Estimating Costs and Arriving at Budget
Objectives
On completion of this chapter, you should be able to understand
Once you understand the scope of the work and plan the schedule, the next logical step is to arrive at the cost of tasks and computing the budget. In this chapter, we shall discuss key project management processes related to cost, namely, estimating and budgeting. Cost is a key constraint in most of the projects and it is important that the project is completed within the approved budget to keep the cost of the resultant product or service competitive.
Estimating costs is the process of approximating financial resources needed to complete the project activities (identified as tasks in MS-Project). The next step in arriving at the budget involves aggregating the estimated costs of individual activities or work packages and adding reserves (like contingency and management reserves), at appropriate stages. This will establish a cost baseline for the project. The cost baseline is the baseline of the project that gives us an idea about the amount of money the project is estimated to cost and how the money will be spent over a period of time (giving an idea of cash flow). Generally, it is an approved budget (by the sponsor) usually in a time-distribution format used to estimate, monitor, and control the overall cost performance of the project.
The Cost Tree Structure
To begin with, let us understand how we arrive at the project budget. Chapter 2 and 3 discussed about the work breakdown structure (WBS) and activity definitions. Figure 6.1 illustrates how individual activities are rolled up to form work packages. As a first step in estimating the cost of work packages, the work packages are decomposed into smaller components called activities. The activity definition process deals with creating activities (also known as schedule activities) by breaking down work packages. It is these activities that require cost estimation. This is known as the estimate costs process. Once these costs are estimated, contingency allowances are added to these estimates at various levels. Contingency reserves are allowances that a project manager will use, in case the identified risks get realized. These are then rolled up into associated work package costs. The same process is repeated at the work package level to come out with the control account estimates. (Control account is the WBS component used for the project cost accounting. Each control account is assigned a unique code to link it to the performing organization’s accounting system.)
These control account estimates have to be rolled up and added with reserves. Management reserves are budgets that a project manager shall use with the approval of the senior management, to mitigate the effect of unplanned or unexpected changes to scope and cost. (As discussed earlier, in the case of MS-Project, we have only tasks to represent activities, work packages, control accounts, and so on. However, we can use subtasks to represent activities and summary tasks to represent work packages and control accounts, etc.)
With a basic understanding of how a budget is determined by rolling up costs, let us examine how MS-Project allows us to accomplish this. This case study deals with a small project of Software Testing.
Example Problem: Arriving at the Budget for a Software Testing Project
In the following example, we discuss the case of arriving at the budget of a small software testing project. The resources required and the quantities of the material have been estimated. Based on this, we shall estimate the cost of the project.
It is a project with two summary tasks (Planning & Preparation, Execute Tests).
Table 6.1 Resources assignment details for the project
Tasks |
Resources |
Units/cost |
Planning and Preparation (Summary Task) |
QA Engineer Hardware |
100% 100% |
Study Functional Specifications |
Project Manager |
50% |
Execute Tests (Summary Task) |
Hardware QA Engineer |
100% 100% |
Execute Automated Tests |
Licensed Software Contingency Allowance |
100% U.S. $ 620 |
Execute User Acceptance Tests |
Travel |
U.S. $2,100 |
Analyze Test Results |
Project Manager QA Engineer |
100% 100% |
Compile Test Statistics |
QA Engineer Paper |
100% 2 Rims |
To conclude, we did learn how to arrive at the project budget summing up various costs and allowances, in this chapter. We also did study, with an example, how we can initiate the process of estimating the project budget with the help of MS-Project.