Budgeting Projects
Chapter 9
Contemporary Project Management
Kloppenborg
© 2009 South-Western, a part of Cengage Learning
At the end of this chapter…
• Describe how to perform cost planning for a
project and give four reasons for its importance.
• Compare and contrast methods of estimating
cost and tell when each is appropriate.
• Compare and contrast pairs of cost terms.
• Describe several issues in cost estimating and
how to deal with each.
• Create a bottom-up budget for a project.
At the end of this chapter…
• Assign costs per time period to determine
commitments, invoiced amounts and cash flow.
• Describe activity based costing and its role in
project budgeting.
• State several assumptions and constraints that
apply when estimating for your example project.
• Describe three causes of variation that impact
project cost and how to deal with each.
Cost Planning
• Involves developing a cost management plan for
a project
• For small projects 
– Ensure accurate cost estimates
– Secure the funding
– Develop cost reporting procedures
• For large projects 
– Develop and use accurate cash flow estimates
Cost management planning – “the document that sets out the
format and establishes the activities and criteria for planning,
structuring, and controlling the project costs.” PMBOK® Guide
Purposes of the Cost Management
Plan
•
•
•
•
The plan shows how to develop and share
relevant, accurate and timely information for
decision making
The plan provides feedback linking the project
to business objectives
The plan provides detail and summary
information
The plan helps project stakeholders focus on
schedule and performance as well as cost.
Cost Estimating
• Cost estimating is linked to scope, schedule, and
resource planning
• Never lie to yourself
– You must understand what the project costs really are
• Never lie to anyone else
– Avoid shading the truth to secure necessary funding
Cost estimating – “the process of developing an
approximation of the cost of the resources needed to
complete project activities.” PMBOK® Guide
Cost Estimating
• Types of costs
• Timing and accuracy of cost estimates
• Methods used to estimate costs
• Cost estimating issues
Types of Costs
Types of Costs – Fixed vs. Variable
• Fixed costs remain the same regardless of
volume of work
• Variable costs vary directly with volume of use
• Cost curve reflects as low a total cost as
possible at the current project size
• Fixed and variable costs involve consideration of
the project scope
Project cost and volume curve
Types of Costs – Direct vs. indirect
• Direct costs only occur because of the project
– Direct labor
– Other direct costs – material, travel, consultants,
subcontracts, purchased parts, computer time
• Indirect costs are costs necessary to keep the
organization running that are not associated with
one specific project
– Salaries, buildings, utilities, insurance, clerical
assistance
– Costs are allocated across projects
Direct and Indirect Costs in a Work
Package
Types of Costs – Recurring vs.
Nonrecurring
• Recurring costs repeat as the project work
continues
– Cost of writing cost; laying bricks
– Occur during project evaluation
• Nonrecurring costs happen only once during a
project
– Design development
– Occur during project planning and closing
Types of Costs – Regular or
Expedited
• Regular costs occur when progress can be
made by normal work hours and purchasing
agreements (the preferred cost)
• Expedited costs occur when the project must be
conducted faster than normal
– Overtime and extra charge apply
Types of Costs – Estimate vs.
Contingency reserve
• Project estimates to be aggressive – some
estimates will run over and others cost less
• Project managers frequently add a contingency
to cover activities that run over aggressive
estimates
Estimate – “a quantified assessment of the likely amount…
It should always include an indication of accuracy.”
PMBOK® Guide
Contingency reserve – “the amount of funds… needed
above the estimate to reduce the risk of overruns of project
objectives to a level acceptable to the organization.”
PMBOK® Guide
Types of Costs – Accrual vs. Cash
Accounting
• Accrual – transactions are recorded in the time
period the expense occurred
• Cash – records transactions when money is
spent
• Cash accounting is more frequently used on
projects
Accuracy and timing of cost
estimates
• When should cost estimates be developed?
• How accurate do cost estimates need to be?
• How will cost estimates be used?
