How to Estimate Project Costs: A Method for Cost Estimation

project finances are anybody's favorite topic unless you're a finance director at estimating is one of the greatest challenges anybody faces in a project environment because we are assailed by biases and in an environment of uncertainty but we're gonna tackle it anyway because in this video I'm going to look at how to estimate project costs [Music] before I start looking at how to make our estimates I want to highlight one of the real problems we face as project managers and leaders and that's what I call the estimating knife edge of the knife edge separates the two competing pressures we have to deal with whenever we're making estimates of cost or at lead of time on the one side of the knife edge is the pressure of the pull even from our clients or our bosses must sponsors are from our stake holders to minimize costs or indeed to minimize the duration of a project to get it done as quickly and as cheaply as we possibly can on the other side of the knife edge is the pull in the opposite direction to include as much cost as much contingency as much time as we possibly can to reduce the risk of cost or schedule overruns to give us as project managers the best possible chance of delivering what we've promised when we promised it and to the budget that we committed and you are always going to be walking along that knife edge trying to balance those two competing pulls the process of project cost estimation needs to start with understanding the scope of the work you need to do and the tool for that is a work breakdown structure once you have your work breakdown structure you can estimate the time it will take to deliver each component of work and from that you can allocate people into the roles to do the work and when you combine the time it will take with the cost of each of those resources that starts to build up a cost estimate for the work that it will take but there are other resources as well and for each piece of work you can also overlay and the materials and the equipment and the assets that you need to do that piece of work and to put in place cost estimates from those the fundamental tool for building a cost estimate is a work breakdown structure which you convert into a cost breakdown structure so what are likely to be the sources of cost that we need to build into our estimates well for many projects the single largest cost is people and these are your staff your contractors and your consultants each will come with a different methodology for calculating it and bear in mind that some organizations do not account for the cost of their own staff seeing them as a completely sunk cost as a project manager even if my client organization doesn't wish to account for the cost of its staff I always like to calculate it to give a true picture of how much the project is costing them next are real estate assets property facilities offices warehousing all of these costs are large and there are other assets besides property and in estimating these you may need to treat them as capital costs or you may be able to treat them as revenue costs if you're going to lease or hire them in some way then we've got non-capital costs revenue costs things like materials and components we've also got licenses because a large part of many projects now involves software which needs to be licensed whether it's the project management software tools or software that is part of the thing you're creating as a project and finally there are the financing costs things like interest foreign exchange and insurances so what are some of the techniques that you can use to estimate I'm going to offer you six basic estimating methods and the first is an order of magnitude estimate and the idea of starting at the top and thinking about the big chunks and the approximate amounts that each of those are going to cost to produce a figure that is very round if your project is going to be in the millions then each of these sections may only be estimated to hundreds of thousands if your project is going to be in the tens of thousands then each of these components may be estimated to the nearest thousand order of magnitude costs will give you a sense of how big your project is and therefore some of the key elements of how much detail you're going to need to satisfy your client your boss your sponsor the next method is to look at past projects and similar examples technically known as reference class forecasting your forecasting or estimating the costs and based on known examples that are comparable but even when you do find comparable examples from the past look at where there will be systemic variations between the past example and your present example and of course the most obvious one is cost inflation if something cost $100,000 ten years ago as a good chance it's gonna cost 150,000 dollars today the next method is called parametric forecasting what I like to call rule of thumb forecasting if we know that one worker can light hundred bricks an hour then if we know we need to lay two hundred thousand bricks we can work out how many hours of work and if we know we're going to fit it within a certain amount of time that tells us how many people were going to need and if we know the daily rate of an average bricklayer we've got all the data we need to make the calculation of the time cost so parametric forecasting takes P numbers and multiplies them and adds them in a logical mathematical way the next method is to ask for bids or tenders to find out how much people are prepared to do the work for and to use that as the basis of your estimate now one would think that if you get a firm tender that that will give you the firm cost but not all bids are based on a fixed cost and so you're going to need to build in some assumptions and of course there may be contract variations along the way so you need to pack contingency into any estimate even if you've got a fixed price bid the next is catalogs and pricing tables these are great working with your parametric forecasting methods if you can draw down comparable data from published catalogs from published pricing tables you've got a great resource for building up your estimates and finally a great way to get really good data is to build the sample or a test or a pilot or a prototype calculate the actual cost of doing that and use that as an input into your estimate for the bigger full production version and of course the secrets a good estimating is to combine as many of these techniques as you can and if you build an estimate but it really matters how robust that estimate is what about using a red team to either tear your estimate apartment look for false or better yet have built their own parallel estimate and compare the two done in different ways by different minds with different approaches you'll learn a lot by finding out why one team has done it one way and another has done it in another way and the first team got answer a second team got answer B by comparing the two and understanding those differences you'll be able to generate a better estimate always always always add contingency to your estimates and my guidance is always not just to add one single contingency figure but to look at the different work streams or the different functional components of your project or the different phases and to look at the different levels of uncertainty associated with each of those based on their characteristics and what's in them and therefore you may add ten percent contingency to one work stream because it's fairly familiar fairly well understood technology but another work stream may be use not using off-the-shelf components may be doing something we've not done before and you may choose to put something like 40 percent contingency into that work stream and when you combine all of those contingencies then you'll get a robust project contingency finally when you've got your estimates and you've got your contingency it's time to build them into a cash flow that way you can see how expenditure will flow out of your project and hopefully revenue into your project if appropriate over time and if it's a long project and therefore the cost of interest and the effects of inflation are going to be significant that needs to be what's called a discounted cash flow that takes into account those changes and we have a video answering a question what is a discounted cash flow that you can watch and of course once you've got your cash flow and your budget you've got the basis for building your business case because your business case is nothing more than a comparison between all of the costs that you just estimated and all of the benefits which is a whole separate exercise take a look at our videos on business case for more information so cost estimating it's uncertain it is difficult but there are tools and techniques to help you understand the different elements that go into your estimate and the different approaches you can take and you will be able to produce a reliable estimate for your project [Music] please give us a thumbs up if you liked this video there's loads more great project management videos to come so please subscribe to the channel and why not hit the bell so you don't miss any of it and in the meantime I look forward to seeing you in the next video

Channel: Online PM Courses - Mike Clayton

Views: 52,217

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Keywords: estimate project costs, estimate costs, cost estimation, cost estimating, estimating project costs, budget estimating, project cost estimation, project cost estimating, estimating methods, estimation tips, costs in project management, estimating, project cost management, estimating tips, project budget, estimation, cost management, project knife-edge, project 'knife-edge', budgeting, buget, budgetting, cash flow, project cash flow, Project management tutorial

Id: YQ2Wi3Jh3X0

Length: 11min 43sec (703 seconds)

Published: Wed Apr 15 2020