Budgeting Cost and Estimation

Topics: Project management, Strategic misrepresentation, Budgets Pages: 6 (761 words) Published: July 7, 2013
Chapter 7

Budgeting and Cost Estimation

Copyright 2009 John Wiley & Sons, Inc.

Low Bids


If you are bidding on a project, do you want your bid to be as low as possible and still make a profit?

Accept Low Bid


If you are accepting bids on a project, do you want to accept the lowest bid?

Budgeting
A plan for allocating scarce resources to the various endeavors of an organization  A budget implies constraints  Thus, it implies that managers will not get everything they want or need 

Budgeting
  

Continued

The budget for an activity also implies management support for that activity The higher the budget, relative to cost, the higher the managerial support The budget is also a control mechanism – –

Many organizations have controls in place that prohibit exceeding the budget Comparisons are against the budget

Estimating Project Budgets


On most projects


Material + Labor + Equipment + Capital + Overhead + Profits = Bid Resources + Profits = Bid



In other words




So we are left with the task of forecasting resources

Estimating Project Budgets
 

Continued

Like any forecast, this includes some uncertainty There is uncertainty regarding usage and price –

Especially true for material and labor





The more standardized the project and components, the lower the uncertainty The more experienced the cost estimator, the lower the uncertainty

Rules of Thumb


Some estimates are prepared by rules of thumb
– –

These rules of thumb may be adjusted for special conditions However, this is still easier than starting the estimate from scratch

Estimating Budgets is Difficult
1. There may not be as much historical data or none at all 2. Even with similar projects, there may be significant differences 3. Multiple people have input to the budget

Estimating Budgets is Difficult

Continued

4. Multiple people have some control over the budget 5. There is more “flexibility” regarding the estimates of inputs (material and labor) 6. The accounting system may not be set up to track project data 7. Usage of labor and material is very lumpy over time

Types of Budgeting
1. Top-down 2. Bottom-up 3. Negotiated

Top-Down Budgeting
 



Top managers estimate/decide on the overall budget for the project These trickle down through the organization where the estimates are broken down into greater detail at each lower level The process continues to the bottom level

Advantages
Overall project budgets can be set/controlled very accurately  Management has more control over budgets  Do not need to do as much up-front planning 

Disadvantages
More difficult to get buy in  Leads to low level competition for larger shares of budget 

Bottom-Up Budgeting
Project is broken down into work packages  Low level managers price out each work package  Overhead and profits are added to develop the budget 

Advantages
Greater buy in by low level managers  More likely to catch unusual expenses 

Disadvantages
People tend to overstate their budget requirements as “padding”  Management tends to cut the budget 

Work Element Costing
Labor rates include overhead and personal time  Direct costs usually do not include overhead  General and administrative (G&A) charge 

Negotiated Budgets
Most projects use some combination of top-down and bottom-up budgeting  Both are prepared and compared  Any differences are negotiated 

Category Budgeting Versus Program/Activity Budgeting
 

Organizations are used to budgeting (and collecting data) by activity These activities correspond to “line items” in the budget –

Examples include phone, utilities, direct labor,…

 

Projects need to accumulate data and control expenses differently This resulted in program budgeting

Typical Monthly Budget

Table 7-1

Project Budget by Task & Month

Table 7-2

Improving The Process of Cost Estimation...
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