What Are Cost Estimation and Budgeting?

What Are Cost Estimation and Budgeting?

Generating an accurate estimate is one of the crucial aspects of job management, leading to successful project execution. Not only do estimates help you win new business, but they also determine the project budget, manage resources, focus on schedule, and ultimately deal with invoicing.

Unfortunately, companies often underestimate what's necessary to complete the job. That's when you miss deadlines, spend more money than planned, or overwork your staff—working on a budget that ensures minimal costs while boosting the project's quality and scope can be challenging.

So, let's take a closer look at cost estimation and budgeting and see how these affect the project's outcome.

Cost Estimation and Budgeting in Project Management

The project can only succeed if you have the necessary people and materials, which cost money. In project management, cost estimation is defined as the process that calculates the total expenditure of the project.

The accuracy of the cost estimate will mostly depend on the details and accuracy of the project scope, which is essentially the scope baseline. The scope is essential for various reasons as it defines constraints like budget, resources, and date.

To further simplify this, the cost estimate indicates how much the project is likely to cost, while the purpose of this process is to complete the job within the project scope. Using software such as ActiveCollab can help track your projects and enables you to gather data automatically as you finish work. This is a great tool with a diverse range of features, which helps customers track profitability and time, estimates costs and budgeting, and makes invoicing a piece of cake.

How To Do Cost Estimation in Project Management?

A few easy techniques can help you perform cost estimation. However, for any of these techniques to work, it's necessary to have up-to-date data about previous projects along with the requirements at hand. Using software like ActiveCollab to bring all this data together facilitates your job significantly.

Bottom-up estimation. This is the most accurate estimating technique, and you start by dividing project deliverables into work packages. Each package contains a specific number of tasks. The project team will calculate the cost of each task and then add up all task costs to have the final estimate for the entire project.

Top-down estimation. Historical costing or top-down estimate focuses more on historical project data to create estimates for a new project. If a company works on similar projects repeatedly, it's easy to draw a parallel between associated costs and deliverables.

Parametric estimation. To apply this technique, you need to break down the project into work units and calculate the cost per unit. To estimate the overall cost, multiply the cost per unit by the total cost.

Three-point estimation. Using different formulas, it calculates cost from three perspectives, optimistic, pessimistic, and most probable.

Time and Cost Estimation in Project Management

Know your team's job responsibilities and skills. Most of the time, the project focuses only on numbers while neglecting people. Successful project estimation techniques are built on strong working relationships. The more you know how your team members work, the easier it is to evaluate their work.

Know how the PM process works. Once you know who does what and how, it's time to move to the next stage in your project estimation: understanding how work is done in your company or an organization. For example, many companies focus on methods like waterfall or agile. It's your responsibility to study either of these processes, understand all your dependencies, and run with your estimates.

Review the latest trends and estimation techniques. Regardless of your job position, things will change. And, if you choose to build your project management career, you always have to stay on top of deliverables, changes, and trends in your industry. While this can be challenging, it directly impacts your success as a project manager.

Use historical data to your advantage. Project managers can analyze historical data to create better estimates.

Set up a questionnaire to improve cost estimation. When dealing with RFP or requesting a proposal, you should have every little detail to generate a realistic and accurate estimate.

Example of Cost Estimation and Budgeting in Project Management

Even though it relies on different techniques, cost estimation is pretty straightforward. Here's an example.

  • The profitability overview and budget can be seen in the Project info in ActiveCollab
  • Budget: the total amount you have charged or are planning to charge to your client
  • Spent: The spent amount while working on a project
  • Spent=[(Billable hours*Job type hourly rate)+Billable expenses]
  • The ratio between the Budget and the Spent amount will be expressed in percentages, right next to the Budget
  • Cost: Your project's internal costs (For example, your employee's wage)
  • Cost=[(All tracked hours*Employee's internal hourly rate)+Non-Billable expenses]

ActiveCollab allows you to set internal hourly rates for each user (except for Client and Client+ roles) to keep track of all your projects' costs in detail. There are various ways and tools to keep track of employee hours.

What Is Project Budgeting?

Many people use budgeting and cost estimates interchangeably, but note that these two are different and should not be used in the same context.

The project budget is created from the schedule and cost estimates; therefore, you work on the cost estimate and then move to the budget. Now, to further identify this term: the budget represents an overview of the project's total cost from a periodic and total perspective.

The budget must be within funding limits to ensure enough money is pushed toward the project. It determines the total amount of money channeled into the project.

What Is the Purpose of Budgeting?

There are four purposes of budgeting:

  • Plan: the budget is your game plan for the exact amount of money you expect to receive.
  • Track expenditure: monitoring your costs and bills that need to be paid means making your budget work.
  • Manage money needs: budget is the tool you use to manage money. At the same time, it helps you accomplish the financial goals of your organization.
  • Improve: we all want different things for our companies, paid off debt, better working conditions, more clients, and successful projects, but when everything is planned carefully, your budget can help you do all these things.

Importance of Cost Estimation in Project Management

Cost estimates provide the foundation for planning and determining whether the project can meet its objectives.

  • More precise planning: accurately predicting resources and tasks is necessary to complete your work. This further helps you follow the project timeline, assign tasks and projects to your staff, and break down the schedule.
  • Better profit margins: inflation, poorly scoped work, or unexpected events can cause costs to increase throughout the project's lifecycle. That's why an accurate estimate protects your profit margins.
  • Improved resource management: once you have a better insight into timelines and tasks necessary to complete work, you can ensure your team members possess the right skills needed to complete each deliverable.
  • Strong client relationship: your client needs to understand the "why" behind every project's cost. When that happens, they are more likely to trust your estimate and expect changes as the project progresses, helping you create a better working relationship.
  • Great reputation and more work: when you deliver projects within budget and on time, you create an array of happy customers who trust your services and are ready to work with you again.

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