Projects must be funded. However, the stakeholders must first determine the cost performance baseline and project funding requirement, which calls for both the cost estimate and the project budget. Given their closeness, most people confuse these two.
This article looks at these two subjects, which are part of the cost knowledge area and planning process. We will look at the concept, differences, and examples to help you understand how they apply to your project.
However, before delving too deep, let us look at the definition of these two terms.
Project Cost Estimate
The cost estimate comes before the budget. In fact, cost estimation is done to ensure that the project is kept underneath a budget. What then is the project cost estimate? It is a forecast of the cost of completing the project. It is the first element of project cost management, which plays a crucial role in planning, monitoring, and controlling the monetary costs of a project.
The cost estimate is, therefore, the approximate total project cost. It is usually used to authorize the project’s budget, explaining why it must be drafted before coming up with a budget. It is also used to determine whether a project is feasible or not, budget for project cost, and monitor spending.
Project managers must ensure that they have an accurate project cost estimate to help them decide whether they should take on a project and its final scope. It also ensures that no cost overruns are experienced, and the project remains financially feasible.
Keep in mind that cost estimation is usually a continuous process, and estimates are customarily revised and updated as the scope of a given project becomes more precise and more risks are realized. As we mentioned, the estimate is needed to prepare the cost baseline, which comes in handy when assessing the project’s actual and final cost performance.
Components of a Project Cost Estimate
Remember, the cost estimate summarizes all the costs expected to be incurred in the project. It covers its entire duration, from the start to the end. Even though most people classify costs into many categories, there are two main classifications: direct and indirect costs. Let us take a look at these two:
- Direct Costs
These are costs touching directly on the project. These are the expenses to be incurred in the particular project. Direct costs are made of wages, cost of resources, fuel for any machine, and financial resources spent on project-specific risks.
- Indirect Costs
The indirect costs do not point directly to a given project. These are the expenses incurred by several projects at once and may vary in amount. Some of the common categories are quality control, security, and utilities cost.
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Indirect costs are shared across several projects and cannot be billable to one.
You also need to understand that the cost estimate goes beyond forecasting the expenses incurred in a project. It details the assumptions behind every cost. The assumptions alongside the cost estimate are usually contained in a report called the basis of estimate, allowing stakeholders to interpret the project costs and understand the difference between the actual and approximate costs.
Other project expenses included in the project cost estimate are labor, materials, services, equipment, hardware, software, services, facilities, and contingency costs, which are put in place for specific risks.
Types of Cost Estimates
Given the ongoing nature of cost estimation, there are different cost estimates that we ought to look at. These are:
- Order of magnitude estimate
This is usually prepared before the project is defined. It is, therefore, an extremely rough cost estimate based on expert judgment and similar past projects. The range of costs lies between -25% to +755 of the actual project costs. This estimate only comes in for high-level decision-making to determine financially feasible projects.
- Intermediate estimates
The intermediate cost estimate is created once the project is defined to a limited extent. It can either be developed using stochastic or parametric techniques and has a similar purpose as the magnitude estimate order.
- Preliminary estimate
The preliminary cost estimate is drafted when a project is halfway defined. It takes into account the detailed scope information to come up with unit costs. This can be used as a basis for project financing, and some stakeholders may use it to authorize project budgets.
- Substantive estimate
Substantive estimates are crafted once the project design has been reasonably finalized to depict an accurate cost estimate based on unit costs. This comes after the objectives and deliverables of the project have been defined. Project managers can use this estimate to control the project expenditure.
- Definitive estimate
This usually comes when the project’s scope and tasks are almost fully defined. It is created using deterministic estimating techniques to give an accurate and reliable estimation of costs. One can use the definitive estimate to create tenders, cost baselines, and bids.
However, you should note that just like other cost estimates, the definitive estimate also changes over time, provided that there is a change in base assumptions or risk comes up. To come up with these estimates, several estimation techniques are often used. These carry different levels of accuracy.
Project Cost Estimate Examples
Here is an example of a cost estimate for a classroom remodeling project:
Installing sheet rocks: $2000
Installing fixtures(lighting): $2000
Painting : $500
Labor : $3000
Contingency fund: $2000
Total estimate: $14,500
Now that you have a clear understanding of what a project estimate cost looks like, we should look at the project budget. Note that these two are different and should not be used exchangeably at any point.
What is a project budget? The project budget is built from the cost estimate and the schedule. Therefore, you have to work on the cost estimate before drafting a budget. The budget is a view of the project’s total cost from both a periodic and total perspective.
