Estimating project costs with confidence and accuracy
April 21, 2023
Estimating project costs is like playing a game of Jenga — one wrong move and everything can come tumbling down. Whether you love or loathe it, cost estimating is essential for any successful project. However, it can be a daunting process. You need to consider labor, materials, time, and risks. Plus, you need a deep understanding of the project’s goals and requirements. So, where do you start?
In this article, we’ll explore different techniques and examples for estimating project costs. We’ll cover top-down approaches like analogous estimation, as well as bottom-up methods for detailed results. Whether you’re an experienced project manager or just starting out, get ready to learn how to estimate project costs like a pro.
What is a cost estimate?
Let’s talk about cost estimates and why they’re important in project management.
Simply put, a cost estimate is an educated guess at how much a project will cost. Think of it like trying to budget for a road trip — you need to consider factors like how long the trip will be, where you’ll stay, how much gas you’ll need, and so on. For a project, you need to consider factors like labor, materials, and time to come up with a realistic estimate of the project’s cost.
Getting the cost estimate right is crucial because if it’s too low, you might run out of money mid-project, and if it’s too high, you might not get the funding you need to start. That’s why project managers spend a lot of time and effort developing accurate cost estimates that factor in all the project’s requirements and potential risks.
There are different techniques and methods for estimating project costs, each with its own advantages and disadvantages. Some methods take a broad view of the project, while others require a detailed breakdown of costs. In this article, we’ll explore various techniques for estimating project costs so that you can choose the one that works best for you.
There are four main estimating techniques:
- Analogous estimating
- Bottom-up estimating
- Parametric estimating
- 3-point estimating
By choosing the appropriate technique and applying it correctly, you can develop a reliable cost estimate that will help ensure the project’s success. We’ll talk more about this later on.
Types of cost estimates
There are variations on the above four approaches, each defined by the stage at which the calculation is carried out.
Order of Magnitude Estimate
The Order of Magnitude Estimate is a rough estimate of a project’s cost, usually made in the initial stages of project planning when information is limited. It’s based on historical data and experience from similar projects and typically has an accuracy range of -50% to +100%. It’s a form of analogous estimation.
The Budget Estimate happens after you’ve defined the project’s scope and requirements and is typically used to allocate funds. It’s usually more accurate than an order of magnitude estimate and has an accuracy range of -10% to +25%.
The Definitive Estimate is the most accurate and detailed. It’s made after the project’s scope and requirements are well-defined and detailed. It includes a comprehensive breakdown of all costs, including labor, materials, equipment, and other expenses, and has an accuracy range of -5% to +10%.
The Conceptual Estimate happens in the early stages of project planning. It’s based on general assumptions and industry averages and is typically used to decide whether to proceed with the project. Like Order of Magnitude Estimation, it’s rough and based on past data.
The Control Estimate takes place during the project’s execution to track and monitor costs and ensure the project stays within budget.
Rough Order of Magnitude vs. Definitive Estimate
The two most commonly used types of cost estimates are the Rough Order of Magnitude (ROM) estimate and the Definitive Estimate.
A ROM estimate is a rough estimate of a project’s cost and takes place during the early stages of project planning. It’s based on historical data and experience from similar projects and typically has a wide accuracy range of -50% to +100%. ROM estimates are good for giving stakeholders an idea of the project’s overall cost and whether it’s feasible to proceed with it. You’ll most likely use the analogous estimation to work this one out.
On the other hand, a Definitive Estimate is the most accurate and detailed estimate. It happens after you’ve defined the project’s scope and requirements and is far more detailed and includes a comprehensive breakdown of all costs, including labor, materials, equipment, and other expenses, and has a much narrower accuracy range of -5% to +10%. This gives project managers a more precise picture of the project’s cost and allows for more effective resource allocation and risk management.
As a project progresses, the level of detail and accuracy required in cost estimates increases. For example, a ROM estimate made in the early stages of a project may be sufficient to determine the project’s feasibility. Still, later on, you’ll need a Definitive Estimate to allocate funds and manage the project’s costs effectively.
Terms to know
In addition to Rough Order of Magnitude and Definitive Estimates, there are two more terms that project managers should know — Estimate to Complete (ETC) and Estimate at Completion (EAC).
Estimate to Complete (ETC)
ETC is an estimate of the remaining costs to complete a project. It’s used to update the original cost estimate and adjust the project budget accordingly. ETC accounts for any changes in scope, schedule, or resource changes since you made the initial estimate. Project managers use ETC to determine whether the project is still on track and identify potential budget overruns.
Estimate at Completion (EAC)
EAC, on the other hand, is an estimate of the project’s total cost when it’s completed. EAC takes into account the actual costs incurred to date, as well as any future costs. Use it to determine whether the project will stay within the original budget or whether you’ll need additional funds.
Why are cost estimates important?
- Allocation: First and foremost, they help project managers to allocate resources, set budgets, and make informed decisions about a project’s feasibility.
- Risk identification: Accurate cost estimates can also help to identify potential risks and challenges, allowing project managers to plan and prepare accordingly.
- Planning: By knowing the project’s expected cost, project managers can develop a timeline that considers the necessary resources and activities needed to complete the project within the allocated budget.
- Transparency: By providing a clear breakdown of project costs, project managers can communicate effectively with clients, investors, and other stakeholders, building trust and helping to ensure the project’s success.
