AD 642 Budgeting and Network Layout 1 Budgeting
AD 642 Budgeting and Network Layout 1
Budgeting • A plan for the costs of project resources • A budget implies constraints • Thus, it implies that managers will not get everything they want or need 2
Budgeting Continued • The budget for an activity also implies management support for that activity • Higher the budget, relative to cost, higher the managerial support • The budget is also a control mechanism – Many organizations have controls in place that prohibit exceeding the budget – Comparisons are against the budget 3
Estimating Projects • Estimating – The process of forecasting or approximating the time and cost of completing project deliverables. – The task of balancing the expectations of stakeholders and the need for control while the project is implemented • Types of Estimates – Top-down (macro) estimates: analogy, group consensus, or mathematical relationships – Bottom-up (micro) estimates: estimates of elements of the work breakdown structure Copyright © 2006 The Mc. Graw-Hill Companies. All rights reserved. 4
Why Estimating Time and Cost Are Important • Estimates are needed to support good decisions. • Estimates are needed to schedule work. • Estimates are needed to determine how long the project should take and its cost. • Estimates are needed to determine whether the project is worth doing. • Estimates are needed to develop cash flow needs. • Estimates are needed to determine how well the project is progressing. • Estimates are needed to develop time-phased budgets and establish the project baseline. EXHIBIT 5. 1 Copyright © 2006 The Mc. Graw-Hill Companies. All rights reserved. 5
Factors Influencing the Quality of Estimates Planning Horizon Other (Nonproject) Factors Organization Culture Project Duration Quality of Estimates Padding Estimates Copyright © 2006 The Mc. Graw-Hill Companies. All rights reserved. People Project Structure and Organization 6
Estimating Project Budgets • On most projects – Material + Labor + Equipment + Capital + Overhead + Profits = Bid • In other words – Resources + Profits = Bid • So we are left with the task of forecasting resources 7
Estimating Project Budgets Continued • Like any forecast, this includes some uncertainty • There is uncertainty regarding usage and price – Especially true for material and labor • The more standardized the project and components, the lower the uncertainty • The more experienced the cost estimator, the lower the uncertainty 8
Rules of Thumb • Some estimates are prepared by rules of thumb – Construction cost by square feet – Printing cost by number of pages – Lawn care cost by square feet of lawn • These rules of thumb may be adjusted for special conditions • However, this is still easier than starting the estimate from scratch 9
Estimating Guidelines for Times, Costs, and Resources 1. Have people familiar with the tasks make the estimate. 2. Use several people to make estimates. 3. Base estimates on normal conditions, efficient methods, and a normal level of resources. 4. Use consistent time units in estimating task times. 5. Treat each task as independent, don’t aggregate. 6. Don’t make allowances for contingencies. 7. Adding a risk assessment helps avoid surprises to stakeholders. Copyright © 2006 The Mc. Graw-Hill Companies. All rights reserved. 10
Estimating Budgets is Difficult • There may not be as much historical data or none at all • Even with similar projects, there may be significant differences • Many people have input to the budget 11
Estimating Budgets is Difficult Continued • Multiple people have some control over the budget • There is more “flexibility” regarding the estimates of inputs (material and labor) • The accounting system may not be set up to track project data • Usage of labor and material is very lumpy over time 12
Types of Budgeting • Macro vs Micro ● Top-down ● Bottom-up • Negotiated 13
Macro versus Micro Estimating Conditions for Preferring Top-Down or Bottom-up Time and Cost Estimates Condition Macro Estimates Strategic decision making X Cost and time important High uncertainty X Internal, small project X Fixed-price contract Customer wants details Unstable scope X Micro Estimates X X X TABLE 5. 1 Copyright © 2006 The Mc. Graw-Hill Companies. All rights reserved. 14
Top-Down Budgeting • Top managers estimate/decide on the overall budget for the project • These trickle down through the organization where the estimates are broken down into greater detail at each lower level • The process continues to the bottom level 15
Methods for Estimating Project Times and Costs • Macro (Top-down) Approaches – Consensus methods – Ratio methods – Apportion method – Function point methods for projects Project Estimate software. Times and system Costs – Learning curves Copyright © 2006 The Mc. Graw-Hill Companies. All rights reserved. 16
Apportion Method of Allocating Project Costs Using the Work Breakdown Structure FIGURE 5. 1 Copyright © 2006 The Mc. Graw-Hill Companies. All rights reserved. 17
Simplified Basic Function Point Count Process for a Prospective Project or Deliverable TABLE 5. 2 Copyright © 2006 The Mc. Graw-Hill Companies. All rights reserved. 18
Example: Function Point Count Method TABLE 5. 3 Copyright © 2006 The Mc. Graw-Hill Companies. All rights reserved. 19
Advantages • Overall project budgets can be set/controlled very accurately – A few elements may have significant error • Management has more control over budgets • Small tasks need not be identified individually 20
Disadvantages • More difficult to get buy in • Leads to low level competition for larger shares of budget 21
