PMI CAPM – Estimate, Budget, and Control Project Costs Part 2

  1. Estimate Project Costs

Now that we’ve created a cost management plan, that plan will direct how we create the project cost estimates. So it’s really important to understand when estimating happens. The earlier in the project it happens, the less reliable and viable those estimates are going to be. As you have more and more information available about your project, your level of confidence and the accuracy of your estimates are going to increase. And this is an example of the progressive elaboration that we saw a little bit earlier in the course. So let’s look at estimating the project’s cost.

The predictions are based on the information that you have available. And as I mentioned, while the cost management plan may be something that we aspire to and that I have right away, the reality is that you don’t always have that done before people start asking you how much this is going to cost. So predictions are based on the information you have available at the time of your estimate. We have to look at cost trade-offs and the risk that maybe you have to consider when you think about how much the things in the project are going to cost your organization.

So you think about the cost that you might spend to build it internally versus to buy it, the cost to just purchase something versus to lease it, or the cost of having a resource that’s only dedicated to your project versus sharing a resource with another project or operations. So you have to look at how much I’m going to use the thing. What’s the benefit of long-term ownership versus a short-term lease? Or do we want to build this, or should we hire a company to do it for us? So we’ll talk about that information throughout this section. The level of accuracy I was just mentioning depends on the amount of information you have, which affects how accurate your cost estimates will be. so early in the project, I don’t have a whole lot of information.

I haven’t built the work breakdown structure yet. I might have a scope started, but more likely I just have the charter. And then people are going to start asking me, “Hey, how much is this thing going to cost?” What do you think? Just give me a ballpark. Well, that ballpark is called a rough order of magnitude, or a Rom estimate. and it’s really a wild estimate. It’s very unreliable. In fact, as an asmy qualifier for that Rom estimate, I might say plus 100% to 50%. So these are those early estimates, which are not very reliable. How much something should cost is just a guess based on your experience and discipline. Then, once I have the scope statement and a little bit more insight into the project, maybe then I’ll do a budget estimate. So a budget estimate is an estimate that has a little bit more information and is a little bit more reliable. As a result, the range of variation could be a little tighter, like plus 25% and minus 10% or something like that, so you don’t need to know those ranges of variance.

I’m just giving an example, but my point is that a budget estimate is a little bit more accurate than the Rom estimate. Now the most accurate estimate is a definitive estimate. a definitive estimate. It’s also known as a bottom-up estimate. A definitive estimate means that I have the project scope and the work breakdown structure created. So I’m very precise. I know exactly what we’re going to create. I can then predict the cost of each individual work package based on the work packages, the items in the WBS. I can look at the aggregate of all of that information and tell you with more precision what this project is going to cost. So a definitive estimate is really reliable. It just takes longer to do.

We also have to look at all categories of costs that need to be estimated. And what I mean by this is that you must consider what items we must purchase; what about labor? What about permits, for example? What about the facilities that we have to lease for airfare? So I have to look at everything that I have to purchase or where I’m spending money on anything. Now, your organisation may have some rules about the labour on your project. So I’ve consulted with some companies where you do account for the actual cost of the labour on your project team. And in other organizations, that’s an exception to your cost estimate. That your employees and the organisation do not have to account for their time, or, to put it another way, their hourly rate, on your project team. So, in your organization, you must decide whether or not to calculate what these people cost the company or the project.

And I’ve also worked as a consultant in some companies where we had people like an instructional designer, a developer, a tester, a writer, a help desk representative, and so on. Those were the roles that we used on the project. And so each of those roles had a predefined amount. So, like an instructional designer, it was $95 an hour.

So now, whether that person made $95 an hour, I have no idea. But for anyone in the company that served in the role of an instructional designer, that’s what we charged the clients that we were doing instructional design work for, or a developer, or anyone that was coding, that’s their role as a developer, and they had a flat rate of like $125 or whatever it was. And that’s what was billed to the client that was paying for the project. So you have to understand your enterprise environmental factors and how they are accounted for, no pun intended, in your project. Okay, let’s take a look at the eddo here for cost estimation, which has a lot of inputs, tools, and techniques, and a few outputs. So in order to estimate costs, I need the cost management plan. Remember, I don’t always have a cost-cutting strategy in place, though someone could come to me on day one and ask how much?

