Framework: An Integrated Approach to Portfolio, Program and Project
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III. PROJECT CONTROL PROCESS - CHAPTER 7 - PROJECT CONTROL PLANNING
7.3 Cost Estimating and Budgeting
Cost estimating is the predictive process used to quantify, cost, and price the resources required by the scope of an investment option, activity, or project. Budgeting is a sub-process within estimating used for allocating the estimated cost of resources into cost accounts (i.e., the budget) against which cost performance will be measured and assessed.
Cost estimating is a process used to predict uncertain future costs. In that regard, a goal of cost estimating is to minimize the uncertainty of the estimate given the level and quality of scope definition. The outcome of cost estimating ideally includes both an expected cost and a probabilistic cost distribution. As a predictive process, historical reference cost data (where applicable) improve the reliability of cost estimating. Cost estimating, by providing the basis for budgets, also shares a goal with cost control of maximizing the probability of the actual cost outcome being the same as predicted.
The cost estimating process is generally applied during each phase of the asset or project life cycle as the asset or project scope is defined, modified, and refined. As the level of scope definition increases, the estimating methods used become more definitive and produce estimates with increasingly narrow probabilistic cost distributions. The specific estimating tools and techniques used vary widely depending upon the life cycle phase, the type of asset or project, and the level of definition of scope information available. The analysis, development, and maintenance of estimating tools and techniques are steps that are considered part of the estimating process.
The cost estimating process is typically performed concurrent to or iteratively with the asset and project planning and evaluation processes described in Chapters 3 and elsewhere in Chapter 7. Because costs are often dependent on time duration, while resource requirements identified in cost estimating may affect the schedule, the estimation of the time duration of activities (see Section 7.2) must be considered concurrently with costs. Iterative approaches are used because outcomes of a cost estimate often lead to changes in scope or plans. In fact, the estimating process can be viewed as part of the scope definition process because iterative trading off between cost and scope intertwine the processes.
While some steps of the cost estimating process are mechanistic and conducive to semi-automation (e.g., determinations of quantities by computer-aided design tools, and so on), estimating is a predictive process for which judgment and experience add value. Effective cost estimating requires an understanding of the work being planned. In some industries, such as engineering and construction, cost estimating is a recognized discipline because of the specialized knowledge required. In all industries, many individuals contribute to the performance of the estimating process.
.1 Classification of Cost Estimates
Given the goals of reducing uncertainty in the estimating process and improving communication of estimate results, it is desirable to establish standard estimate classifications for the enterprise. The classification system will define the specific input information needed to produce a desired estimating outcome quality at each phase of the asset or project life cycle. Classification schemes help define the requirements for scope definition and they will indicate estimating methodologies appropriate to that scope definition (Recommend Practices 17R-97 and 18R-97 provide classification methods recommended by AACE International).
7.3.2 Process Map for Cost Estimating and Budgeting
Figure 7.3-1 illustrates the process map for cost estimating and budgeting. At its core, cost estimating involves the application of techniques that convert quantified technical and programmatic information about an asset or project into finance and resource information. The outputs of estimating are used primarily as inputs for business planning, cost analysis, and decisions or for project cost and schedule control processes The process is supported by tools and data that are created and maintained to support the various types of estimates that need to be prepared during the life cycle of the asset or project. The process is illustrated without recycle loops, but in actual practice, findings in any step or at review may require that all or part of the estimate be recycled through any of the preceding steps of the process.
Figure 7.3-1 Process Map for Cost
Estimating and Budgeting
The following sections briefly describe the steps in the cost estimating and budgeting process.
.1 Plan for Cost Estimating and Budgeting
Initial planning for this process should be integrated with planning for all the other project control planning processes (Sections 7.1, 7.2, 7.3, 7.4, 7.5, 7.6, and 7.7). Project control planning is typically a phased process during which the project implementation process (see Section 4.1) is revisited to obtain incremental authorization and funding at the completion of each phase. Plans for the process must consider the time, costs, resources, tools, and methods for its performance during each phase. Roles and responsibilities for each step and transitions between each phase should be planned as well.
At the start of any phase, the current documented scope basis and defining technical (including contractual) deliverables are the key inputs. Based on an assessment of these inputs, the project team further identifies activities, resources, and tools needed. The output of the planning step is documentation of the scope of the cost estimating and budgeting effort as appropriate to the project size and complexity.
