Chapter 7

Cost Estimation & Budgeting Process

Erny Apriany Sylwana Widya Adi Nugraha Fauzan Baskoro Very Budiman Harris

What is needed to develop a budget?

Forecast of: What resources the project will require Quantity of each When they will be needed How much they will cost (including the effect of potential price inflation) Uncertainty

ESTIMATING PROJECT BUDGET

1. 2. TOP-DOWN BUDGETING BOTTOM-UP BUDGETING

TOP-DOWN BUDGETING
A B C B C B

Estimators

Top-down budgeting is based on: Judgements and experiences of top and middle managers Available past data concerning similar activities

Advantages: Aggregate budgets can be often developed quite accurately Avoid overbudget
Weakness: Potential debate with the lower level managers Small but important aspects sometimes overlooked

BOTTOM-UP BUDGETING
A B C B C B

Bottom-up budgeting is based on: Budgeting from detailed tasks in terms of resources then constructed following the EBS Advantages: More accurate resources management Giving junior manager experiences in budgeting process Weakness: Complex process Potential overbudget because preparation of cutted budget

Estimators

WORK ELEMENT COSTING

Each work element in the action plan or WBS is evaluated for its resource requirements and, and the cost of each resource is estimated This cost consist of: 1. Direct cost 2. Overhead 3. General & Administrative (G&A) charges PM usually prepare 2 budgets: 1. With overhead and G&A charges (to estimate profit) 2. Without overhead and G&A charges

ITERATIVE BUDGETING PROCESS

In combination of top-down and bottom-up budgeting approach, Superiors (PMs) review the plan, perhaps suggesting amandments (negotiation in action) Resource requirements (ri) and duration of each step (ti) from Superiors, in fact, different with budgeting from lower level (ri & ti) Iterative is time-consuming process, because it involve superior & subordinate at all levels. But it allows a free flow of ideas up and down the system. This iterative process will reduce uncertainty in budget estimations

Category/Activity Budgeting vs. Program Budgeting

The traditional organization budget is either category oriented or activity oriented Often based upon historical data accumulated through an accounting system With the advent of project organizations, it became necessary to organize the budget in ways that conformed more closely to the actual pattern of fiscal responsibility

Category/Activity Budgeting vs. Program Budgeting

Under traditional budgeting methods, the budget could be split up among many different organizational units This diffused control so widely that it was almost nonexistent This problem gave rise to program budgeting which alters the budgeting process so that budget can be associated with the projects that use them

Program Budgeting
Program budgeting aggregates income and expenditures across programs (projects) Aggregation by program is in addition to, not instead of, aggregation by organizational unit These budgets usually take the form of a spreadsheet with standard categories disaggregated into regular operations and charges to the various projects

Improving the Process of Cost Estimation

There are two fundamentally different ways to manage the risks associated with the chance events that occur on every project:
The most common is to make an allowance for contingencies usually 5 or 10 percent Another is when the forecaster selects most likely, optimistic, and pessimistic estimates

Funding Non profitable Projects

There are several reasons that firms would choose to fund a project that is not profitable:
To develop knowledge of a technology To get the organizations foot in the door To obtain the parts or service portion of the work To be in a good position for a follow-on contract To improve a competitive position To broaden a product line or a line of business

Learning Curves
In a cigarette manufactory, A product made in 70 man hour. labor paid = $12/hour estimated of 25 unit? $25 unit * $12/hr * 70 hr/unit = $21000

Nope, its below $21000 Its that true? Because Human Learn

Learning Curves
Experiences is a plus More experiences = easy cost estimation, its fairly routine Each time the output doubles, the worker hour per unit decrease to a fix percentage of their previous value The fix percentage called learning rate

Learning Curves
If individual need 10 minutes to accomplish certain task at first time, and only 8 minute in second time, it said learning rate=80% Time required to produce a unit of output
Tn The time required for the nth unit of output T1 The time reguired for the initial output N The number of units to be produced, and R Log decimal learning rate/log 2

Total time required:

Learning Curves
time

Additional time used for leaning Without allowance for learnig

Number of unit

Learning Curves
Special case of Learning Technological stock If the parent organization is not experienced, performance measures such as time to installation, time to achive 80 percent etc are quite uncertain When we alter a system, we disturb it and it reacts in unpredictable ways. Other Factors Project involve a tangible medium that tends not be under control exp: a program with 1000 line code and 99,99% reliable just only working about 36% Mythical man-month worker and time are interchangable Adding manpower to a late software project makes it later

Types of Estimation Error

There are two generic types of estimation error: Random error - where overestimates and underestimates are likely to be equal Bias - a systematic error where the chance of overestimating and underestimating are not likely to be equal