7.2 Estimate Costs – A Guide to the Project Management Body of Knowledge (PMBOK® Guide), Fifth Edition

7.2 Estimate Costs

Estimate Costs is the process of developing an approximation of the monetary resources needed to complete project activities. The key benefit of this process is that it determines the amount of cost required to complete project work. The inputs, tools and techniques, and outputs of this process are depicted in Figure 7-4. Figure 7-5 depicts the data flow diagram of the process.

Cost estimates are a prediction that is based on the information known at a given point in time. Cost estimates include the identification and consideration of costing alternatives to initiate and complete the project. Cost trade-offs and risks should be considered, such as make versus buy, buy versus lease, and the sharing of resources in order to achieve optimal costs for the project.

Cost estimates are generally expressed in units of some currency (i.e., dollars, euros, yen, etc.), although in some instances other units of measure, such as staff hours or staff days, are used to facilitate comparisons by eliminating the effects of currency fluctuations.

Cost estimates should be reviewed and refined during the course of the project to reflect additional detail as it becomes available and assumptions are tested. The accuracy of a project estimate will increase as the project progresses through the project life cycle. For example, a project in the initiation phase may have a rough order of magnitude (ROM) estimate in the range of −25% to +75%. Later in the project, as more information is known, definitive estimates could narrow the range of accuracy to -5% to +10%. In some organizations, there are guidelines for when such refinements can be made and the degree of confidence or accuracy that is expected.

Sources of input information are derived from the outputs of processes in other Knowledge Areas. Once received, all of this information will remain available as inputs to all of the cost management processes.

Costs are estimated for all resources that will be charged to the project. This includes, but is not limited to, labor, materials, equipment, services, and facilities, as well as special categories such as an inflation allowance, cost of financing, or contingency costs. A cost estimate is a quantitative assessment of the likely costs for resources required to complete the activity. Cost estimates may be presented at the activity level or in summary form.

7.2.1. Estimate Costs: Inputs

7.2.1.1 Cost Management Plan

Described in Section 7.1.3.1. The cost management plan defines how project costs will be managed and controlled. It includes the method used and the level of accuracy required to estimate activity cost.

7.2.1.2 Human Resource Management Plan

Described in Section 9.1.3.1. The human resource management plan provides project staffing attributes, personnel rates, and related rewards/recognition, which are necessary components for developing the project cost estimates.

7.2.1.3 Scope Baseline

The scope baseline is comprised of the following:

  • Project scope statement. The project scope statement (Section 5.3.3.1) provides the product description, acceptance criteria, key deliverables, project boundaries, assumptions, and constraints about the project. One basic assumption that needs to be made when estimating project costs is whether the estimates will be limited to direct project costs only or whether the estimates will also include indirect costs. Indirect costs are those costs that cannot be directly traced to a specific project and therefore will be accumulated and allocated equitably over multiple projects by some approved and documented accounting procedure. One of the most common constraints for many projects is a limited project budget. Examples of other constraints are required delivery dates, available skilled resources, and organizational policies.
  • Work breakdown structure. The WBS (Section 5.4) provides the relationships among all the components of the project and the project deliverables.
  • WBS dictionary. The WBS dictionary (Section 5.4.3.1) provides detailed information about the deliverables and a description of the work for each component in the WBS required to produce each deliverable.

Additional information that may be found in the scope baseline with contractual and legal implications, such as health, safety, security, performance, environmental, insurance, intellectual property rights, licenses, and permits. All of this information should be considered when developing the cost estimates.

7.2.1.4 Project Schedule

Described in Section 6.6.3.2. The type and quantity of resources and the amount of time which those resources are applied to complete the work of the project are major factors in determining the project cost. Schedule activity resources and their respective durations are used as key inputs to this process. Estimate Activity Resources (Section 6.4) involves determining the availability of staff, the number of staff hours required, and quantities of material and equipment needed to perform schedule activities. It is closely coordinated with cost estimating. Activity duration estimates (Section 6.5.3.1) will affect cost estimates on any project where the project budget includes an allowance for the cost of financing (including interest charges) and where resources are applied per unit of time for the duration of the activity. Activity duration estimates can also affect cost estimates that have time-sensitive costs included in them, such as union labor with regularly expiring collective bargaining agreements or materials with seasonal cost variations.