In some cases, much, if not all, the cost estimating detail is undertaken by and is the responsibility of contractors. In those cases, the contractors schedule submittals are inputs to the owners process and must be planned in alignment with the execution strategy (Section 7.1) and procurement planning (Section 7.7).
.2 Quantify Scope Content (Take-off)
The scope definition of an investment or a project is generally described in various planning and technical documents, databases, or other deliverables. To cost and price the scope, information in the scope documents must first be quantified in terms or formats required by the estimating algorithms. For example, an algorithm that estimates the cost of developing software programs may require the number of lines of software code as an input. Likewise, a construction estimating algorithm may require the linear meters of pipe as an input. The output of quantification is referred to as a take-off when the quantities are derived or developed from a drawing.
.3 Cost the Scope Content
Costing includes a core technique of estimating, which is the translation of quantified technical and programmatic scope planning information into expressions of the resource and financial investment or expenditure required to effect the plan. The translation is done with a mathematical algorithm. Costing does not in itself consider business concerns of how work is to be charged, billed, marked up, or otherwise accounted for by various stakeholders (see pricing and budgeting). Life cycle costing is costing applied to the entire life cycle of the asset including creation or modification, operation or use, and decommissioning or retirement to support investment option development and decision making.
Algorithms and Cost Estimating Relationships
The costing step always uses an estimating algorithm or formula. The algorithm transforms project technical and programmatic descriptive information into cost and resource terms. Estimating algorithms are often referred to as cost estimating relationships (CERs). In its simplest form, a CER will appear as:
Cost Resource = Factor x Parameter
Cost Resource = $ (labor, material, total, etc.), or time (labor hours, equipment rental hours, etc.)
Factor = a unit cost factor in terms of cost resource/parameter unit
Parameter = quantification of a scope item
There are a wide variety of CER types. Some CERs are highly probabilistic in nature (i.e., the relationships tend to be highly uncertain). These types of CERs are often called parametric CERs. These tend to aggregate a broad chunk of scope and cost into relatively simple algorithms. For example, a parametric CER may estimate the total cost of a building as follows:
Total Building Cost = (Gross Floor Area) x (Cost Per Unit of Floor Area)
Given the wide variety of building types and construction methods, the CER above is unlikely to be an accurate predictor of the cost of most buildings. However, it does not follow that all parametric CERs are highly uncertain. In this example, if the building being estimated was of the same design as all of the buildings upon which the CER was derived, then the CER could be an accurate predictor.
Models are another type of algorithm that tends to be highly probabilistic in nature. Models are complex algorithms (usually a computer program) designed to replicate the performance of a process or system. Models that result in cost outputs are often called cost models. Cost models are particularly well suited for simulation and optimization uses. Models are also the primary costing algorithm used for asset planning (see Section 3.2).
Other CERs tend to be more certain in nature and are often called definitive, detail unit cost, or line-item CERs. These CER types tend to disaggregate scope and cost into more clearly defined pieces. For example, a detailed CER may estimate the cost of one item as follows:
Valve type A installation hours = (Number of valves of type A) x (Hours per valve of type A)
An overall detailed estimate then re-aggregates the results of a large number of these types of CERs, and taken together, the overall estimate is likely to be an accurate predictor of the final cost. However, it does not follow that all estimates based on definitive CERs are highly certain. There may be uncertainties in scope definition, in quantification, in cost database quality, or in other areas that result in an inaccurate estimate. Keep in mind that the above examples are somewhat simplistic; CERs can be as complex and varied as mathematics allows.
As successive or phased estimates are prepared over the course of a projects life cycle, the mix of CERs used tends to progress from highly uncertain to highly certain in nature. However, most estimates will use a mix of CER types. In particular, most estimates use probabilistic methods for estimating contingency cost.
Factors and Mark-ups
Basic estimating algorithms are often adjusted by the application of factors to make the result match the current estimate situation. Factors, as drawn from project history or a standard database, almost always reflect conditions from past experience that do not match those in the current estimate situation. The conditions that may vary from the database basis include time differences, escalation and inflation, exchange rates, labor rates, labor productivity, jobsite conditions, material mark-ups, location factors, environmental impacts, and taxes, duties, and fees. Parameters or quantity measures used reflect preliminary models that do not precisely match actual technical or programmatic conditions. The conditions that may vary from the measurement basis include waste and spoilage allowance, accuracy of measurement (take-off) allowance, and specification, function, or content differences.
