Accurately estimating project costs is crucial to the success (and completion) of a project. Yet, cost estimation and budget management are two of the most difficult challenges for project managers today.
In 2016, only 53% of projects were completed within their original budget, according to PMI. And these missed budgets and failed projects accounted for as much as $122 million dollars wasted for every $1 billion invested.
That’s a lot of moolah.
This year, make every dollar count by conducting clear and accurate project cost estimations.
What is project cost estimation?
Project cost estimations forecast the resources and financial investment needed to execute a project successfully. The goal of estimation is to identify all the costs associated with the project in order to create an accurate budget and timeline.
The better the estimation, the better you will be able to map out your project.
A project estimation typically includes a breakdown of the tasks, resources, billing rates, and schedule for a project. The costs associated with each element are tallied to create a comprehensive estimate for the entire project.
A project cost estimation helps project managers and clients:
- Gauge whether the project is financially feasible.
- Create a clear project roadmap with accurate timelines.
- Define the approach to the project based on budget and resources.
Cost estimations occur before the project is started (though they may be updated multiple times before and during a project). While they aren’t a guarantee of the final price tag, estimates give clients a range to help them approve a budget and secure the necessary funding to start the project.
The challenge to any project cost estimation is to strike the balance between over- and underestimating. Because project managers have a responsibility to deliver projects on time and on budget, it can be tempting to play it safe and overestimate the costs of the project. That way, you are more likely to come in under budget and exceed expectations.
However, overestimating can cost your team the project entirely or delay its launch if the price tag is too high. On the other hand, come in too low and you risk blowing the budget and managing a frustrated client down the road.
So how can project managers find the sweet spot?
There are several types of cost estimates in project management as well as cost estimation tools and methods to help managers forecast accurately.
Types of costs to consider
When beginning an estimation, there are two types of costs to consider in any project: direct costs and indirect costs.
Direct costs
Direct costs are pretty straightforward. They include any costs or resources needed that are directly related to the project. These costs can include labor, materials and equipment, and even travel costs.
Labor: Salaries and wages for team members and contractors working on the project.
Materials: Any supplies or equipment needed to produce the deliverables or execute the project objectives.
Travel: Any travel costs (e.g., gas, airline tickets, hotel stays) you incur to complete the project. For example, if you need to travel to a remote work site or conduct research at different locations, you should include these expenses as part of your cost estimation.
Indirect costs
Indirect costs break down into any resources that aren’t directly allocated to the project but are necessary to its success.
These costs typically fall under overhead and administrative costs. These can include management salaries, legal and accounting services, rent for the office space, and general equipment or supplies that furnish the business as a whole.
Project cost estimation methods
There are several cost estimation techniques in project management. Consider these four methods on how to estimate project cost.
Analogous
Another project cost estimation example is analogous (or top-down) estimating. This method makes cost projections based on historical costs for similar projects. In other words, if your team or organization repeats similar projects (such as specific equipment repairs or other regular initiatives), you can compare those past projects and their associated costs to your current project specs.
This method is most effective for projects that have a high degree of similarity in deliverables, scope, and context. The more variations or complexity between projects, the more difficult it will be to make accurate estimations.
Analytic
An analytic estimate (also called bottom-up estimating) is one of the most accurate cost estimation techniques—but it can also be time-intensive.
Bottom-up estimating breaks the project down into smaller parts and then creates cost estimates for those variables. This involves analyzing both what resources need to be purchased and what specific tasks need to be completed, then enlisting subject-matter experts to estimate costs for each item and task.
To do this, bottom-up estimating typically uses a work breakdown structure (WBS) to outline and subdivide a project into smaller parts called work packages.
Parametric
Parametric estimating is a highly accurate cost estimating method for projects with a high degree of repeatability. Cost estimators break the project into units of work, estimate the cost per unit, and then add the unit costs together.
This method works best for skill-based projects with concrete, repeatable tasks or units of work. In contrast, creative projects are harder to estimate using this technique because the units of work are often less comparable or repeatable by nature.
Three-point estimation
Three-point estimation evaluates three levels of estimation based on uncertainty and risk in a given project. You can apply this method to an entire project or to its component parts in a WBS. This method results in three projected project costs:
- Optimistic costs
- Pessimistic costs
- Most likely costs
To conduct a three-point estimation, the project manager will break down the project into tasks or activities and then work with their team to identify potential risks to project three cost estimates. A PERT chart can help you determine the relationships between tasks and any dependencies that might affect the time and cost spent on the project.
The value in a three-point estimate is greater accuracy in cost projection and better risk management. By accounting for the risks (such as scheduling delays and other roadblocks), project managers can avoid significantly over-estimating project costs.
Characteristics of a good cost estimate
So how can determine if your estimate is good? There are several factors for evaluating the quality of a given estimate.
But the bottom line is an estimate should be accurate, reliable, and well-documented.
To ensure your cost estimates meet these top criteria, choose estimation techniques that best fit your project specifications. You may even conduct two or more types of estimates to compare projections.
Additionally, make sure all estimates are carefully documented. This information will help keep stakeholders on the same page from the beginning and serve as a valuable reference point should you need to adjust cost estimates mid-project or estimate costs reliably for similar projects in the future.
Estimating costs can be a daunting project in itself. Lucidchart can help you get started. Lucidchart’s robust diagramming platform helps project managers plan and execute projects with ease.
Use Lucidchart to create clear work breakdown structures, PERT charts, and Gantt charts to outline project deliverables, estimate deadlines, and identify how many team members you need to enlist.
Lucidchart’s library of templates makes it easy to fill in project information. You can even give access to other team members to collaborate on project documents and share your progress with stakeholders in real time. With careful planning and reliable cost estimation tools, you can estimate costs with confidence.
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