Estimate Project Costs and Budget

It’s that time of the year again. Your company has a new potential project in the works, and your sales team is working hard on negotiating with a client. But before the client signs the contract, they want to know how much it’s going to cost them. That’s where project estimates come into play.

Project estimates are the basis of every new project and client agreement. They are important for your business, too, because they can tell you early on whether the project will be profitable or not. 

So, what are the steps to making a project estimate, and how do you get better at it? Keep reading to find out.

Estimate Project Costs and Budget
In this guide, you’ll learn:
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what are project estimates, project costs and project budget

What Are Project Estimates?

Estimating costs or creating project cost estimates is a crucial project management step. With project estimates, you can predict and quantify the resources (financial, human, physical) and the time required to complete a project successfully.

Project estimates consider all possible project expenses and use that data to calculate and determine the budget.

Sometimes, you’ll have clients who operate on a fixed budget and will offer you a specific amount to complete a project. In this case, the role of project estimates is to try and work out the project profitability and answer the following question: Will working under the constraints of the client’s budget leave enough room for you/your company to make a profit? 

Estimates are also a crucial component of the execution phase. They give team leads an overview of the estimated and actual costs, which can help ensure a project stays within the financial scope of the initial budget and calculate project costing.

What Are Project Costs?

Project costs are the overall financial costs incurred by a company to complete a project. There are two main types of project costs:

Direct Costs

Direct costs are all costs directly associated with the project and its completion. They encompass different types of expenditures, such as:

  • Anyone directly working on the project – This includes the company’s employees or, in the case of outsourcing, contractors and freelancers hired to complete specific tasks.
  • Equipment – Any tools or software used by the people working on the project.
  • Power – The electricity consumed while working on the project.
  • Fuel/transportation – Any costs related to transportation that your company has to pay and are directly associated with the project (e.g., staff transportation to and from work, additional project travel expenses, and such).

This, of course, is not an exhaustive list of direct costs. These costs will depend on the type of project you are working on and the exact nature of your business. 

Indirect Costs

Indirect costs refer to the costs that are not directly associated with the particular project. Instead, the company has to cover these costs to operate and maintain its business. By indirect costs, we mean:

  • Rent for office space
  • Different utilities 
  • Usual office equipment 
  • Employees’ salary

What Is a Project Budget?

A project budget is the sum of money devoted to successfully completing a project. The budget can be based on project cost estimates set by the client or the company working on the project. There’s usually a deadline or a specific time frame for spending the money. 

The main difference between a project budget and a project cost estimate is that the latter represents the approximate costs the company might spend to finish a project, while the former stands for the maximum amount of money a company is allowed to spend on a project. 

The project estimates are basic guidelines with some leeway, while the project budget offers strict directions and allows for no slack (at least in theory).

6 Steps to Make Precise Project Cost Estimates

Let’s take a look at the five key steps to making precise project cost estimates.

6 steps to make precise project costs estimates

Step 1: List All Tasks and Resource Requirements 

The first step to ensure your project cost estimate is as accurate as possible is to break down the entire project into smaller tasks from start to completion and assign a cost to each task separately. 

For example, let’s say that your project is developing an app. The tasks required to finish the app could include:

  1. Research and brainstorming 📋
  2. App design 🖌️
  3. Engineering/Front and back-end development ⚙️ 
  4. Copywriting ✍️
  5. Testing and bug fixing 🛠️
  6. Launching the app 🚀

Now, obviously, the project you’re working on won't include these exact tasks and might not be that simple to break down, but the main idea is still the same. Instead of making one big estimate for the entire project, you can make a number of small ones for each task. 

When you break down a project into individual tasks, you can get a clearer picture of how much each task takes to complete and add those numbers when creating your final estimate.

Another benefit of breaking down a project into tasks comes into play when you assign tasks to your team members (Step 6). This allows you to monitor their workload and the progress on individual tasks more efficiently and ensure everything is on track (i.e., your team members are doing what they’re supposed to do).

Bonus tip: Try to include things such as meetings, sending emails, and overall client management in your estimate. They might not always move the project forward, but they still take time to complete and are a necessary part of every project.

After you’ve done that, try and figure out all the resources you’ll need to finish the project (e.g., tools, software, and such). Whether you have all the right tools and equipment needed for the project or don't can affect the project estimate in a couple of different ways:

  • If you don’t have the equipment, you’ll need to purchase it.
  • If you have the equipment, but it’s not presently available, you might need to tweak your project timeline and book the equipment for the days or period of time you’ll need it.

Step 2: Check Team Availability 

In this step, you need to identify the team members with the right skills for the project you’ll be working on and find out whether they have free slots to do the work

To do this successfully, your best bet is to employ a capacity planning strategy. This method helps you pair up free employees with adequate skill sets with the particular tasks within a larger project. 

Capacity planning allows managers to calculate the absolute maximum number of work hours their team is able to put into the project within a specified time frame. It shows whether: 

  • You have enough people for the project.
  • People on your team have the right skill sets for the project.
  • People on your team have available free hours to work on the project.
  • You need to hire contractors/freelancers to fill certain gaps.
  • You need to cancel or delay the project until you can increase capacity. 

