the investment of labor, materials,
and overhead expenses required to complete a
project or task.
– Based on analysis and judgment
– Result of a formal or an informal process
– May employ metrics/historical data (lines of code per
man day etc.)
Definitions (cont)
• Budget –the process of combining the estimated
costs of individual activities or work packages to
establish a baseline profile of project costs over
time
– Also provides a plan for obtaining resources and
tracking costs throughout the project life-cycle
– Requires having all cost estimating processes
completed
– Most common methods: Top Down, Bottom Up,
Iterative
Definitions (cont)
• Cost Management – the processes required to
ensure that a project team completes a project
within approved budget. Successful cost
management requires:
– Well-defined project scope
– Accurate cost estimates
– Realistic budget
Estimating Costs
• Elements of Cost
– Labor
– Materials
– External Resources
• Subcontractors
• Consultants, etc.
– Overhead Expenses
•
•
•
•
•
Facilities/Utilities
Benefits
Taxes
Management Costs
Financing
Estimating Costs
• Factors Affecting Cost
– Specification of Scope and/or Requirements: more
detail allows better cost estimating
• Detailed requirements provides for better task breakdown
• Less contingency required for uncertainty
– Experience of Project Team
• Highly experienced teams typically more efficient in achieving
project objectives
• Highly experienced team members typically more expensive
(per labor hour)
• Balance of experience and labor cost must be achieved
Estimating Costs
• Factors Affecting Cost (cont)
– Project Schedule
• Highly compact schedule requires on-demand availability of
resources, experienced team and short lead time on
materials and equipment
• Long, disjointed schedule injects dead-time, allows for loss of
momentum and focus and inefficient use of resources
• Realistic schedule based on team experience and availability
of resources most cost effective
Estimating Costs
• Factors Affecting Cost (cont)
– External Factors
• Availability of specialty equipment, materials, or experience
• Economic factors - such as lending rates, currency exchange
rates when dealing with “offshore” partners and vendors
• World affairs – such as increased fuel costs affecting travel
and shipping rates, high demand for unique personnel
experience or products critical to completion of the project
– Simple example: building materials costs skyrocketed after
Katrina. Projects dependent on availability of materials at a
market price that pre-dated Katrina suffered significant adverse
cost impact (I.e. less profit – or more loss)
Estimating Costs
• Types of Cost Estimates
– Rough Order of Magnitude (ROM)
– Budgetary
– Definitive
Estimating Costs
• Rough Order of Magnitude (ROM)
– Typically a best-estimate based on similar
(prior) efforts, experience, and various
assumptions
– Should be “high” to provide for downward
adjustment as more detail is available
– Provided purely for planning purposes to
establish an initial framework or upper
boundary for estimated costs
Estimating Costs
• Budgetary Estimate
– Provided when more detail is available
regarding project scope, schedule, etc.
– Established based on preliminary cost
estimates and anticipated project schedule
– Typically accurate to within 25% of final
budget
Estimating Costs
• Definitive Estimate
– Final assessment based on all available
information
– Addresses scope, resource availability,
external costs (materials, subcontracors,
other factors), and schedule
– Includes appropriate contingencies for scope,
schedule, and other risk uncertainties
Budget Preparation
• Methods:
– Top-down: Budgets for top level tasks established first
– then broken down to lower-level task allocations
– Bottom-up: Budgets for lowest-level tasks established
first – then rolled up to establish upper-level budgets
– Iterative: Budgets are established at each level by
responsible person(s) assigned. Upper-level budgets
are established as an outcome of a negotiation
between upper and lower-level estimates
Budget Preparation
• Top Down Budgeting
– Process
• High-level budget made first
• High-level budget used to dictate low level budgets
– Advantages
• Provides high degree of control for experienced managers
• Helps address overlap between tasks
– Disadvantages
• Lower-level tasks may be under-funded
• Individuals responsible for lower level tasks may not have a
sense of ownership for the budget
Budget Preparation
• Bottom Up Budgeting
– Process
• Budgets established at lower-levels first
• Lower-level budgets combined to establish upper-level
budgets
– Advantages
• High degree of accuracy for individual tasks
• Individuals responsible for low-level tasks “own” the budgets
(i.e. they developed them).
– Disadvantages
• More tendency towards duplication where tasks partially
overlap (I.e. each task treated in isolation)
• Roll-up of lower-level budgets to overall budget frequently
exceeds overall budget constraints (due to duplication in
estimates and inflated low-level estimates).
Budget Preparation
• Iterative Budgeting
– Process
Final Budget
• Obtain budget estimates at each level Estimated Budget
• Negotiate between upper and lower-levels to agree on a
final budget
– Advantages
• Establishes ownership of budgets at all levels
• Provides good mechanism for identifying tradeoffs
necessary to meet budgeting goals and disseminating ideas
throughout the project team
– Disadvantages
• Time-consuming process typically required to negotiate
budgets between levels
Profile of Top-Level Tasks as proportion of
Overall Budget
Relationship Between
Cost Estimate and Budget
Project XYZ Cost Estimate
1. Labor Estimate (Average)
1.1 Design
1.2 Prototype Development
1.3 Testing
Total Labor
2. Materials, Equipment, and Licenses Estimate
2.1 Server(s)
2.2 Graphics Processor
2.3 Software License Type 1
2.3 Software License Type 2
Total Materials:
Total Estimated Costs
Project XYZ Budget
1. Labor Estimate (Average)
1.1 Design
1.2 Prototype Development
1.3 Testing
Total Labor
2. Materials, Equipment, and Licenses Estimate
2.1 Server(s)
2.2 Graphics Processor
2.3 Software License Type 1
2.3 Software License Type 2
Total Materials:
Total Estimated Costs
Jan
$1,560
$1,560
Feb
$780
$780
Mar
$975
$975
Apr
$585
$585
Unit Cost
Quantity
$39
$28
$19
$29
135
360
125
620
$5,265
$10,080
$2,375
$17,720
$6,500
$12,000
$3,000
$500
2
1
1
3
$13,000
$12,000
$3,000
$1,500
$29,500
$47,220
May
$780
$780
Total
Jun
Jul
Aug
Sep
Oct
$585
$2,240
$2,240
$2,800
$1,680
$2,825
$2,240
$2,800
$1,680
$1,120
$380
$1,500
$6,500
Nov
$1,520
$1,520
Dec
$475
$475
$5,265
$10,080
$2,375
$17,720
$500
$500
$975
$13,000
$12,000
$3,000
$1,500
$29,500
$47,220
$6,500
$12,000
$3,000
$0
$1,560
$0
$780
$6,500
$7,475
$0
$585
$12,000
$12,780
$3,000
$5,825
$6,500
$8,740
$500
$500
$3,300
$0
$1,680
$500
$500
$2,000
$0
$1,520
Totals
Pricing
• Concepts Revisited:
Cost is the total of all expenses associated with
completing a project
Price is the total amount of compensation received
for completion of a project or sale of a product
Profit is the difference between Cost and Price
Cost Profit Price
Pricing
• Factors Affecting Price and Profitability
– Competitive Environment: More competition drives
Price down
– Degree of Specialization: Requirement for highly
specialized skill set, experience, or equipment
reduces competitive field and typically drives price up
– Risk and/or Uncertainty: Degree of risk or uncertainty
associated with technical, schedule, or performance
aspects increases cost or profit contingencies
associated with risk and increase price
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