Why Is Cost Estimation Important for Project Planning?

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When you and your team take on a project, one of the goals is to bring it in without exceeding your budget. That's why cost estimation is such an important component of project planning. Making accurate estimates ensures your budget covers what the project needs.

How Do You Write a Budget Proposal?

To set the budget for your project, you need to figure out the costs. These can be direct or indirect costs.

  • The direct costs are the ones that can be billed entirely to your project, such as staff salaries, equipment costs and supplies. If, say, your project is developing a new frozen entree, the ingredients used in your test kitchen would be a direct cost.
  • Indirect costs are costs that aren't directly attributed to your project. Your team probably uses utilities and IT resources, but these expenses are shared across multiple different projects.

A good budget proposal estimates the different expenses and lists the reasons for each figure.

Importance in Cost Management

The reason why a budget is important in project management is that organizations have only so much money to invest in each project. If a realistic estimate shows the project will cost more than the company wants to spend, the options are to lower the budget, change the scope or kill the project.

Another factor is that the project scope and budget are a promise that you'll accomplish X by date Y for cost Z. Your success will be judged by how well you deliver on that promise. You can use several methods to draw up an accurate cost estimate:

  • Historical data. If your company has carried out similar projects in the past, you can use their budgets as a template. If you're building a new factory, the cost of other factories built in the same area gives you some guidelines.
  • Bottom-up analysis. Break down the resources you need into the smallest units and calculate the costs. This detailed approach can produce accurate estimates, but it requires a lot of time and number-crunching.
  • Three-point estimation. This approach starts with three budget estimates covering the best-case scenario, worst-case scenario and the most likely scenario. Then, you use a mathematical formula to derive a cost estimate.

Avoid Estimating Errors

Whichever method you use, it's depressingly easy to mess it up with just a few simple errors.

  • Crunching numbers by hand. Project estimates are complicated. They'll be more accurate with software than if you try to figure everything out on paper or in your head.
  • Not checking your figures. If, say, you enter $1,000 instead of $10,000, you're going to get a bad estimate. Software can't tell that you've fed it bad information.
  • Underestimating the resources you'll need. An underestimate makes it easier to keep the budget low, but it doesn't make the need for resources any less.
  • Underestimating risks. Lots of things can and probably will go wrong. Construction projects, for example, can face delays and added costs due to bad weather, a client's request for changes or discovering forgotten stretches of sewer pipe under the site. Good project budgets include some leeway for potential problems.

Monitor the Budget

Along with knowing why cost estimation is such an important component of project planning, you need to know that estimates aren't magic. Once you launch the project, you'll need to keep constant track of the budget and compare it to your estimate:

  • Make your team aware of the budget and how it's to be spent. If they don't know, there's no way they can spot when they're spending too much.
  • If the project is struggling to stay on budget, it may be tempting to give up managing costs. However, that will create problems when the project finally wraps up. Monitoring spending and taking steps to fix problems will be more cost-effective in the long run. 

References

About the Author

Fraser Sherman has written about every aspect of business: how to start one, how to keep one in the black, the best business structure, the details of financial statements. He's also run a couple of small businesses of his own. He lives in Durham NC with his awesome wife and two wonderful dogs. His website is frasersherman.com

Photo Credits

  • planning process image by Chad McDermott from Fotolia.com