2Learning Goals Understand the various types of common project costs. Recognize the difference between various forms of project costs.Apply common forms of cost estimation for project work, including ballpark estimates and definitive estimates.Understand the advantages of parametric cost estimation and the application of learning curve models in cost estimation.Discern the various reasons why project cost estimation is often done poorly.Apply both top-down and bottom-up budgeting procedures for cost management.Understand the uses of activity-based budgeting and time-phased budgets for cost estimation and control.Recognize the appropriateness of applying contingency funds for cost estimation.
4Cost ManagementCost management has been defined to encompass data collection, cost accounting, and cost control.Cost accounting and cost control serve as the chief mechanisms for identifying and maintaining control over project costs.Cost estimation processes create a reasonable budget baseline for the project.
5Cost ManagementInvolves taking financial report information and applying it to projectsCreates an accountability to maintain a clear sense of money managementEncompasses data collection, cost accounting and cost controlCost a.k.a expenses
6Common Sources of Project Cost LaborTotal cost associated with the hiring and paying of various personnelMaterialsSupplies needed during project executionSubcontractorsCost for subcontracted labor and servicesEquipment & facilitiesTravel
7Types of Costs - classifications Direct vs. IndirectDirect cost are clearly assigned to a specific aspect of the projectIndirect cost are overhead cost of the project including general administrationRecurring (RE) vs. Nonrecurring (NRE)Recurring are ongoing expenses (i.e. labor)Nonrecurring are typically a onetime expense (i.e. training)Fixed vs. VariableFixed cost are cost that do not change based on volume usage (i.e. rental rate on a copy machine)Variable cost do change based on usage (i.e. paper for the copy machine)Normal vs. ExpeditedNormal are expected as part of the routine processExpedited are unplanned cost to speed up the project execution
8Calculating Direct Labor Costs NameHours NeededOverhead ChargePersonal Time RateHourly RateTotal Direct Labor CostJohn401.801.12$21/hr.$1,693.44Bill$40/hr.3,225.60J.P.601.351.05$10/hr.850.50Sonny25$32/hr.1,612.80Total Direct Labor Cost =$7,382.34XXX=
9Cost Classifications Direct Indirect Fixed Recurring Variable Normal ExpeditedCosts ExamplesNon-recurringDirect LaborXBuilding LeaseExpediteMaterialOther project cost?
10Cost EstimatingThe first step in determining if a project can be done profitablyCreates a reasonable budget baselineIdentifies needed resourcesCreates a time based budget for the needed resources
11Cost EstimationThe more clearly you can define the projects’ cost categories in the beginning, the less need there is for estimationIt is best to cost out each work package individually, rather than creating an overall project costMethods of cost estimationBallpark - gueestimate ±30% accuracyComparative – based on history ±15% accuracyFeasibility – based on standard tables ±10% accuracyDefinitive – once uncertainty is removed ±5% accuracyWhen should each of these be used?
12Learning Curves in Cost Estimating Cost estimating typically assumes a steady rate at which work is doneTime activity 1 = Time activity 2 = Time activity nExperience teaches us that repetition of activities often leads to a reduction of needed time to complete a future taskResearch shows that performance improves by a constant fixed percentage each time production doublesUltimately, project budgets must be adjusted since learning curves are likely to occur
13Learning CurvesEach doubling of output results in a reduction in time to perform the last iteration.
15Learning curve example Assume you are a project cost engineer calculating the cost of a repetitive activity for your project.The initial output time for the first unit produced is 12 hours and the second unit is 10 hours.There are a total of 20 iterations of this activity required for the project.Determine learning rate and the steady state rate.Example 2Problem 7 page 270See learning curve example.xls
16Problems with Cost Estimation In spite of the best laid plans, various issues can affect accurate project estimatesLow initial estimatesUnexpected technical difficultiesLack of project scope definitionSpecification changesExternal factors
17Creating a Project Budget The budget, is a plan that identifies the resources, goals, and schedule that allows a firm to achieve those goals.Project PlanWBSSchedulingBudgetingTop-downBottom-upActivity-based costing (ABC)
18Top-down BudgetingAn approach that seeks to get top management input first to create an overall project costCost allowances are passed down level-by-level, broken into allocated pieces for each taskAdvantage: History shows that top management typically estimates pretty well and causes good budgetary discipline and cost controlDisadvantage: All successive levels need to fit their expenses within the allowable spend already chosenAggregate level of safety factor
19Bottom-up BudgetingStarts with the WBS to apply direct and indirect cost to specific project activitiesCost allowances are aggregated level-by- level, until a total project budget is determinedAdvantage: Emphasizes the need to create detailed project plans to be able to acquire necessary resourcesDisadvantage: Reduces top management control to an oversight functionSafety factor at each detailed step
20Activity-Based Costing ABC A budgeting method that assigns cost first to activities and then to the project based on each project’s use of the resources.Assign costs to activities that use resourcesIdentify cost drivers associated with this activity (i.e. material, labor)Compute a cost rate per cost driver unit or transaction (i.e. labor rate/hour)Multiply the cost driver rate times the volume of cost driver units used by the project (the more a resource is used, the more it drives cost)
22Time-Phased Budget Example MonthsActivityJanuaryFebruaryMarchAprilMayTotal bySurvey4,000Design5,0003,0008,000Clear SiteFoundation7,500Framing2,00010,000Plumb & Wire1,000Monthly Planned9,00010,5006,000Cumulative13,00023,50032,50038,500
23Budget Tracking Planned vs. Actual Example ActivityPlannedActualVarianceSurvey4,0004,250250Design8,000Clear Site3,500(500)Foundation7,5008,5001,000Framing10,00011,2501,250Plumb & Wire5,0005,150150Total38,50040,6502,150
24Contingencies are needed because Budget ContingenciesThe allocation of extra funds to cover uncertainties and improve the chance of finishing on time. (safety factor)Contingencies are needed becauseProject scope may changeMurphy’s Law is always presentCost estimation must anticipate task interaction costsNormal conditions are rarely encounteredAccess to these funds should serve as your first warning of project troubles. Cost control needs to be employed.
25Discussion QuestionsDescribe an environment in which it would be common to bid for contracts with low profit margins. What does this environment suggest about the competition levels?How has the global economy affected the importance of cost estimation and cost control for many project organizations?Why is cost estimation such an important component of project planning? Discuss how it links together with the Work Breakdown Structure and project schedule?Imagine you were developing a software package for your company’s intranet. Give examples of the various types of costs (labor, materials, equipment and facilities, subcontractors, etc.) and how they would apply to your project.
26Discussion QuestionsGive reasons both in favor of and against the use of personal time charge as a cost estimate for a project activity.Think of an example of parametric estimating in your personal experience, such as the use of a cost multiplier based on a similar, past cost. Did parametric estimating work or not? Discuss the reasons why.Put yourself in the position of a project customer. Would you accept the cost adjustments associated with learning curve effects or not? Under what circumstances would learning curve costs be appropriately budgeted into a project?Consider the common problems with project cost estimation and recall a project with which you have been involved. Which of these common problems did you encounter most often? Why?
27Discussion QuestionsWould you prefer the use of bottom-up or top-down budgeting for project cost control? What are the advantages and disadvantages with each approach?Why do project teams create time-phased budgets? What are their principle strengths?Project contingency can be applied to projects for a variety of reasons. List three of the key reasons why a project organization should consider the application of budget contingency.