.4 Price the Cost Estimate
Pricing includes charging techniques that various stakeholders in the plan (bidders, contractors, etc.) apply to costs in the estimate to allow for overhead and profit, to improve cash flow, or to otherwise address market conditions and serve their business interests. It is important to distinguish between costs and prices. For example, contractors often unbalance a bid estimate by allocating costs to those items for which payment will be obtained early in a project; therefore, contract bid prices may not be a very useful reference source for developing a cost database. Activity-based costing (ABC) calls for minimizing arbitrary or unbalanced allocations so that optimum cost decisions or control may be obtained.
.5 Simulate and Optimize the Costs
The factors and parameters in an estimating algorithm may have a range of possible values that could occur, or that could be selected from within the scope. There may also be alternate algorithms that could be used for estimating. For estimating, simulation refers to methods that apply alternate factor and parameter combinations, or apply alternate algorithms so as to produce a distribution of possible outcomes. Optimization refers to methods that evaluate trade-offs between inputs, such as scope elements, so as to minimize or maximize the degree to which some set of objectives is met. Optimization commonly uses simulation or mathematical modeling techniques. Simulations and optimization is done concurrently with the costing and pricing steps as appropriate. These methods are useful for value analysis and engineering (see Section 7.5) to optimize scope decisions in terms of cost. They are also useful for evaluating cost risk (see Section 7.6).
.6 Budget Costs
Budgeting includes allocating the estimated cost of asset or project items into cost accounts against which cost performance will be measured and assessed. Budgeting results in a baseline for cost control performance assessment (see Sections 6.1 and 10.1). The cost accounts used from the chart of accounts must also support the cost accounting process (see Sections 5.1 and 9.1). Budgets are often time-phased in accordance with the schedule or to address budget and cash flow constraints.
.7 Analyze Cash Flow
To serve as a basis for earned value and other methods of cost control (see Section 7.1), the budget is time-phased to determine expected rates of cost incurrence and cash disbursement for each account or group of accounts including capital interest charges. As rates of investment are often constrained by the enterprise for financial reasons, the estimate and schedule are generally developed interactively to ensure that financial goals are achieved. The rate of investment may alternatively examine the rates of incurring cost (i.e., obligation made to expend) or actual cash disbursement.
.8 Bidding the Cost Estimate
For contractors, the end product of the estimating process may be submission of the bid or tender to another contractor or owner. A bid is a priced estimate (see Section 22.214.171.124). While the bid or tender is the final estimating task for the contractor, the bid is generally a cost input to the overall asset or project estimate (the dashed line in Figure 7.3-1).
.9 Review and Document the Estimate
Estimates are typically complex compilations of input from many stakeholders. To ensure the quality of an estimate (or budget or bid), a review process is called for. The review seeks to ensure that the estimate reflects the asset or project goals and scope, is suitable for cost accounting and control purposes, serves the stakeholders financial requirements, and that all parties agree on and understand its content and probabilistic nature. Prior to the review, the estimate basis is documented to support the review and, after the review, it is updated as needed to support subsequent change management processes. The estimate should be benchmarked or validated against or compared to historical experience and/or past estimates of the enterprise and of competitive enterprises to check its appropriateness, competitiveness, and to identify improvement opportunities. Validation should always be done even if the reviewer also prepared the estimate (although preference should be given to an independent third party). Validation examines the estimate from a different perspective and using different metrics than are used in estimate preparation. A review may require that all or part of the estimate be recycled through any of the preceding steps of the process.
.10 Develop and Maintain Methods and Tools
The cost estimating process usually uses a wide variety of algorithms, data, software, forms, and so on. As was mentioned, historical reference cost data, including lessons learned, improve the reliability of cost estimating because it is a predictive process. Therefore, a key determinate of estimate output quality is the quality of the databases used.
Cost Estimating Database Development
All estimating algorithms are dependent upon having data such as labor and material unit rates, indices and factors, equipment costs, and other resource rate and cost factor information. The type of data that is used in the algorithm to convert scope quantification input to cost output is specific to the algorithm and estimating methodology used. Data are also used to support the review and validation process. The data may be obtained from published sources or they may be developed in-house. Published sources must be analyzed to determine adjustments needed to make the data applicable to the enterprises situation (e.g., for location, culture, escalation, etc.).
