PMGT1865 Chap.13 Cost Estimation and the Project Cost Estimate
Cost Estimation and the Project Cost Estimate
Cost management on a project covers estimating, budgeting, financing, funding, managing and controlling what gets spent, with the object of finishing inside the approved figure, and its four stated objectives all tie cost to something outside cost: the business case, the schedule and resourcing plan, the scope, and the financial viability review that follows any change to the estimates. This chapter covers the first two verbs.
Three cost documents answer three different questions: the project cost estimate gives the total, the time phased budget gives the shape, and the cash flow gives the timing. The estimate itself is built by turning the work breakdown structure into a cost breakdown structure with three layers, of which only the first is the work. Direct cost is what it takes to carry out the listed work itself.
Indirect cost, also called overhead, is incurred by all projects and cannot be traced to any single one. Contingency is funds for the unknown, split into project contingency for known unknowns and management reserve for unknown unknowns, and it is never a funding source for new scope. Profit sits outside the estimate entirely and is added only when a bid price is quoted.
What this chapter covers
- 01
The four objectives of cost management, and what they all have in common
- 02
Three cost documents and the three questions they answer
- 03
The estimate costs process, covering labour, materials, equipment, facilities and services
- 04
Why estimates are reviewed and refined as the project progresses
- 05
Direct, indirect and contingency layers, and where profit sits relative to them
- 06
Fixed against variable components inside the direct costs
- 07
Management reserve and project contingency, and the two kinds of unknown they cover
- 08
Three ways to estimate indirect cost, and which one moves it inside the cost baseline
- 09
Five ways to size contingency, and the only one tied to this project's own risks
- 10
The five accuracy classes, their published ranges, and why every band is asymmetric
Rolling a cost baseline up to a project cost estimate
- +2Sum each control account and then the baseline. Ground works is $64,000, planting $21,000, lighting $22,000 and closure $3,500, giving a total direct cost of $110,500. Do this first, because every layer above is a percentage of it.
- +1Indirect cost. Ten per cent of $110,500 is $11,050, and it sits outside the cost baseline and inside the budget because it cannot be traced to any control account.
- +1Contingency. Twenty per cent of $110,500 is $22,100. State what it is for: known unknowns inside the agreed scope, not new scope.
- +1Project cost estimate. $110,500 plus $11,050 plus $22,100 is $143,650.
- +1Bid price, with profit added on top of the estimate rather than inside it. At a 12 per cent margin, $143,650 times 1.12 is $160,888. The direct costs come from a decomposed breakdown with priced work packages, so this is a budgetary estimate and the true cost is likely to fall between about $129,000 and $180,000.
Key terms
- Direct cost
- What it takes to carry out the listed work itself, covering goods, services and labour. It is the layer the cost baseline is built from and the only one that traces to a specific work package.
- Indirect cost
- Cost carried by every project and attributable to no one job or package, such as utilities, rent, licences and workers compensation. It may sit outside the baseline or be folded into internal labour rates.
- Management reserve
- Funds held for unknown unknowns, outside the cost baseline. Releasing it is a deliberate act that changes the baseline rather than a variance against it.
- Project contingency
- Funds held for known unknowns inside the agreed scope, forming part of the time phased direct cost. Drawing on it shows up in performance measurement.
- Cost breakdown structure
- The cost view of the work breakdown structure, running from the project cost estimate down through control accounts and work packages to activity cost estimates and their own contingency.
- Rough order of magnitude
- The earliest accuracy class, spanning minus 25 to plus 75 per cent. It is not a bad estimate, it is an early one, and the response to its width is to ask whether the pending decision needs a narrower class.
- Bid price
- The project cost estimate plus profit. Profit is never part of the cost estimate itself, which is why a bid and an estimate are two different figures on the same project.
Cost Estimation and the Project Cost Estimate FAQ
Can contingency be used to fund extra scope?
No, and this is the substantive judgement question in the topic. Contingency covers work the project already agreed to going worse than expected, such as activities running longer or issues arising. New scope is a change and is funded as one, with its own approval.
Spending contingency on new work quietly removes the cover for risks that have not yet been retired, and it does so invisibly, because the total looks unchanged right up until the moment the retained risk actually occurs.
Why does the same project sometimes report two different direct cost figures?
Because overhead can legitimately be treated two ways. Held outside the baseline as a percentage or a fixed sum, it is indirect and the baseline is smaller. Factored into the labour rates charged for internal people, it becomes direct cost and sits inside the baseline, making every work package look more expensive.
Neither is wrong and the difference flows through to earned value, so the convention has to be stated rather than assumed.
How wrong is an estimate allowed to be?
It depends on the class, and quoting the class alongside the number is what makes the figure honest. A rough order of magnitude estimate spans minus 25 to plus 75 per cent, preliminary spans minus 15 to plus 50, budgetary spans minus 10 to plus 25 and definitive spans minus 5 to plus 10. You cannot promote an estimate to a tighter class by being more confident about it, only by doing more decomposition and pricing.
Why is every accuracy band wider on the upside?
Because it encodes something empirical rather than mathematical: projects overrun far more often than they underrun. Scope is discovered rather than lost, estimates are made by people who want the work approved, and the things nobody thought of are always additions. An answer that notices the asymmetry and explains it is worth more than one that reproduces the five ranges correctly and says nothing about them.
Assessment move
A full cost estimate has seven visible elements and the two carrying the most marks are the ones where judgement shows. A table of direct costs grouped by control account and traceable to the breakdown. A subtotal, checked by addition before any percentage is applied. Indirect cost with its basis stated. Contingency with its basis stated. The project cost estimate. The accuracy class.
And, if a bid is asked for, the margin applied on top. Practise stating the two bases rather than just applying them, since a benchmark percentage used in the absence of a quantitative risk assessment is defensible if you say that is what it is and indefensible if you present it as an assessment.
Drill against the four recurring errors: funding new scope from contingency, folding profit into the cost estimate, reporting a number with no accuracy class, and computing a percentage on the wrong base. Then keep the cost baseline separate in your notes from the project cost estimate, because the next two chapters use the baseline and never the total.
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