- Delay prevention: Finally, project estimates can help to prevent budget overruns and project delays, which can be costly. By developing realistic and reliable estimates, project managers can manage expectations, avoid surprises, and stay on track toward achieving the project’s goals.
When should cost estimates take place during the project?
Estimates should occur at different stages throughout the project to ensure that the project stays on track and within budget. The frequency will depend on the project’s size, complexity, and duration, as well as the methodology you’re using — such as Agile or waterfall.
With the Waterfall methodology, you’ll typically create estimates during the project’s planning phase, before any work begins — so this is where your Rough Order of Magnitude comes in. You’ll then move on to your budget estimates once you’ve got stakeholder buy-in. This approach requires a comprehensive understanding of the project scope and deliverables, as well as the time and resources required to complete each task. After that, you’ll move on to your definitive estimate. Once you’ve established your estimates, use them as a baseline for the rest of the project.
In contrast, Agile methodologies such as Scrum involve more frequent estimating and re-estimating throughout the project lifecycle. This approach allows for more flexibility in adapting to changing requirements and priorities. Estimates happen during each sprint planning session and are reviewed and adjusted as needed during the sprint, which allows for more accurate forecasting.
Generally speaking, though, estimates should happen at the beginning of the project to determine the overall budget and schedule. These initial estimates will help set expectations for the project and identify any potential roadblocks. As the project progresses, update estimates to keep the project on track.
Four types of estimates, and when to use each one
There are several types of estimates, and you’ll choose which to use depending on the project’s stage, available data, and the level of accuracy required. This section will provide a quick guide to the four types of estimates and when to use each.
The three-point estimation technique involves calculating an estimate based on three factors: the optimistic estimate, the pessimistic estimate, and the most likely estimate, with different weightings for each.
The optimistic estimate is the best-case scenario, assuming everything goes perfectly according to plan. The pessimistic estimate, on the other hand, is the worst-case scenario, assuming that everything goes wrong and the project faces numerous delays and obstacles. The most likely estimate is a more realistic estimate based on historical data or expert opinions.
It’s a helpful technique when dealing with complex projects or tasks with high uncertainty. By considering both best-case and worst-case scenarios, the approach helps project managers to account for potential risks and develop contingency plans.
Bottom-up estimation involves breaking down a project or task into smaller, more manageable components and estimating the time and resources required for each component individually.
Think of it like building a house — you wouldn’t try to estimate the entire project’s cost. Instead, you would break it down into smaller tasks, such as laying the foundation, framing the walls, and installing the roof, and estimate the time and resources required for each job.
This approach allows project managers to create a more accurate estimate by considering the specifics of each task. It also helps to identify any potential roadblocks or dependencies between tasks, enabling project managers to develop more realistic schedules and allocate resources more effectively.
While bottom-up estimation can be more time-consuming than other estimation techniques, it ultimately saves time and money in the long run by helping to avoid unexpected delays and budget overruns. It’s especially useful for larger and more complex projects that require a high level of precision. It’s also helpful when the project scope is likely to change or evolve over time: breaking the project down into smaller jobs makes it easier to adapt and adjust the project plan as needed to accommodate changing requirements.
Analogous estimation involves using historical data from similar projects to estimate the time, resources, and costs required for a new project.
It’s like estimating how long it will take to build your own house by looking at how long it took to build a similar house down the street, considering factors such as size and complexity.
It’s a quick and easy way to create an estimate, especially for projects similar in scope and complexity to past projects. It’s also helpful when there is a tight deadline or limited information.
However, analogous estimation relies heavily on the accuracy and relevance of historical data. The estimate may not be accurate if the past projects were significantly different in scope or had different requirements.
Parametric estimation uses statistical models and historical data to estimate the time and resources required for a project or task. It involves identifying key parameters that impact the project’s duration and cost, such as the number of team members, the amount of work, or the complexity of the task. It then relies on the project manager to use a mathematical formula to estimate the duration and cost based on these parameters.
Parametric estimation is most useful for tasks or projects that are similar in nature and can be easily broken down into quantifiable parameters. It’s also effective when historical data is available to help develop statistical models. The accuracy of parametric estimation depends on the quality and relevance of the data used to develop the statistical models. The estimate won’t be reliable if the data is outdated, incomplete, or inaccurate.
Who is responsible for estimating projects?
Estimation is typically performed by a team of professionals with relevant experience and expertise in the project’s domain. This is usually the project manager, but it could also be a contractor or external expert.
In addition to the project manager, members of the project team and external stakeholders such as customers, vendors, or contractors may also help out in at least some of the estimation process.
Ideally, you’ll have the same person managing estimations throughout the project’s lifecycle. People have different approaches, so keeping it to the same person helps ensure consistency. You’ll also want this person to have a firm knowledge of the project’s domain, available resources, and overall goals and objectives — something only experience can provide.
In conclusion, project estimation is a critical aspect of project management that requires careful consideration and planning. While there are several tools available to help with project estimation, project management software is the gold standard. It provides essential features for task management, collaboration, data analysis, and resource management, all of which can significantly improve project estimation accuracy. With project management software, project managers can streamline the estimation process and allocate resources efficiently, ultimately improving project success rates and delivering projects on time and within budget.