What is cost estimation? We explain it to you in 4 steps

cost estimation

Cost estimation in project management is the process of forecasting the cost and resources needed to complete a project within a defined scope. Cost estimation accounts for each element required for the project and calculates a total amount that determines a project’s budget.

In project management, estimating typically generates all the cost data for the project. Based on one of AACE’s recommended practices, estimates are usually classified in 5 levels based on increasing levels of definition. Table 1 shows AACE’s cost estimate classification system.

AACE Cost estimate classification system

However, you should keep in mind that a good estimate includes not only the cost but also all data related to the way the project was envisioned to be carried out.

Key Considerations in Cost Estimation

In most cases, project teams complete this exercise early in the project lifecycle, obtain the approved for expenditure (AFE) funds, and promptly file away and forget all that data.

In the early stages of the project, project teams apply various methods to develop estimates based on available data. This includes capacity factoring, equipment factoring and parametric estimating.

In most cases, the project then advances to its execution phase, and the team selects the best path forward. However, they often a neglect the differences between this execution path and the path envisioned during budget creation, which constitutes the estimate.

Using a project cost management system, such as a software tool, that integrates all project control units makes it impossible to ignore execution changes after baselining the budget from the estimating data. This is because the data remains consistent. The inherent structure of the software compels it to highlight and clearly distinguish any alterations from the baseline. Consequently, the cost estimate automatically updates with execution changes. This ensures the estimate remains dynamic and accurate.

4 Principles of Cost Estimation

1. Cost estimation is used to predict the quantity, cost and price of the resources required by the scope of a project. A project is any process started to perform work activities and/or create assets. The accuracy of the estimate depends heavily on the level of project scope definition. As the design and conditions of the project become better defined, so do the estimated values. Think of the 5 estimate classes of AACE shared above.

2. Cost estimation is necessary to enable decision-makers to make investment decisions, choose between alternatives, and establish the budget during the front end of projects. Additionally, clients need to validate estimates provided by vendors and contractors as well. Later phases of the project utilize the budget estimate as a baseline to evaluate project performance.

Related to this principle, it is always challenging to collect and read the huge amount of cost data, which doesn’t help with the decision making. Analyzing and visualizing the cost data opens the doors to making the data useful and meaningful. Project control software system dashboards are data-driven graphical representations of a project. They offer decision-makers a quick overview of a project’s progress and convert data into actionable decision points.

3. Estimating involves breaking down the total scope of a project into manageable parts, assigning resources, and determining costs. Standardised ways of breaking down a project include the Work Breakdown Structure (WBS) and the Cost Breakdown Structure (CBS). However, project teams and external parties often implement multiple structures to align reporting and sharing of cost data depending on their needs.

4. A cost estimate is more than a list of costs. The estimate also includes a detailed Basis of Estimate (BOE) report that describes the assumptions, inclusions, exclusions, accuracy, and other aspects necessary to interpret the total project cost. Otherwise, it would be a meaningless number.

The BOE is necessary to communicate the estimate to the various parties involved in decision-making. Furthermore, it is also handy during closeout when comparing the performance of the project with other projects. Despite its vital role in learning from experince and mistakes, project teams often overlook it.

Conclusion

Cost estimation is easier said than done. An accurate estimation method can be the difference between a successful plan and a failed one. Keep these 4 principles in mind and you already have a framework to start making estimates.

Make sure to set up the estimate in a structured way to allow for an easy transition into project cost estimating software. This transition will help you make more solid and accurate estimates in the long run.

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