7.2.1.5 Risk Register

Described in Section 11.2.3.1. The risk register should be reviewed to consider risk response costs. Risks, which can be either threats or opportunities, typically have an impact on both activity and overall project costs. As a general rule, when the project experiences a negative risk event, the near-term cost of the project will usually increase, and there will sometimes be a delay in the project schedule. In a similar way, the project team should be sensitive to potential opportunities that can benefit the business either by directly reducing activity costs or by accelerating the schedule.

7.2.1.6 Enterprise Environmental Factors

Described in Section 2.1.5. The enterprise environmental factors that influence the Estimate Costs process include, but are not limited to:

  • Market conditions. These conditions describe what products, services, and results are available in the market, from whom, and under what terms and conditions. Regional and/or global supply and demand conditions greatly influence resource costs.
  • Published commercial information. Resource cost rate information is often available from commercial databases that track skills and human resource costs, and provide standard costs for material and equipment. Published seller price lists are another source of information.

7.2.1.7 Organizational Process Assets

Described in Section 2.1.4. The organizational process assets that influence the Estimate Costs process include, but are not limited to:

  • Cost estimating policies,
  • Cost estimating templates,
  • Historical information, and
  • Lessons learned.

7.2.2. Estimate Costs: Tools and Techniques

7.2.2.1 Expert Judgment

Expert judgment, guided by historical information, provides valuable insight about the environment and information from prior similar projects. Expert judgment can also be used to determine whether to combine methods of estimating and how to reconcile differences between them.

7.2.2.2 Analogous Estimating

Analogous cost estimating uses the values such as scope, cost, budget, and duration or measures of scale such as size, weight, and complexity from a previous, similar project as the basis for estimating the same parameter or measurement for a current project. When estimating costs, this technique relies on the actual cost of previous, similar projects as the basis for estimating the cost of the current project. It is a gross value estimating approach, sometimes adjusted for known differences in project complexity.

Analogous cost estimating is frequently used to estimate a value when there is a limited amount of detailed information about the project, for example, in the early phases of a project. Analogous cost estimating uses historical information and expert judgment.

Analogous cost estimating is generally less costly and less time consuming than other techniques, but it is also generally less accurate. Analogous cost estimates can be applied to a total project or to segments of a project, in conjunction with other estimating methods. Analogous estimating is most reliable when the previous projects are similar in fact and not just in appearance, and the project team members preparing the estimates have the needed expertise.

7.2.2.3 Parametric Estimating

Parametric estimating uses a statistical relationship between relevant historical data and other variables (e.g., square footage in construction) to calculate a cost estimate for project work. This technique can produce higher levels of accuracy depending upon the sophistication and underlying data built into the model. Parametric cost estimates can be applied to a total project or to segments of a project, in conjunction with other estimating methods.

7.2.2.4 Bottom-Up Estimating

Bottom-up estimating is a method of estimating a component of work. The cost of individual work packages or activities is estimated to the greatest level of specified detail. The detailed cost is then summarized or “rolled up” to higher levels for subsequent reporting and tracking purposes. The cost and accuracy of bottom-up cost estimating are typically influenced by the size and complexity of the individual activity or work package.

7.2.2.5 Three-Point Estimating

The accuracy of single-point activity cost estimates may be improved by considering estimation uncertainty and risk and using three estimates to define an approximate range for an activity's cost:

  • Most likely (cM). The cost of the activity, based on realistic effort assessment for the required work and any predicted expenses.
  • Optimistic (c0). The activity cost based on analysis of the best-case scenario for the activity.
  • Pessimistic (cP). The activity cost based on analysis of the worst-case scenario for the activity.

