Cost Estimate

Purpose

The cost estimate is a prediction of project costs either for a phase, the project as a whole, or for the life cycle of the system or product being produced. The cost estimate is most commonly used to determine whether or not the investment in the project will be worthwhile given the perceived gain. It will ultimately contribute to the cost baseline, which is a critical metric for evaluating performance against projections.

Application

The cost estimate may be developed (and, as such, applied) at a variety of different levels. An initial feasibility estimate (sometimes referred to as a conceptual estimate, “guesstimate,” or SWAG) is generally presented as a single number or value representing the overall anticipated cost of the project. It is not broken down into components or subcomponents but normally takes the form of a single monetary figure. Even for this value, there should be some explanation as to the scope of the project, the assumptions made, and the relative time frame for completion, because those considerations will ultimately impact the estimate.

A budget cost estimate is perhaps the most common, breaking out the cost estimate into its component parts. This estimate normally includes anticipated resource and material costs, as well as miscellaneous expenses, travel, and organizational overhead.

Content

The sources for budget information vary widely from organization to organization. Although most hourly/daily rate information and overhead percentages are often available through the accounting or finance departments, the number of hours or materials anticipated for consumption may be drawn out of the resources, out of management projections, or from the imagination of the project manager.

Expense projections can be among the most challenging because they include miscellaneous costs that may be unique to the project and for which historical data may be limited. Travel expenses, for example, can easily be underestimated because they do not normally assume any last-minute travel or supplemental travel requested by the customer.

The estimate confidence level may reflect a best guess by the project manager or may be rooted in extensive statistical analysis based on advanced risk tools such as Monte Carlo analyses. The confidence level affords a relative sense of how sure the project manager is of his numbers and the relative likelihood of hitting the budgetary targets. A low confidence level (e.g., +100%/-100%) indicates a lack of confidence

Based on confidence level, risk models, organizational project risk practice or other approach in the numbers generated through the process. A high confidence level (+10/-5%) indicates a higher degree of certainty in the information provided. Contingency budgets are used to address those varying levels of confidence and to ensure that the project manager will not be forced to pad other budgetary figures to account for any project unknowns. Invariably, some project issues will surface that require supplemental funding, and if they were part of the original project scope, such issues should be funded through contingency reserves. The level of contingency reserve may be established through confidence level assessments, Monte Carlo analyses, organizational protocols, or risk models.

Approaches

Cost estimates may follow established organizational formats if they exist. If not, the project manager becomes responsible for ensuring a level of consistency in how the cost estimate information is presented and how the assumptions backing up that cost information are captured. Without effective documentation of that information, the bases for the estimate may be misunderstood (or not considered at all). Consistent formatting and documentation encourages consistent progressive evaluations of the estimates as the project evolves.

Considerations

Cost estimates are built on the assumption that they will be used as tools for resource and fund allocation by the supporting organization. As such, it is important that they be recognized for what they are—estimates. Estimates cannot divine the future. They provide guidance as to the expectations for project spending. Keeping the estimates realistic can only be accomplished when they are acknowledged as a range of possibilities, rather than a single, absolute figure. There will always be some financial unknowns within any project’s budget. The key is to ensure that the budget accounts for both the known and the unknown elements in an open and honest fashion.