Accuracy and timing of cost
estimates
• Costs in Project Initiation
– Necessary for project charter approval
– Estimates are only approximate
• Costs in Project Planning
– Cost estimates are more precise
• Cost estimates should be documented
• The level of confidence in the cost estimate
should be described
Project Cost Estimate Comparisons
Estimate Names
• Order of magnitude
– Often used to seek initial charter approval
– Created when limited project detail is available
– Ball park, conceptual, initial, or level one estimates
• Budget
• Definitive
• Rolling wave planning allows for creating a
definitive estimate for the first stage of planning
and an order of magnitude estimate for the rest
of the project
Methods of estimating costs
• As more details of a project are known, more
detailed estimating methods may be used
– Analogous estimating
– Parametric estimating
– Bottom-up estimating
Methods of estimating costs
Analogous Estimating
• Consider a similar project as a cost estimating
starting point
• Requires that the organization have experience
performing similar projects and actual cost of
similar projects
Analogous estimating – “an estimating technique that
uses the cost along with measures of scale such as size,
weight or complexity from a previous project to estimate
cost for a similar, future project.” PMBOK® Guide
Analogous Estimating
• Requires knowledge of how the proposed
project differs from the previous project
• Estimator needs to have experience with
methods to be used in the project
Parametric estimating
• Involves finding more information regarding the
project
Parametric estimating – “an estimating technique that
uses a statistical relationship between historical data and
other variables to calculate project costs.” PMBOK® Guide
Bottom-up estimating
• Most detailed – specifications need to be very
clear
• Time consuming
• Most accurate form of estimating
• Ensure every item is included
Bottom-up estimating – “a method of estimating project
costs in which the work is decomposed into more detail.
An estimate is prepared of what is required to meet the
requirements of each of the lower, more detailed pieces of
work, and these estimates are then aggregated into a total
quantity for the project.” PMBOK® Guide
Cost Estimating Method
Comparison
Issues in project cost estimating
Issues in project cost estimating –
Supporting detail
• Includes describing the scope, method used to
create the estimate, assumptions, constraints,
and range of possible outcomes
• Version control is critical
Issues in project cost estimating –
Use of assumptions and constraints
• People from different backgrounds may make different
assumptions
• Untrue assumptions cause more work or other problems
• Assumptions related to direct labor costs
– Workers will be paid at the prevailing wage rate of $14 per hour,
– Workers are already familiar in general with the technology being
used on the project,
– Workers will be paid for 40 hours per week whether there is
always that much work for them or not,
– Overtime will never be authorized, and
– The project schedule can be delayed if the only alternative is to
pay overtime.
Issues in project cost estimating –
Use of assumptions and constraints
• Constraints often dictate methods available for
performing the work
• Examples of constraints:
–
–
–
–
Only in-house workers will be used,
No extra space will be provided,
No extra budget will be allowed, and
The current version of the XYZ software will be
incorporated into the design.
Issues in project cost estimating
• The range of possible outcomes should always
be stated with any project cost estimate
• There are many causes of variation in project
costs
• Statisticians classify variation as coming from
either normal or special causes
Normal and Special Cause
Variation
Variation
• Occurs in all work processes
• Normal variation comes from small causes
inherent in a work process
• Special cause variation is the result of
something out of the ordinary
Securing services and supplies
from vendors
• Use vendor bid analysis to determine whether
the price is reasonable
• For competing buds, assume the lowest
responsible offer is fair
• Prices may be determined in the market place
– Examine business papers and web sites
• Develop a “should cost estimate”
– Try to determine vendor effort expended and add a
fair profit margin to arrive at a price
Value engineering
• A powerful method of double checking all of the
chosen methods for accomplishing work and the
features of the project deliverable
• A separate stage may be incorporated late in the
project planning to ensure time is spent on value
engineering
Value engineering – “a creative approach used to
optimize project costs, save time, increase profits, improve
quality, expand market share, solve problems, and/or use
resources more effectively.” PMBOK® Guide
Issues in project cost estimating – what
type of accounting system is used
• Functional based accounting systems used
historically
– Overhead (indirect) costs were assigned to a cost
pool allocated to direct costs based on volume
• Contemporary approach
– Indirect costs form a larger percentage of total costs
– Allocation of indirect costs is more carefully
considered
Activity based costing
• Indirect costs are allocated to fixed costs based
on drivers
• Cost drivers
–
–
–
–
Number of units produced
Number of batches run
Number of product variations
Amount of facility utilized
• More involved methods for allocating indirect
costs yields more accurate cost information
Life cycle costing
• Includes the total costs of creating and using the
project during its useful life
• Consider disposition costs of the product after its
useful life is complete
Time value of money
• Discounting the value of future revenue and cost
streams will enable better project decisions
• Discount future dollars by the appropriate factor
• The finance department may provide the
appropriate rate
• The rate depends on the underlying inflation rate
plus the cost of capital
Cost Budgeting
• Aggregating costs
• Analyzing reserve needs
• Determining cash flow
Cost budgeting – “the process of aggregating the
estimated costs of individual activities or work packages to
establish a cost baseline.” PMBOK® Guide
Aggregating Costs
• Direct and indirect costs add up to the cost
baseline
• The cost baseline is an integral part of the
project management plan
• The cost baseline can only be changed through
a formal change management process
Cost baseline – “the approved time-phased budget
against which project execution is compared and
deviations are measured for management control.”
