Estimating costs correctly is important because it help make the right commitment of dollars to a business activity. The process takes a bit of experience, research, decision-making and judgment. However, none of these elements alone will produce a good cost estimate. Put together, managers and analysts who practice a combined preparation of cost estimates can do so with reliable accuracy. In turn, their work can then be used to make financial decisions that affect the direction of an organization going into the future.
The better the accuracy of a cost estimate, the better the planning and decision-making is in predicting and adjusting for future change. This is critical when business decisions need to be made on educated guesses where a bad decision can end up in a serious loss of profit. Good cost-estimating also helps keep operating margins down by avoid unnecessary expenses.
Bad estimates cost a business in two ways. Obviously, underestimating expenses of a project can create a financial emergency half-way through or at an important juncture, which can put the project completion at risk. Insufficient resources or support of labor can effectively shut a project down, making it more expensive to finish due to delay. All of this unexpected cost increase then reduces or eliminates profit. Overestimating creates fat in the project with too many resources. Valuable funds get wasted on over-consumption, again reducing dollars that could have been attributed to profit.
Cost-estimate accuracy forces a business project to stay on schedule and on track. Particularly with client projects, once an estimate is confirmed, the business has to stay within budget if it doesn’t want to lose money. This has a ripple effect on all the business’ activities to come in at or below budget while meeting all of the client’s goals, including schedule and delivery.
Good business decisions are only as good as the data they are based on. The importance of accurate cost estimates becomes significant when decisions that can result in changes occur. Investment of funds in new directions as well as cost-cutting for savings both depend heavily on cost estimates being correct. The assumed numbers are then built into commitments, contract, budgets, procurement and accounting accruals. If the data turns out to be wrong, then further emergency changes have to be made at the last second to compensate. Avoidance of such a situation makes getting the estimates right the first time around critical.