it all about budgeting and cost estimation

1. Budgeting and Cost Estimation

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

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

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

5.  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

6.  On most projects
◦ Material + Labor + Equipment + Capital +
Overhead + Profits = Bid
 In other words
◦ Resources + Profits = Bid
 So we are left with the task of forecasting
resources

7.  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

8. 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

9. 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

10. 1. Top-down
2. Bottom-up
3. Negotiated

11.  This strategy is based on collecting the
judgment and experiences of top and
middle managers
 These cost estimates are then given to
lower level managers, who are expected to
continue the breakdown into budget
estimates
 This process continues to the lowest level

12.  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

13.  In this method, elemental tasks, their
schedules, and their individual budgets are
constructed following the WBS or project
action plan
 The people doing the work are consulted
regarding times and budgets for the tasks to
ensure the best level of accuracy

14.  Initially, estimates are made in terms of
resources, such as labor hours and materials
 Bottom-up budgets should be and usually
are, more accurate in the detailed tasks, but
it is critical that all elements be included

15. ◦ Individuals closer to the work have a more
accurate idea of resource requirements
◦ The direct involvement of low-level managers in
budget preparation increases the likelihood that
they will accept the result with a minimum of
aversion
◦ Involvement is a good managerial training
technique, giving junior managers valuable
experience

16.  People tend to overstate their budget
requirements
 Management tends to cut the budget

17.  Labor rates include overhead and personal
time
 Direct costs usually do not include overhead
 General and administrative (G&A) charge

18.  Most projects use some combination of top-
down and bottom-up budgeting
 Both are prepared and compared
 Any differences are negotiated

19.  Top-down budgeting is very common
 True bottom-up budgets are rare
◦ Senior managers see the bottom-up process as
risky
◦ They tend not to be particularly trusting of
ambitious subordinates who they fear may
overstate resource requirements
◦ They are reluctant to hand over control to
subordinates whose experience and motives are
questionable

20.  The traditional organization budget is either
category oriented or activity oriented
 Often based upon historical data
accumulated through an accounting system
 With the advent of project organizations, it
became necessary to organize the budget in
ways that conformed more closely to the
actual pattern of fiscal responsibility

21.  Under traditional budgeting methods, the
budget could be split up among many
different organizational units
 This diffused control so widely that it was
almost nonexistent
 This problem gave rise to program
budgeting which alters the budgeting
process so that budget can be associated
with the projects that use them

22.  Program budgeting aggregates income and
expenditures across programs (projects)
 These budgets usually take the form of a
spreadsheet with standard categories
disaggregated into “regular operations” and
charges to the various projects

23. Table 7-1

24. Table 7-2

25.  Inputs from a lot of areas are required to
estimate a project
 May have a professional cost estimator to
do the job
 Project manager will work closely with cost
estimator when planning a project
 We are primarily interested in estimating
direct costs
 Indirect costs are not a major concern

26.  Even with careful planning, estimates are
wrong
 Most firms add 5-10 percent for
contingencies

27.  There are several common causes:
 Unreasonable and impossible goals
 Changes in resource prices
 Failure to include an allowance for waste and spoilage
 Bad luck

28.  Projects are known for being over budget
◦ It is unlikely that this is due to deliberate
underestimating
 There are two types of errors
◦ Random
◦ Systematic
 There is nothing we can do about random
errors
 Want to eliminate systematic errors