PMBOK® Guide
Aggregation of Project Budget
Analyzing Reserve Needs
Analyzing Reserve Needs
• Known knowns are discovered during planning
and can be estimated directly
• Known unknowns are events discovered during
risk identification that may or may not occur
• Unknown unknowns (unk unks) are totally
unexpected occurrences that cause an increase
in cost and/or schedule
– The money used to cover unk unks is called
management reserve
Analyzing Reserve Needs
• The amount placed into contingency reserve is
calculated during risk analysis
• The amount placed into management reserve
is determined by how much uncertainty
management feels exists in the project
• The cost baseline, contingency reserve, and
management reserve are used to determine if
sufficient funds are available
Determining cash flow
• Expenses are applied to individual activities in
the schedule to see when case is needed
• Cash may be supplied through organization
budgets on a periodic basis
• The cumulative amount of cash coming in to the
project must meet or exceed demands for cash
payouts
Project Cumulative Cash and
Revenue
Establishing Cost Control
• Approved project budget serves as a baseline for project
control
• Milestones are used as a typical measuring point
– Identified in the milestone schedule in the project charter
– Identified in constructing the project schedule
• Use cash flow projections to determine how much
funding is expected to reach each milestone
• Create enough milestones to keep track of progress
without creating an administrative burden
Using MS Project for Project
Budgets
• MS Project supports bottom up and summary
level cost modeling
• Bottom up cost modeling is based on the cost of
each resource assignment
• Summary level cost modeling consists of a
summary level estimate for all effort represented
by that level
Develop Bottom-up Project Budget
• Assignment cost
• Activity cost
• Project total cost
• Various Perspectives
Assignment Cost
• Required data
– Assignment work hours
– Resource Standard Rate
– Resource Overtime Rate
• Assignment Cost = total number of assignment
hours times the standard rate
Assign Cost Rates
Source: Microsoft product screen shot reprinted with permission from Microsoft Corporation.
Activity Cost
• The sum of all assignment Costs values plus
any activity Fixed Cost
• Start at the Gantt view, right-click and select
split, select task usage view from the View menu
Task Usage View with Resource
Work Form
Source: Microsoft product screen shot reprinted with permission from Microsoft Corporation.
Various Perspectives
• Cost data may be viewed from a resource
perspective using the Resource Usage view
– Assignment costs are summarized at the resource
level
• The “unassigned” set represents activities with
no assigned resources.
• Resources with no show/hide control have no
assignments
Resource Usage View
Source: Microsoft product screen shot reprinted with permission from Microsoft Corporation.
Develop Summary Project Budget
• Add a dummy activity under each phase
summary not yet planned in detail
• Estimate the phase duration and the phase cost
• Put the duration estimate in the dummy activity’s
duration field
• Put the cost estimate in the dummy activity’s
Cost field
• Remove each dummy activity when detail is
added
Dummy Activity for Late Phase
Source: Microsoft product screen shot reprinted with permission from Microsoft Corporation.
Summary
• The cost management plan lays out how
you plan to structure and control project
costs
• Cost estimating can be challenging because
some activities may have a great deal of
variation.
• Many methods are available to assist in cost
estimating.
Summary
• Cost budgeting includes aggregating individual
costs, analyzing needs for cost reserves where
uncertainty exits, and determining cash inflow
and outflow.
• Establishing cost controls includes establishing
cost reporting systems.
• MS Project can assist in developing either
bottom-up project budgets or summary project
budgets.