The most commonly used capacity planning strategies are:

Lag Strategy

The lag strategy relies on procuring enough resources to fulfill the actual demand, as opposed to acquiring resources based on demand estimates. This is a strategy utilized mainly by smaller firms with smaller workforces and with the goal of operating at 90-100% capacity. 

Lead Strategy

The lead strategy is considered by many a bellicose approach to capacity planning. Its goal is to accumulate enough resources to fulfill potential estimated demand. The way to achieve this is by making an upfront expenditure to increase capacity. This is a strategy deployed by companies experiencing or anticipating large growth. 

Match Strategy 

The match strategy depends on both actual and estimated demand when resolving capacity issues. It’s the mixture of both the previous two strategies, where you neither wait to expend all your capacity resources to invest in capacity nor invest too much in anticipation of future growth. It considers actual real-time demand and uses it to enact small incremental changes to capacity.

Step 3: Estimate Task Duration

“Time is money,” as Benjamin Franklin so eloquently put it. Before you can start calculating costs, you need to first determine the time it will take to finish individual tasks.

When estimating the duration of individual tasks, team leads tend to underestimate the amount of time their teams would need to complete them successfully. 

This usually happens because managers either blindly rely on past experiences or have a strong desire to prove themselves to company higher-ups. They tend to push the needle towards: “My team can handle anything,” even though, realistically, that's not always the case. When they do this, they run the risk of overworking their team, causing burnout.

A more successful and healthier approach to estimating task duration is using the data from the time-tracking tools and methods your company employs. Tools, such as:

  • Mechanical time clocks and punch cards.
  • Biometric time clocks that rely on biometric data (fingerprints, retinal scans, and such).
  • Time clock desktop and mobile apps installed on the company's devices that employees use to clock in and out. 
  • Swipe cards.
  • Employee timesheets and various spreadsheets. 
  • Regular pen and paper.
  • Time tracking software.

Out of the above-mentioned tools, the most precise one by far is time-tracking software. It’s one of the easiest ways to track time and will provide you with the most accurate time frame for completing individual tasks. 

Using time tracking software for estimating task duration relies on one simple thing – the longer you track the time of your team and the more data about the duration of different types of tasks you collect, the easier it will be to estimate costs for future projects. 

This will allow you to get the real picture of both the task and the project’s duration, as you can track in real-time the difference between estimated and actual time. With that information, you can adjust the task duration estimate as the project keeps moving forward.

Step 4: Use Your Experience and Data

Next is to use all your historical data and records about past projects to create a more accurate project cost estimate.

The data you should be focusing on is:

  • The overall duration of past projects
  • The duration of individual tasks within past projects
  • Costs incurred on past projects
  • Costs incurred for individual tasks within past projects

In case you haven’t been using time-tracking tools until now or don’t have records of past projects (e.g., this is your first), you have to rely on your experience and that of your team.

Communicate with them and try to discern the necessary information you’ll need to create the most accurate educated guess together. Don’t worry if you make mistakes on your first try, instead, try to learn from them and move forward. 

Next, you need to combine your historical information (past data), experience, and estimates with the project costing method you wish to employ. Popular methods for estimating costs include:

Analogous Estimating 

Analogous estimating relies on historical data from previous similar projects or professional experience as a means to help you determine project costing. It’s looked at as a “rough” estimate, primarily used when all the minutiae of a specific project are not well known. 

For example, let’s say a client wants to outsource the development of a fitness app to your company. If you’ve already worked on developing similar apps, all you have to do to create an analogous estimate is look at the budget from a previous project/app and use it as your new estimate. 

There are some obvious problems with this approach, as the analogous estimate presupposes that:

  • You’ve collected all the necessary historical data (such as the observed cost, the length of the project, the duration of individual tasks, and the expended resources) to make an estimate.
  • There are no discernable differences between the new project and past projects.

Although not entirely accurate, analogous estimates are a great way to determine a ballpark figure of how much a project might cost. And, they can be made pretty quickly.

Bottom-Up Estimating

Bottom-up estimating takes into account the time, cost, and difficulty of the required work for each individual task within the project. 

This method can give you a truly accurate estimate and is especially good if you are working on a tight budget. The best way to utilize bottom-up estimating is to use a Work Breakdown Structure or WBS. 

WBS will help you break down projects into different phases, categories, and tasks, estimate costs for everything separately and then add those costs up to get the final project cost estimate.

The main value of this type of estimating is that it’s one of the most accurate ones and allows for detailed tracking of a project’s progress and cost against the original cost estimate.

Three-Point Estimating

Three-point estimating incorporates three different figures to give you a more accurate and easily amenable estimate. This estimate relies on either past data or the experience of a person making an estimate/educated guessing.

