Enumerate the differences between an Estimate and budget. Also describe the likely pitfalls which can impede the pricing function

Estimating Costs and Determining Budgets

In general we understand how to create the project human resource plan. To get resources you need to spend money (Cost) and you can’t spend an infinite amount. Every project has certain limits on the amount of money you can spend (Budget). Here I am going to explain about estimating the costs and determining the budget involved in a project.

Difference between Cost & Budget:

Many people confuse the terms cost & budget and even use them interchangeably. Unfortunately they are both not the same. So, the first thing we need, understand clearly the difference between cost and budget.

Cost is the value of the inputs that have been (or will be) used up to perform a task or to produce an item: product, service, or result. This value is usually measured in units of money. For example, you paid two programmers Rs. 5000/- each for developing a software program, and you paid Rs.1000/- to a tester to test the program. So, the cost for the task of developing and testing the software program is Rs. 11,000/-. You can add the costs of components of a system, and the sum will represent the cost of the system, but it’s still a cost and not a budget.

Budget is an aggregated cost with a timeline. You aggregate the costs of all the resources needed to perform the project and put a timeline on it: the availability of funds over time. That is called a budget. Look at the image below:

Cost management consists of estimating project costs, determining budget from the cost estimates, and controlling the cost while the project is being executed. This is just a high level depiction of cost management and we will cover the details now.

Estimating Project Costs

Estimating project cost means developing an estimate for the monetary resources needed to complete the project work; that is, activities. These estimates are based on the information available at a given time. The estimates in the beginning are less accurate; for example, their accuracy may be only as good as + or - 50 percent. For example, if you say the cost will be $50,000, it could be anywhere between $25,000 and $75,000. As the project moves along and more information becomes available, the cost estimates can be improved to get better estimates.

The standard process used to estimate costs is called the Estimate Costs process. Look at the image below:

Estimating project cost means estimating the costs required to complete the project scope by executing schedule activities. Therefore, you need the scope baseline and the schedule baseline for estimating costs. The lists of items used as input to this process are:

•     Human resource plan - The information in the human resource plan useful for estimating costs includes the list of roles and responsibilities, personnel rates, and recognitions and rewards.

•     Project schedule - An approved project schedule will give you the information about the resources needed to complete the project work. This information is crucial to make cost estimates. As you learned in the previous chapter, activity resources are estimated by performing the Estimate Activity Resources process. Therefore, the Estimate Costs process should be closely coordinated with the Estimate Activity Resources process, which in turn depends on the Estimate Activity Durations process because activity duration is determined for the given resources.

•     Scope baseline - All three components of the scope baseline; scope statement, WBS, and WBS dictionary are useful in estimating the project cost. The scope statement will provide the cost-relevant information, such as project and product acceptance criteria, assumptions and constraints, product description, key deliverable, and project boundaries around the scope.

•     Risk register - Both kinds of risks—threats and opportunities have an impact on the cost in the form of risk mitigation costs and revenues or savings from the opportunities.

•     Enterprise environmental factors - Enterprise environmental factors relevant to estimating costs include market conditions and published commercial information that will provide the cost of resources, including human resources, materials, and equipment. This will also provide the information related to the availability of products and services and their cost and rates. Supply and demand conditions can also influence the project cost.

•     Organizational process assets - This includes the organization’s policies regarding cost estimates, cost estimating templates, and information from previous projects, including lessons learned.

Determining Project Budget

Determining the project budget is the process of aggregating the cost estimates for all project activities and assigning a timeline to them. Cost aggregation is the technique used to calculate the cost of a whole by summing up the costs of the parts of which the whole is made. You can use the bottom-up estimation technique to aggregate the costs of all the components and activities to calculate the total cost of the project. The timeline assigned to this cost will be important to reconcile the expenditure with the funding limits.

The reconciliation may require rescheduling some activities.

The budget is determined by using the Determine Budget process. Look at the picture below:

Most of the items in the input to this process are already described in this chapter. Organizational process assets may include organizational policies and tools for determining the budget. The reserve analysis at budget level includes management reserve in addition to contingency reserve, and you must understand the difference between the two. Contingency reserves are the funds that can be used to deal with the unplanned events that can potentially transpire in case one or more identified risks occur, whereas management reserves are the funds that can be used in case of yet unplanned but future changes in some aspects of the project, such as the project scope.

The approved budget that includes the aggregated cost with timeline is called the cost baseline. The cost performance of the project is monitored, measured, and controlled against this baseline. This is why it’s also called the cost performance baseline. Funding requirements for the project are derived from the cost baseline and the reserve analysis.

Do not leave out the cost of the internal employees of the organization who will work on the project. They are not free, for two reasons: The organization pays for them, and they do not have infinite numbers of hours to put into the project. Their cost to the project will be determined just like any other project role based on the hours of work they will put into the project.

In the process of determining the budget, you may need to update the project schedule, cost estimates, and the risk register.

Your organization may not have the resources to complete all parts of the project. For those parts of the project, you will need to use what is called procurement.

Factors which change costs over time

Once implementation begins, a project’s costs rarely remain static. As further information becomes available the costs may be further defined. Yet, even when a cost has become firmly fixed, there are numerous factors that can lead to the cost increasing. Delays are a major factor. Whatever the reason, delays almost invariably increase budget costs. Many events may have contributed to the delay – some which could have been foreseen and others which could not.

In the context of program funding, time and cost over-runs have obvious implications for the number of projects that can be funded within a program period, and for the scale of the outputs and impacts generated. These lead to projects over-running either in time or costs. As indicated above, delays generally translate into higher project costs.

Poor Project Management: The role of the project manager or project management team is probably the most important element in containing the costs of a project. It is often true that a poor project with a good project manager will be completed satisfactorily. But even a good project, if combined with poor project management, will almost always face serious difficulties.

A poor project management structure will have an impact at all stages of the process leading to:

•    A lack of planning and coordination;

•    Poor communication between members of the project team and the project sponsor;

•    Failure to identify problems and institute necessary design and programming changes;

•    A lack of control over time and cost inputs.

Major or minor changes in requirement: A change in a project’s design can arise for a number of reasons. It may be that the project sponsor wants additional elements to be included in the project or changes to existing ones. Usually, these design changes require additional time inputs from experts as well as the additional time and cost inputs from the team members.

Funding Problems: Overall lack of finance to complete a project or delays in the payment for services by the project sponsor can lead to significant problems arise. If the costs of a project have increased significantly beyond the original estimate, then work on the project may have to stop or be delayed until additional funds can be found.

Funding problems can also arise if funds allocated to one project have been diverted to other projects within a program of development.

Other Factors: In addition to all the categories listed above, experience shows that problems also arise from premeditated under-estimation of initial costs simply in order to obtain initial approval for a project. This can lead to major projects being approved, and started, in the knowledge that actual costs will be very much higher than the “agreed” estimate. Once started, a high profile project is often difficult to stop. So, when the true costs do become apparent, it is difficult for authorities to refuse the additional funding required to complete the project.