But these are the ideal inputs. So the cost management plan, the HR management plan, the scope baseline project schedule, the risk enterprise, environmental factors, and organizational process assets are our tools and techniques for estimating costs. We have expert judgment, analogous estimating, parametric estimating, bottom-up estimating, and three-point estimating. And then we have reserve analysis, a different type of reserve we’ll talk about. We have to consider the cost of quality, which we’ll get into in a moment. And then we have your project management software, vendor bid analysis, and group decision-making techniques. There are only three outputs for estimating costs: activity cost estimates, the basis of those estimates, and project document updates. There are four cost categories you should be aware of. A direct cost means it’s an expense just for your project. No one else has these expenses but your project. An indirect cost is something that is for the organisation as a whole, but your project may contribute to or use that facility, but it’s paid for by the organisation as a whole. Or your project has a piece of equipment that everyone can use and that’s not owned by one project but is part of the overhead. So sometimes this is where labor—the people on your team—are an indirect cost where you have to account for people’s time, but that time is not necessarily part of your project budget.

A variable cost is something that fluctuates. Airfare is a great example of a variable cost. You could take the same trip from Tampa to New York every month, and each month you could have a different fee. Unfortunately, it’s not going to be the exact same amount each month for that airfare, unfortunately. So anything that’s a variable cost, like gasoline, fuel, airfare, or just anything to travel, even hotels, that’s a variable cost that your project has to pay for. And of course, those are hard to predict. And then we have a fixed cost. The fixed cost is similar to a direct cost. However, a fixed cost could be that you lease a piece of equipment that is only used for your project, and the cost is the same whether you use that piece of equipment or not. So in this case, we have a back coherer; that’s what that piece of equipment is called, and they are renting that for one year, and they only use it maybe 15 to 20 hours a week.

So even though it’s sitting idle and not being used, you still have to pay the fee to have it available. It’s slightly different than a direct cost because, with a direct cost, if that developer weren’t coding or they took a day off for whatever reason, you may not have a uniform fee that they only bill for each hour that they work on your project, whereas this fixed cost is more uniform. Whether you use it or not, you’re paying the same amount every month or whatever the time agreement is. All right, so those are four cost categories. Let’s look now at our project schedule and cost estimating and how those two things are related. Resource availability. So if resources aren’t available, you might have to use different resources, and that can affect your cost. You should also consider that if you’re working with a contract company and bringing in labor, there may be some fluctuations depending on how available those people are.

So supply and demand affect not just people but also materials. So supply and demand definitely affect costs. If you’re purchasing materials, you have to consider the timing of procurement resources. I need cabinets at the job site in 60 days. It takes about 45 days for procurement to work its magic. And so I need to make certain that I start that procurement process to buy the cabinets 45 days before. So in the lead time before the job, I need the cabinets delivered at the job site. If you have a large project, maybe you take out a loan or your company takes out a loan to finance the construction project or whatever project you’re working on. So you could have interest rates to consider in your longer project. Time-sensitive costs are similar to market conditions or seasonal cost variations; as you will see later, if you wait too long, prices will rise. Airfare is a great example of a time-sensitive cost.

If I know I’m going to take a trip two months from now, I can go ahead and buy my ticket and save on the cost of the airfare. But if a client needs me next week and I have to purchase airfare for next week, it’s going to be much more expensive because it’s much more urgent and short-term. There are also seasonal costs to consider. There are different peak seasons for different types of work. So, consider the wintertime construction. It’s not always a good thing to have construction, especially if you’re in the northern states or a cold climate. And then you also think about an accounting firm. They have a tax season; they’re going to be very busy during that time. Or retail when you get close to the holidays—it’s not always a good time to be doing projects, but all of those seasonal cost variations can affect your cost based on market conditions.

All right, you’ve seen this before. We have comparable estimating. Analogous estimating is where project A costs 100,000. Project B is about twice as big, so I’m going to say 190,000. So it’s a top-down approach, making an analogy from one project to another. I have to have historical information to do an analogous estimate. It’s not really reliable, but it’s very quick. Our next one we have here is a parametric estimate. A paragraph estimate is where I have a parameter to multiply across.