In project management, the budget can either be the accepted estimate for the entire project or a given schedule activity or work breakdown structure. It can be modified once the higher authority has approved, although mostly project managers tend to stick with the pre-defined budgets.
A project budget is, therefore, more detailed than the cost estimate. It is from there that the cost performance baseline is built, which is then used to perform earned value analysis and other cost management variance analysis techniques.
The budget must be in agreement with the organization’s funding limits to ensure that it can appropriate enough money towards the project. It determines the total finances channeled into the project.
We depend on the cost estimate to prepare the budget because you must have an idea of what the cost will be before creating a final copy. Therefore, the budget goes beyond identifying the amounts as it also considers the sources of funds to be used in covering the cost estimate.
Also, note that your project budget and the cost estimate should be in line, which may be pretty hectic. Therefore, first, start by identifying the source of funds to cover the final assessment or figure out what needs to be revisited to ensure that the final cost estimate is under the budget.
To help you understand just how coming up with a budget can be hectic, here are the sequences of building one:
- Preparing the scope
- Preparing the schedule
- Building the cost estimate
- Determining the budget
The project scope comes first before everything else since it is impossible to prepare an estimate if you do not know what goes into the project. Everything else comes after the scope as it is the ideal sequence of events.
The schedule offers you the time frame, which is essential when coming up with a budget. Keep in mind that a sudden change in timeframe will significantly impact the estimate, which affects the budget in the end.
If you intend to get things done quicker, you ought to factor in added expenses such as faster shipping and overtime labor, reflect them on your cost estimate, and lastly, on the budget. Remember, any change to the timeframe will reflect in the budget as that will affect the cost estimate.
Poor estimation of the project budget may force the project manager and stakeholders to modify it as soon as possible. There are four techniques for budget estimation, namely: parametric, analogous, top-down, and bottom-up.
The budget, therefore, serves to estimate the total project cost and the necessary efforts for the activities associated with project management. In general, budgeting is about approximating costs, setting a budget, and managing all these costs while monitoring them against the actual costs.
Apart from the scope and schedule, one also needs a well-executed resource plan for accurate cost budgeting.
Project Budget Examples
Like we mentioned, the project budget should be pretty detailed. Here, there should be a timeline for all the activities captured in the cost estimate. To help you understand how the project budget works and looks like, we will use our cost estimate in the article to build an example.
Demolition: $2000- Week 1
Installing sheet rocks: $2000- Week 2
Tiling: $3000- Week 3
Installing fixtures(lighting): $2000- Week 4
Painting : $500- Week 5
Contingency fund: $2000
Total estimate: $11,500
Here is the budget:
Week 1- $2000
Week 2- $2000
Week 3- $3000
Week 4- $2000
Week 5- $500
Contingency fund- $3000
Total budget amount- $12500
You can establish that the budgeted amount is more than that provided in the cost estimate, which is good. The project will be highly successful if the financier is willing to allocate more funds than the estimate.
You can also see that we included the timeline for completing the activities, which should always be on your budget.
Differences Between the Project Budget and the Project Cost Estimate
Now that you have a clear idea of what a project cost estimate and budget are, it is time to look at their differences. Here is s complete breakdown:
These two documents are prepared at different times. The cost estimate precedes the project budget because project managers and project teams rely on the latter to develop the budget. Therefore, the project budget is usually the last item in the long chain.
Given that the project budget comes after the cost estimate, it is usually considered an absolute indication of the project costs. Even though it may change at times, most project managers prefer to stick with it till the end of the given schedule.
Cost estimates are subject to change when new risks are identified and cannot, therefore, be relied on in totality. The budget only changes when all the stakeholders decide to do so. Consequently, it is not as spontaneous as the project budget.
Even though these two are closely related, they serve different purposes. The project cost estimation seeks to uncover the approximate cost of the project. It is, therefore, more of a forecast. On the other hand, the budget shows what the project sponsor is willing to spend on the project.
You will most likely have to resize your estimate to fit the budget if there is a vast disparity unless the project sponsor decides to add extra funding.
One last difference that we may have mentioned at a given point of our discussion is how receptive to change these two are. Whereas the project cost estimate and the budget are not static, the former changes easily than the latter.
The project cost estimate will constantly change when a new risk is established, whereas the budget only changes when the stakeholders decide and not as constantly as the cost estimate.
The project cost estimate is quite different from the project budget. Whereas the cost forecasts the expected expenses, the budget represents what the financier is willing to spend on the project. Therefore, when estimating the cost of a given project, one needs to align the value to the organization’s funding capability, or else the budget will reflect a different value.