Cost Estimating Algorithm Development
Estimating methods often require that custom algorithms be developed and maintained to support the estimating process. These algorithms are commonly based upon statistical analyses or modeling of historical or other cost information. The algorithms are needed to convert scope quantification input to appropriate cost output. For example, if early in design development, the only scope quantification available for a building is gross floor area, then an algorithm is needed to convert floor area into total cost; i.e., Total Building Cost = (Gross Floor Area) x (Cost Per Unit of Floor Area). Cost models are a form of algorithm.
7.3.3 Inputs to Cost Estimating and Budgeting
.1 Scope Definition. The investment option (see Section 3.2) or project scope (see Section 7.1) is defined, and information needed to support development of the estimate is provided. The information needed depends on the desired classification of the estimate at that phase (see Section 126.96.36.199).
.2 Technical Deliverables. The scope definition is supplemented with documents, databases, and other detailed technical information (including contract documents) to support quantification of the scope. These deliverables are the output of work processes (e.g., engineering, design, and so on) that interface closely with, but are outside of, the TCM process.
.3 Schedule Information. While schedules are usually developed concurrently with cost estimates, expected schedule durations, constraints, and other schedule data are inputs to various steps of the estimating process.
.4 Work Breakdown Structure (WBS). The WBS (see Section 7.1) provides the overall organization of project work to be estimated. The chart or code of accounts (188.8.131.52) provides the mechanism for coding the WBS.
.5 Chart or Code of Accounts. Coding structures that support the work breakdown development (Section 7.1) and cost accounting process (see Sections 5.1 and 9.1) are provided. Each stakeholder with cost accounting and cost control responsibilities may have his own chart of accounts; coordination may require that stakeholders map their accounts with each other so that cost information can be exchanged. Budgeting allocates estimated costs to the proper cost accounts. There may also be a separate chart or code of accounts for cataloging information in a cost estimating database; this chart may differ from that used for cost budgeting and accounting.
.6 Historical Cost Information. The development and maintenance of cost estimating tools and data are often, but not always, based on feedback of actual asset and project (see Sections 6.3 and 10.4) cost performance information.
.7 Estimate Information. Information from previous estimates for this asset or project (or from other assets or projects as applicable) supports the development and maintenance of cost estimating tools and databases. Examples include parameters (e.g., ratio of building exterior skin area to gross floor area), factors (e.g., freight cost as a percentage of material cost), and rates (e.g., labor cost per hour).
7.3.4 Outputs from Cost Estimating and Budgeting
.1 Cost Control Baseline. A tabulation of costs in accounts that are formatted for cost accounting and cost control purposes. For some control methods, the costs are time-phased by account or group of accounts. As cost performance measures are made, they are assessed against the cost baseline (see Sections 6.1 and 10.1).
.2 Resource Requirements. Quantities of resources such as labor, material, and equipment are outputs of the estimating quantification process and costing algorithms. The resource requirements are used as a basis for resource planning (see Section 7.4) and procurement (see Section 7.7).
.3 Cost Information for Analyses. Investment decision making (see Section 3.3), value analysis and engineering (see Section 7.5), risk analysis (see Section 7.6), and procurement planning (see Section 7.7) all require cost information from the estimating process as their input. Risk analysis is typically performed concurrently with estimating. Among other planning and decision-making uses, risk analysis yields contingency costs used in estimating.
.4 Estimate Basis. Because cost estimates are approximations based in varying degree upon assumptions and interpretations of scope, plans, and objectives, stakeholders often misunderstand what a cost estimate represents. Communicating the basis of an estimate reduces misunderstanding, error, and misuse. The estimate basis generally includes a description of the scope, methodologies, references, and defining deliverables used, assumptions and exclusions made, and some indication of the level of risk and uncertainty. In general, the estimate basis (and all estimate backup) becomes the one deliverable that defines the scope of the project. As such, the estimate basis is also the basis for change management (see Section 10.3). After review of the estimate basis (and all estimate backup) by the project stakeholders, project scope definition and other inputs may need to be revised to ensure that all objectives have been achieved (i.e., estimate definition leads to refined scope definition).