So $329 per software license, with a total of 1000 licences required. So you do the math and multiply it across, or you buy something, like gravel or whatever, at $4,500 per metric ton. So how many metric tonnes do you need? And you multiply it across parametric estimating, which is also what we talked about. I’m going to charge x dollars per light fixture to be installed. And I have 1,000 light fixtures. So we say this is $400 because it takes about an hour of labour to instal these light fixtures. that you can’t see it. That one right there Really nice. $400. All right, so if we send our crew out to do this and they have 1,000 to install, they might be able to develop a system, and they probably will develop a system to instal that fixture more efficiently and faster, and so on. So the current level of efficiency is that they now instal light fixtures.

Well, this is a new type of light fixture. They’ve never installed this fixture before. So although they’re really used to installing light fixtures of a certain brand, type, and configuration, this new one has some other features to it. So their current efficiency actually dips because they have to learn how to instal this new type of light fixture type. So that’s the regression—you’re going backwards in order to become more efficient at installing these light fixtures. So your current level of efficiency takes a dip, but they learn how; that’s the learning curve. And then they become more efficient at installing this fixture over time. Especially when they’re performing 1000 of these installations over and over. So that’s a parametric estimate. You have to consider the learning curve. Exactly what we were just talking about All right, bottom-up estimating. We’ve seen this one. It’s a definitive estimate.

It’s based on the work breakdown structure’s creation. It’s also to give the definitive estimate. We look at the cost of each work package, and then the cost of those work packages is rolled up to predict the total cost of the project. It’s the most reliable, but it takes the longest to do a three-point cost estimate. just like we saw back in time. A three-point average is the sum of the optimistic, likely, and pessimistic costs divided by three. So that’s an average. PERT stands for optimistic plus four times the most likely plus pessimistic divided by six. So pert is weighted towards the most likely. So this is an example of a three-point triangle, and pert is a beta vendor bid analysis. So as part of cost estimating, we may have to work with vendors to see how much something costs to get them to bid on our project?

There is, however, an approach you can take, particularly in larger projects. It’s called a third-party estimate. And what we do is hire a vendor from the field, like an electrician, for example, and say we want to redo all the wiring. We have some bad wiring in here. We want to update all of our electrical components, the receptacles, the lighting, and everything. So I want you to create an estimate for me of what you think is fair and what this should cost. And then we’ll pay that electrician for their time. So they come in, study it, and create an estimate of what this should cost. Then we open up a bid for all of the electricians in our community that qualify, and they can bid on what we want them to do about updating all these electrical components. The vendor we will select is the electrician who comes closest to our estimated cost.

That is why it is referred to as a “should cost” or a “third party estimate.” We also often have to create a statement of work when we do a vendor bid analysis and are looking for proposals, quotes, or bids, we alsooften have to create a statement of work. A statement of work describes the thing that we want the vendors to create for us. Then we might have a bidders’ conference. It’s an opportunity for bidders to come all at once and ask questions about our statement of work. And then we get into vendor selection. We might have a screening system where you have to qualify based on years of experience, references, your cost, or whatever the case may be. We can set up rules that if you don’t have this on your bid, you have to have, for example, a PMP as your project manager. If the company doesn’t have a PMP, then they can’t bid. They’re screened out. A scoring model is where I give points to different factors like schedule, cost, experience, reputation, or whatever the case may be.

And then we could just come right down to just buying on price. We’ll talk all about vendors in Chapter Twelve and the Pinbach on Procurement Management. That wraps up our talk about cost estimating. I know it was a long lecture. However, there is a lot of information here. very important topic for your exam. So, some important points here. We talked about the activity cost estimates and the process of arriving at an estimate. And then we always have some basis for our estimates. What’s our supporting detail? What assumptions or constraints did we use or do we now have based on our cost estimating? What’s that range of variance? So Rom was definitive, and Budget was the one in the middle. And then, how confident are you that this estimate is going to hold true? All right, good job. I know it was a long lecture. Let’s go ahead and keep moving forward, though. We’re going to talk about creating the project budget in the next lecture, so off to you real soon.

  1. Create the Project Budget

In this lecture, we’re going to discuss creating the project budget. Now, I know a lot of you say that the budget is not created; it’s just assigned. So there are some things to consider when the budget is a predetermined amount. First off, that is a constraint for your project.

