2.2 Cost Estimation and Management in Projects
Cost estimation is the process of estimating all of the costs associated with completing a project within scope and according to its timeline. It is important to realize that different programs, projects, organizations, industries and situations requires different approaches to estimating. As such the process of estimating must be tailored for specific programs and projects taking into account the uncertainties and complexities of the programs and projects. It is important to remember that estimating is a continuous activity throughout the project life cycle or program. Project Estimation is needed to:
- Support good decision making?
- Schedule work?
- Determine how long the project should take and its cost?
- Determine whether or not the project is worth doing?
- Develop cash flow needs.
- Determine how well the project is progressing
Project cost estimating is linked to so many other aspects of the project, including but not limited to, scheduling, resource planning, procurement, and stakeholder expectation management.
Estimating costs is one of the core activities of project management and planning. This is because a project is defined as being subject to at least three fundamental constraints: scope, budget and time. Cost estimates address the budget constraint; hence they are highly relevant for the management of a project. The initial rough cost estimate is usually included in the project charter as well as in the business case of a project.
The estimation of costs is also necessary to compute the project budget which is subject to the approval of the project sponsor(s).
Cost estimates are the basis for allocating budget to work packages and deliverables which can be politically sensitive within a project as well as among its stakeholders. Therefore, budget determination and assignment require some stakeholder involvement, communication and, in many cases, their approval.
Cost estimates are also used for the earned value and variance analyses as well as forecasting of project costs. Below are different definitions of costs:
Cost Management in Projects
Cost is an important factor in determining project success. Cost is measured in monetary terms – dollars for example. Projects that are over budget are often terminated because stakeholders either run out of money. Many projects that run out of money do so because of poor estimating, poor budgeting and poor controlling. The management of cost in projects is a process where organizations monitor and control the costs of implementing projects.
Effective cost management will increase value delivered to the customer. Before a project is started, the anticipated costs of that project should be identified. These costs should be evaluated and approved before any purchases are made. During the implementation all costs should be recorded, tracked and monitored to keep them in line with initial expectation.
Direct Material and Labour Costs
Direct costs: These are direct cost of material and labour used in projects and are essential part of the finished product system or service. In other words these direct costs are linked to the production of the final product or service.
Indirect costs (Overhead): Indirect costs which includes materials and labour costs that are necessary to complete a project but do not become an actual part of the final project. Overhead expenses, ongoing operational cost incurred by an organization for projects in general, and administration cost shared amongst many projects are indirect costs. Cost of utilities, paper towels, office supplies other services etc. are examples of indirect cost. Other group of indirect cost includes overheads and general administration costs.
Fixed and Variable Costs
Fixed costs remains constant in total regardless of the changes in the level of project activities. Examples include: rent and administrative salaries are not affected by the level of project activities.
Variable costs vary directly with the changes in the level of project activities. Direct materials and direct labour are examples of variable costs.
Tangible and Intangible Costs
Tangible costs are quantifiable costs related to an identifiable resource or asset and are expenses from procuring materials paying projects team members and renting or leasing equipment.
Intangible costs are unquantifiable costs relating to an identifiable source customer goodwill or losses in productivity.
Sunk Costs
Sunk costs are costs that have already been incurred in a project and cannot be changed by present or future decision or actions. Sunk costs in a project should be forgotten.
Opportunity Costs
Opportunity costs are potential benefits given up when one activity is selected over another. For example if there are two projects – Project Bono and Project Vono being considered by an organization and project Bono is promising $50,000 more in return than Project Vono, assuming the organization proceeds with Project Vono, then there is an opportunity cost of $50,000 being lost.