.5 Refined Scope Development. Results and lessons learned from the estimating process often lead to modifications and refinements in the requirements, scope description, implementation plans, and WBS (see Sections 3.2 and 7.1).
.6 Refined Plan and Schedule. Results and lessons learned from the estimating process often lead to modifications in asset or project work plans and schedules (see Sections 3.2 and 7.2). The estimate and schedule are generally developed concurrently or iteratively.
.7 Estimate Information. Information from the estimate supports the development and maintenance of cost estimating tools and databases. The information may include all estimate detail data and documentation, factors, rates, and other metrics derived from the estimate, or any other estimating lessons learned.
7.3.5 Key Concepts for Cost Estimating and Budgeting
The following concepts and terminology described in this and other chapters and sections are particularly important to understanding the cost estimating and budgeting process of total cost management:
.1 Activity Based Costing (ABC). (See Sections 3.2 and 5.1). Cost management and control is improved when all costs are attributed or budgeted to the item or activity causing or driving the expenditure rather than through arbitrary or non-causal allocations.
.2 Algorithm and Cost Estimating Relationship (CER). (See Section 184.108.40.206).
.3 Budgeting. (See Section 220.127.116.11).
.4 Chart or Code of Accounts. (See Section 18.104.22.168).
.5 Contingency. (See Section 7.6). Contingency is an amount added to an estimate to allow for unknown items, conditions, or events that experience shows will likely occur. Every project cost estimate should evaluate risk and uncertainty and include identifiable contingency costs in the estimate if needed.
.6 Cost Accounting. (See Sections 5.1 and 9.1). Accounting provides the measure of commitments and actual expenditures. The process, tools, and systems an enterprise uses to handle cost performance measurement information will often drive the chart or code of accounts and constrain how cost may be estimated and budgeted. Accounting also serves financial reporting purposes in addition to cost control purposes.
.7 Cost Control Baseline. (See Section 22.214.171.124).
.8 Costing and Life Cycle Costing. (See Section 126.96.36.199).
.9 Estimate Basis. (See Section 188.8.131.52).
.10 Pricing. (See Section 184.108.40.206).
.11 Scope. (See Sections 3.2 and 7.1). The scope is the sum of all the technical, programmatic, and other information that defines that which is to be estimated.
.12 Quantification and Take-off. (See Section 220.127.116.11).
.13 Uncertainty. (See Section 7.6 and 18.104.22.168). A cost estimate or budget is always an approximation. Therefore, understanding the probabilistic characteristics of the estimate is essential. Measures of uncertainty (range, confidence intervals, and so on) are often key determinates of estimate quality.
Further Readings and Sources
There are many texts and articles that describe cost estimating, budgeting, and related practices for various asset and project types in various industries. The following provide basic information and will lead to more detailed treatments.
AACE International. Cost Engineers Notebook. Morgantown, WV: AACE International (most recent revision.)
Adithan, M., and B.S. Pabla. Production Engineering, Estimating and Costing. Delhi: Konark Publishers, 1989.
Amos, Scott, J., Editor. Skills and Knowledge of Cost Engineering, 5th ed. Morgantown, WV: AACE International, 2004.
Gransberg, Douglas D., Editor. Professional Practice Guide (PPG) #6: Construction Cost Estimating. CD ROM. Morgantown, WV: AACE International, 2000.
Jones, Capers. Estimating Software Costs. New York: McGraw-Hill, 1998.
Leo, Douglas W., Larry R. Dysert, and Bruce Elliott, Editors. Professional Practice Guide (PPG) #13: Parametric and Conceptual Estimating. CD ROM. Morgantown, WV: AACE International, 2002.
Neil, James M. Construction Cost Estimating for Project Control. Englewood Cliffs, NJ: Prentice-Hall, Inc., 1981.
Ostwald, Phillip F. Cost Estimating for Engineering and Management. Englewood Cliffs, NJ: Prentice-Hall, Inc., 2000.
Stewart, Rodney D. Cost Estimating, 2nd ed. New York: John Wiley and Sons, 1991.
Westney, Richard E., Editor. The Engineers Cost Handbook. New York: Marcel Dekker, Inc., 1997.
Winchell, William. Realistic Cost Estimating for Manufacturing, 2nd ed. Dearborn, MI: Society of Manufacturing Engineers, 1989.
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