That’s something you have to live with. And then we go back to the idea of the “triple constraints” of project management: time, cost, and scope. Well, the budget must be in proportion to the amount of time and the scope. If it’s not, then we have a risk that the project is setting itself up for failure. So those are things to consider. But we’re going to hop in here and talk about how the project budget represents the actual amount of funds available for project expenses. So this process—seven, three in the pinbox—is to determine budget. What we’re talking about is aggregating the estimated cost. So our work packages and the activities, all of the resources—talking about labor, materials, equipment, and facilities—all of that labour is attached to this and rolls up to determine our budget.

This helps to create the authorized cost baseline. What should things cost throughout the project, and when do you anticipate spending that money? Excludes management Reserves, so a management reserve in regard to money, are typically created when we’re talking about risk, as you’ll see in Chapter 11 of the Penbox on risk. We’re going to talk about creating a management reserve or a contingency reserve for risk events. So management reserves are amounts of money for cost overruns that you don’t get; they’re only for risk events or for really extreme cost overruns for things that were unknown at the time of your planning. And then performance is measured against the budget. So we have that cost baseline, and if there’s a variance, then we can see very quickly how we are doing on our costs in the project. Let’s look at our edo here for determining the budget. The management plan is costed by many inputs, including your scope, baseline activity, cost estimates, and the basis for these estimates.

The project schedule So remember, the project schedule is when the work can take place, but this can also set us up for when we are going to be spending the money. So some cash flow forecasting, followed by a resource calendar: when are people available, when are we going to bring people on board? our risk register because that gets into our contingency reserve and the cost of risk events. We have any agreement, so contracts with vendors, so financial terms and OPA tools and techniques will be present. Cost aggregation is the sum of what we are spending. The reserve analysis determines how much money remains in the reserve in the event of a risk event. And we’ll talk more about that when we get into Chapter eleven on risk. For now, just know that it’s an amount of money set aside only for risky events. And so we’re trying to distribute our risk throughout the project. And so we’re looking for a risk-reward scenario. So if a risk happens, then we would have to pay to respond to that event. If it doesn’t happen, then we don’t have to pay, and we save the money, so to speak, by not responding to the risk event. And we’ll talk more about that when we get into Chapter 11. For now, just know that if an event happens, it’s going to take money from our contingency reserve. And so if we take money out to pay for a risk event, how much is left to COVID, so to speak, the remaining risk in our project? Historical relationships.

So has this type of stuff happened before? Can you predict when you’re likely to have some problems based on past projects? So do you have any type of history of what’s happened in the past? And how have other projects responded with a predetermined budget or a project of this nature? What was their budget, and how did they compare to their cost baseline? Funding limit reconciliation means that when you spend money, you have to account for it. You have to reconcile what you said it would cost with what it actually cost. And if there’s a difference, what’s happened? The budget, the actual cost baseline, your project funding requirements, and possibly some project document updates are all produced here. Because if your scope is this big but you only have this much to spend, then some things have to go out of scope. So you might have to update the scope. Reserve analysis. All right, I kind of got ahead of myself a little bit. I was talking about the contingency reserve, sometimes known as a management reserve.

But the reserve analysis—just to be clear—is a pool of funds that we set aside for unknowns and risk events that could happen in the project. If the risk event happens, we take money out of this reserve, and then we have to look at, all right, well, how much money do we have left for the remainder of the risk that may be in the project? The reserve is not part of the cost baseline, all right? It’s only set aside for risky events. So it’s part of your budget, but it’s not part of the cost baseline. And the idea that it’s part of your budget means that if you have a budget of 100,000, let’s say, but you have a contingency reserve of 25,000, if you start having defects and some things come in late or the team paints the room the wrong color, you don’t get to take that from this reserve. That’s an error. So that has to be somehow accounted for. You just can’t dip into this for errors. This is only for risky events. This being our reserve, creating the project budget is the actual cost of the budget. So a lot of things are happening here in this little chart. So we have them; let’s look at our two axes here. Right on the Y axis, we have the project cost.

