How can you know for sure that a specific project will be profitable? The answer is simple — accurately estimating project costs. By doing it, you’ll know your profit margins even before you start working on a project. If the margins are not there, you can focus on projects that do bring in profits.
Now, the important question becomes — how to make a project cost estimation. Before we get to answering that pending question, let’s first review some basics to ensure we’re all on the same page.
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FREE PROJECT COST ESTIMATION TEMPLATE
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 are all costs directly associated with the project and its completion. They encompass different types of expenditures, such as:
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 refer to the costs that are not directly associated with the particular project but that the company has to cover to operate and maintain its business. By indirect costs, we mean:
Making a project cost estimation means determining the total amount of required resources to finish a project within a specified time frame. There are various types of resources in the cost estimating process, such as:
The cost estimation process takes into account all the previously mentioned resources (and more, if the project requires it.), and it’s designed to evaluate the costs connected to each and add those costs up to create the final cost estimate. The project cost estimate can be used to determine the project budget and to evaluate whether a specific project will be profitable. Project cost estimating can also help companies decide if they should take on a particular project or not.
If and when a company decides to start working on a project and move it from the initial to the project planning phase, a project cost estimation can be used to define the project's scope.
Cost estimations are also a vital part of the project monitoring and controlling phases in project management. They can be used to help control budgets, manage resources (and the costs associated with them), and ensure the project execution phase goes as smoothly as possible.
Project cost management encompasses the entire process of planning resources, estimating costs and costs budgets, and controlling costs. The main purpose of project cost management is to ensure that the expenditures (i.e. costs) don’t go over the pre-approved budget.
The 4 main steps of project cost management are:
This includes analyzing the scope and determining all the required resources necessary to finish the project, such as:
A project resource is anything that can be used to move the project forward and aid in its completion.
You can determine all the resources you’ll need for a project by asking yourself the following questions:
The second step is when you actually estimate the costs of the resources you identified you need in the first phase. There are different ways to do this, and below, we’ve included the 6 most popular.
Budgeting costs in project cost management can be viewed in two ways — as a part of the project cost estimation or as part of the larger budget estimation. No matter how you choose to look at it, it will always be the same — a process to determine the sum of all the costs for all of the resources needed to complete a project.
It’s also important to note that the cost budget and the project schedule are deeply intertwined. The longer a project takes to complete, the more money it will cost. That’s why, to keep the original project deadlines, it’s important to track the time of individual tasks and how long it takes to reach certain milestones. Both of those metrics will help the project stay on track and follow original deadlines.
Cost and resource control means tracking and recording them through various project phases (from initial to closing). By keeping a close eye on the costs and resources, you can take decisive action more easily and make adjustments when necessary.
For example, by using time-tracking software, you’ll know exactly how long it takes to complete each task.
In the case of an unexpected event where some of the project’s resources become unavailable (let’s say one of the people working on the project gets sick), you can use that data to distribute certain tasks (based on how long they take to complete and their difficulty) to available resources (i.e., people that are not sick). And, by distributing tasks, you’ll ensure there are no additional costs to your project (e.g., costs of hiring someone new).
The key aspects of controlling project costs include:
Sticking to the project schedules and carefully managing time
There are many different techniques for creating a project cost estimate. Some of the most common ones include:
Analogous cost estimating hinges on historical data from past projects or expert opinion to evaluate project costs (for a new project). This method for cost estimating is not particularly accurate and is mostly used to get a “ballpark” figure of how much a project would cost. Analogous cost estimating is largely used in the initial phases of the project (when all the details are not known) to determine whether or not a specific project is going to be profitable.
Similarly to the analogous method, parametric cost estimating also uses historical data to estimate project cost. But, unlike analogous estimating, this technique uses statistics to evaluate the relation between historical data and various other variables (e.g. time, difficulty, effort…). The main assumption behind this method is that each project has specific parameters that predictably relate to each other.
This technique considers every single part of a project to determine the final project cost. It looks at each task (required to finish a project) and estimates the costs based on:
After that, the costs for each task are added together to create the final project cost estimate. The bottom-up cost estimating is generally viewed as one of the most accurate methods to estimate project costs.
This cost estimating method creates a rough estimate of how much a project might cost. It takes into account the entire project (scope, length, difficulty) and uses that “bird eye view” to generate an estimate.
Top-down cost estimation relies on either historical data or the professional expertise of the person creating it. It's a preferred method for project managers, executives, and stakeholders who have knowledge about the “big picture” but don’t want to get bogged down in the details.
Three-point cost estimating, just as the name suggests, relies on three different numbers (or estimates) to create the final project cost estimate:
The final cost estimate (E) is an average of all three above-mentioned estimates, that can be calculated with the following formula:
E = ( O + 4M + P) / 6
This method is probably the most detailed and accurate way to create a project cost estimate. It’s usually done when the project scope is determined and all the elements of a project are clearly well-known. Elements such as:
The definite cost estimating process is usually the final step before finalizing budgets or getting approval for funding and creating a baseline to measure the project’s overall performance (based on costs).
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FREE PROJECT COST ESTIMATION TEMPLATE
A study done by Francis Hartman, a professor at the University of Calgary, Canada, that delved into transport infrastructure projects showed that, on average, the actual costs of the projects analyzed by the researcher were 28% higher than their estimated costs. He hypothesizes that this is due to:
This illustrates that it’s relatively common for companies to undercalculate the time and resources needed to finish a project (i.e., project costs), which can lead businesses into taking on projects that end up not being as profitable as estimated and lose money.
That’s why the project cost estimating process is considered the foundation of any successful business enterprise.