The three-point estimate incorporates the following three figures:

  • Best-case scenario or optimistic estimate
  • Worst-case or pessimistic estimate
  • Most likely estimate

The easiest way to implement this method is to break down the project into smaller tasks and determine the work hours needed for each scenario. For example, you’ve done some work with your team and established the following length for a specific “unnamed” task: 

  • Best-case scenario or optimistic estimate: 10 hours
  • Worst-case or pessimistic estimate: 17 hours
  • Most likely estimate: 14.5 hours

Once you’ve done that, there are 2 formulas that you could apply to the above numbers to get your final three-point estimate:

1. Triangular distribution formula

Optimistic estimate (O) = 10 

Pessimistic estimate (P) = 17 

Most likely estimate (M) = 14.5 

If E is the final estimate; E = (O + P + M) / 3; which in this case looks something like this:

E = (10 + 17 + 14.5)/3 = 13.8 

2. Beta distribution (PERT) formula

Beta distribution puts a heavier emphasis on the most likely estimate (M) while giving you an overall, more accurate estimate than the previous formula. 

If E is the final estimate; E = ( O + 4M + P) / 6; with the numbers above it would be:

E = (10 + 58 + 17) / 6 = 14.16

Once you’ve accounted for time, consider the following to calculate the cost of each task:

  • The salary/wage of the employee(s) working on that task.
  • Or, when using the services of freelancers/contractors, their hourly rate.

Top-down Estimating

Top-down estimating is similar to analogous estimating in the sense that it also produces a ballpark estimate. But, whereas analogous focuses on adding up the duration of single tasks to get an estimate, top-down is all about looking at the project as a whole (its possible scope and length) and estimating from there.

This type of estimate can be created using historical data or by relying on the work experience of the person making the estimate. It’s mostly used by managers, stakeholders, or people familiar with what a larger scope of the project entails.

Step 5: Create the Schedule and Send It for Approval

Now it’s time to use the information you’ve gathered from performing Steps 3 and 4 to finalize the dates and create fixed deadlines for tasks. 

You could also perform one final check to ensure everything and everyone you need for the project is in fact available, in case your company is working on multiple projects before you send in your schedule to the potential client.   

After that, all there is left to do is send it in and wait for your clients to approve your estimated schedule

Step 6: Keep Track of the Project Budget and Assess the Team

So, you’ve created an initial project estimate, got the schedule approved by your clients, assigned tasks to your team, and got the project underway.

However, project cost estimates don’t stop once the project has started, in fact, some would argue they’re even more important while the project is in its execution phase. Why? They help managers keep track of expenses and monitor the gap between estimated and actual costs.

Tracking the latter is a good way to improve the accuracy of future estimates, as it allows team leads to learn from it and assess different aspects involved in completing a project and leading a team. Aspects such as:

  • The duration of individual tasks
  • How long it took each team member to complete a single task
  • How long it took to progress through different phases of a project
  • The quality of a team member’s deliverables, i.e., their skill levels.  

The Importance of Estimating Project Costs and Budget

A study done by Francis Hartman, a professor at the University of Calgary, Canada, delved into transport infrastructure projects and showed that, on average, actual costs were 28% higher than estimated costs. He hypothesizes that this is due to:

  • A lack of historical data from previous projects (job performance data, duration of the project, difficulty of the project, and such).
  • The desire to get the contract from the client at any cost.
  • Internal pressures (in infrastructure projects these are usually political or from constituents, but can be also business related).

Because of the above, and more, it’s relatively common for companies to undercalculate the time and resources needed to finish a project. This can lead businesses to take on projects that end up not being as profitable as they have estimated and, thus, lose money. 

That’s why accurate project estimates are important and considered the foundation of any successful business enterprise. The most common benefits of project estimates include:

The importance of estimating project costs and budget

Better Organization

With quality project estimates, you can predict what tasks you need to complete within a given time period. You’ll know what resources you’ll require to finish the project, keep up with deadlines, and send in deliverables on time.

When you’re able to accurately predict the tasks and resources required to complete your project, you’ll be able to efficiently produce a work breakdown schedule, assign work to staff, and adhere to projected timelines.

Increased Profits

Every project is prone to unfavorable circumstances and obstacles, such as inflation, supply chain difficulties, employees getting sick, and more, which can increase project costs. All of them are substantial risk factors and can lead to exceeding the original budget or failing to reach profitability targets.

Accurate project estimates take both expected and unforeseen factors into account with the aim of helping you secure your profit margins. 

Better Managing of Resources 

Project estimates will give you a deeper insight into project tasks and the timelines in which you need to complete them. With that, you can plan and allocate all the resources needed for finishing specific tasks. You can also ensure that the employees you want working on the project possess the required skills to satisfy specific project needs and have enough free time on their schedule to do it. 

Another benefit of project estimates is that they can help you identify gaps in resources or capacity, which you can later fill with contractors/freelancers or other forms of outside help. 

Better Relation With Clients

All clients value transparency. No one wants to pay good money without knowing what they will get in return.

When clients are presented with project cost estimates, they can get the full picture and understand why certain things cost a specific amount of money.

If you’re honest and transparent upfront, clients will have more confidence in your professional experience and will be more likely to accept potential changes in the final cost estimate as the project progresses. This can help build trust and result in a better client relationship overall. 

Get Ready for Repeat Clients

When all of your projects are delivered within specified deadlines, and within the allocated budget, your customers are going to be pleased. It’s as simple as that. Happy customers lead to referrals or repeat business. This is the true value behind project estimates!