And then on the X axis, we have the project schedule. The little curve that you see going up the BAC is the budget at completion. That’s what we think this is going to cost us. So it’s $400,000. That is our cost baseline. Now in that project schedule, you see the little dashed line that’s following the cost baseline. But there’s some separation. That’s our cost to date. What we’ve said in this little figure is that at this point in the project, we’ve already spent more than we should have. So we have a variance. The difference between what was planned and what was actually done is the variance. This also prepares us to do some forecasting so that I can predict where we’re likely to end up in the project based on this curve. And so we’re going to look a little bit more at this when we get into earned value management.

A moment ago, I talked about historical relationships, about looking at past projects and seeing how closely they followed their estimates, their budget, and their range of variants. This is also talking about creating parametric estimates and creating analogous estimates, which I can only do if I have proven information to base them on. So with an analogy, I have to say I have to have a project to create an analogy from; with parametric, I have to have proof that it will cost $150 per fixture that we instal based on the time to do that fixture. So parametric and analogous are examples of historical information. Historical information does affect your estimate. As it was, I got a little ahead of myself in terms of precision. So if that project did not trend with its cost baseline, but they didn’t update and reflect the error, you’re basing your project’s cost on this past project, which is inaccurate. So that’s the problem here.

We need some quantifiable parameters. As a result, we must be able to quantify what they did in the past. And how does that map to ours? Models are scalable for any size project. And a great example of a model is under construction. You might say it’s X dollars per square foot. So, if you’re framing a 4000 square foot house, that’s a model you can use. If you’re only framing out a 500-square-foot garage, that’s scalable and can be scaled across. So models are things that you can scale, and they’re proven for your project funding limit reconciliation. This is where you have to reconcile what you actually spent against what you predicted about what was planned. And if there’s a variance, a cost variance, then you need corrective action. You have to go out and see—okay, well, why are we having this? Are there any flaws? Is this what’s happening, or are estimates wrong? Are people taking longer to do the work than what was planned? So what’s happening? And how can you respond to the difference between what was planned and what was actually done to get your project back on track? So it’s really important. We saw the cost-performance baseline a moment ago. This is a little bit more detailed.

Look at a cost-performance baseline. We still have our cumulative values, project cost on the y axis, and time on the x axis. So ideally, at the end of the project, we will be exactly out of money and out of time. That’s ideal. So that’s the black line, our cost baseline. Actually, it’s the blue line, our cost baseline. Here, the expenditures represent where we think we’re going to be spending the money. So you might be front-loaded when you have to go buy a lot of equipment up front. Or it could be like this, where the money is just distributed across the project when you’re actually spending the money.The red line, though, is the actual. You can see it’s pretty wobbly there, that it’s not trending right with our costs. Maybe they got a late start, or they had a delay or some rework, and then it begins to pass our cost baseline and eventually exceed it. And they go above and beyond in terms of cost and time.

So that’s not a real healthy project that we’re seeing here. The next step is to secure funding. Recall that when we talked about phases early in the course, at the end of each phase you could do a phase gate plan, but we can also do phase gate estimation, where I estimate how long or how much it will take to complete this phase. And then I start the phase with an infusion of money. That is my stepmother’s money. And so then I do the work, I get to the end of that phase, and then I create another estimate for the next phase of the project. So for each milestone, I have a phase-gate estimate, and that’s when the money is received for the project. If you’re building a house, a lot of times you’ll be doing step financing, where the construction company will say, “All right, when we get our permits, you have to pay x amount.” And then that gives them the money to finance their labour and materials to get to the next phase of the project. And they say, okay, when the foundation is complete, then you have to pay x amount, and then when the framing is complete, and so on. So you have this stair step tied to the delivery of milestones.

And it’s a really fair way for both parties to contribute to the project. project funding requirements. So what do we learn in this lecture? Well, we need to know the total funding requirements as we move into our project. That’s what sets up the budget. We have those periodic funding requirements for step funding tied to base-gate estimating and anticipated liabilities. When am I going to spend the money? What is the cash flow forecast? And I need to let management and my stakeholders know. You don’t want to surprise people. Oh, yeah, I forgot to tell you that. In month three, we have to buy those 10,000 laptops. I thought you would know that. And they may have been under the assumption that you’re going to buy a little bit each month. So that’s a liability and a cost. And then we talked about management reserves, which we’ll look at again when we get into Chapter Eleven on Risk Management, because we’re talking about contingency reserves in this chapter. All right, good job. Next, we’re going to talk about controlling project costs. So I’ll see you in that upcoming lecture.