Bottom-Up Budgeting • Project is broken down into work packages • Low level managers price out each work package • Overhead and profits are added to develop the budget 22
Methods for Estimating Project Times and Costs (cont’d) • Micro (Bottom-up) Approaches – Template method – Parametric Procedures Applied to Specific Tasks – Detailed Estimates for the WBS Work Packages – Phase Estimating: A Hybrid Copyright © 2006 The Mc. Graw-Hill Companies. All rights reserved. 23
SB 45 Support Cost Estimate Worksheet FIGURE 5. 2 Copyright © 2006 The Mc. Graw-Hill Companies. All rights reserved. 24
Phase Estimating over Product Life Cycle FIGURE 5. 3 Copyright © 2006 The Mc. Graw-Hill Companies. All rights reserved. 25
Advantages • Greater buy in by low level managers • More likely to catch unusual expenses 26
Disadvantages • People tend to overstate their budget requirements • Management tends to cut the budget 27
Work Element Costing • Labor rates include overhead and personal time • Direct costs usually do not include overhead • General and administrative (G&A) charge 28
An Iterative Budgeting Process–Negotiationin-Action • Most projects use some combination of top-down and bottom-up budgeting • Both are prepared and compared • Any differences are negotiated 29
Level of Detail • Level of detail is different for different levels of management. • Level of detail in the WBS varies with the complexity of the project. • Excessive detail is costly. – Fosters a focus on departmental outcomes – Creates unproductive paperwork • Insufficient detail is costly. – Lack of focus on goals – Wasted effort on nonessential activities Copyright © 2006 The Mc. Graw-Hill Companies. All rights reserved. 30
Category Budgeting Versus Program/Activity Budgeting • Organizations are used to budgeting (and collecting data) by activity • These activities correspond to “line items” in the budget – Examples include phone, utilities, direct labor, … • Projects need to accumulate data and control expenses differently • This resulted in program budgeting 31
Typical Monthly Budget Table 7 -1 32
Project Budget by Task & Month Table 7 -2 33
Developing Budgets • Time-Phased Budgets – A cost estimate is not a budget unless it is time-phased. • Time phasing begins with the time estimate for a project. • Time-phased budgets mirror how the project’s cash needs (costs) will occur or when cash flows from the project can be expected. • Budget variances occur when actual and forecast events do not coincide. Copyright © 2006 The Mc. Graw-Hill Companies. All rights reserved. 34
Types of Costs • Direct Costs – Costs that are clearly chargeable to a specific work package. • Labor, materials, equipment, and other • Direct (Project) Overhead Costs – Costs incurred that are directly tied to an identifiable project deliverable or work package. • Salary, rents, supplies, specialized machinery • General and Administrative Overhead Costs – Organization costs indirectly linked to a specific package that are apportioned to the project Copyright © 2006 The Mc. Graw-Hill Companies. All rights reserved. 35
Improving The Process of Cost Estimation • Inputs from a lot of areas are required to estimate a project • May have a professional cost estimator to do the job • Project manager will work closely with cost estimator when planning a project • We are primarily interested in estimating direct costs • Indirect costs are not a major concern 36
Problems • Even with careful planning, estimates are wrong • Most firms add 5 -10 percent for contingencies 37
Learning Curves • Human performance usually improves when a task is repeated • This happens by a fixed percent each time the production doubles • Percentage is called the learning rate 38
Learning Curve Calculations Tn = Time for nth unit T 1 = Time for first unit n = Number of units r = log decimal rate/log 2 39
Other Factors • Escalation • Waste • Bad Luck 40
Making Better Estimates • Projects are known for being over budget – It is unlikely that this is due to deliberate underestimating • There are two types of errors – Random – Bias • There is nothing we can do about random errors – Tend to cancel each other • Eliminate systematic errors 41
Risk Estimation • Duration of project activities varies • Amounts of various resources needed varies • Value of accomplishing a project varies • Can reduce but not eliminate ambiguity • Want to describe uncertainties in a way that provides useful insight to their nature 42
Applying Risk Analysis • Must make assumptions about probability distributions – Key parameters – Variables • Estimate the risk profiles of the outcomes of the decision – Also know as probability distributions • Simulation is often used 43
Refining Estimates • Reasons for Adjusting Estimates – Interaction costs are hidden in estimates. – Normal conditions do not apply. – Things go wrong on projects. – Changes in project scope and plans. • Adjusting Estimates – Time and cost estimates of specific activities are adjusted as the risks, resources, and situation particulars become more clearly defined. Copyright © 2006 The Mc. Graw-Hill Companies. All rights reserved. 44
Refining Estimates (cont’d) • Contingency Funds and Time Buffers – Are created independently to offset uncertainty. – Reduce the likelihood of cost and completion time overruns for a project. – Can be added to the overall project or to specific activities or work packages. – Can be determined from previous similar projects. • Changing Baseline Schedule and Budget – Unforeseen events may dictate a reformulation of the budget and schedule. Copyright © 2006 The Mc. Graw-Hill Companies. All rights reserved. 45
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