Depending on the assumed distribution of values within the range of the three estimates the expected cost, cE, can be calculated using a formula. Two commonly used formulas are triangular and beta distributions. The formulas are:

  • Triangular Distribution. cE = (c0 + cM + cP) / 3
  • Beta Distribution (from a traditional PERT analysis). cE = (c0 + 4cM + cP) / 6

Cost estimates based on three points with an assumed distribution provide an expected cost and clarify the range of uncertainty around the expected cost.

7.2.2.6 Reserve Analysis

Cost estimates may include contingency reserves (sometimes called contingency allowances) to account for cost uncertainty. Contingency reserves are the budget within the cost baseline that is allocated for identified risks, which are accepted and for which contingent or mitigating responses are developed. Contingency reserves are often viewed as the part of the budget intended to address the “known-unknowns” that can affect a project. For example, rework for some project deliverables could be anticipated, while the amount of this rework is unknown. Contingency reserves may be estimated to account for this unknown amount of rework. Contingency reserves can provide for a specific activity, for the whole project, or both. The contingency reserve may be a percentage of the estimated cost, a fixed number, or may be developed by using quantitative analysis methods.

As more precise information about the project becomes available, the contingency reserve may be used, reduced, or eliminated. Contingency should be clearly identified in cost documentation. Contingency reserves are part of the cost baseline and the overall funding requirements for the project.

Estimates may also be produced for the amount of management reserve to be funded for the project. Management reserves are an amount of the project budget withheld for management control purposes and are reserved for unforeseen work that is within scope of the project. Management reserves are intended to address the “unknown unknowns” that can affect a project. The management reserve is not included in the cost baseline but is part of the overall project budget and funding requirements. When an amount of management reserves is used to fund unforeseen work, the amount of management reserve used is added to the cost baseline, thus requiring an approved change to the cost baseline.

7.2.2.7 Cost of Quality (COQ)

Assumptions about costs of quality (Section 8.1.2.2) may be used to prepare the activity cost estimate.

7.2.2.8 Project Management Software

Project management software applications, computerized spreadsheets, simulation, and statistical tools are used to assist with cost estimating. Such tools can simplify the use of some cost-estimating techniques and thereby facilitate rapid consideration of cost estimate alternatives.

7.2.2.9 Vendor Bid Analysis

Cost estimating methods may include analysis of what the project should cost, based on the responsive bids from qualified vendors. When projects are awarded to a vendor under competitive processes, additional cost estimating work may be required of the project team to examine the price of individual deliverables and to derive a cost that supports the final total project cost.

7.2.2.10 Group Decision-Making Techniques

Team-based approaches, such as brainstorming, the Delphi or nominal group techniques, are useful for engaging team members to improve estimate accuracy and commitment to the emerging estimates. By involving a structured group of people who are close to the technical execution of work in the estimation process, additional information is gained and more accurate estimates are obtained. Additionally, when people are involved in the estimation process, their commitment towards meeting the resulting estimates increases.

7.2.3. Estimate Costs: Outputs

7.2.3.1 Activity Cost Estimates

Activity cost estimates are quantitative assessments of the probable costs required to complete project work. Cost estimates can be presented in summary form or in detail. Costs are estimated for all resources that are applied to the activity cost estimate. This includes, but is not limited to, direct labor, materials, equipment, services, facilities, information technology, and special categories such as cost of financing (including interest charges), an inflation allowance, exchange rates, or a cost contingency reserve. Indirect costs, if they are included in the project estimate, can be included at the activity level or at higher levels.

7.2.3.2 Basis of Estimates

The amount and type of additional details supporting the cost estimate vary by application area. Regardless of the level of detail, the supporting documentation should provide a clear and complete understanding of how the cost estimate was derived.

Supporting detail for activity cost estimates may include:

  • Documentation of the basis of the estimate (i.e., how it was developed),
  • Documentation of all assumptions made,
  • Documentation of any known constraints,
  • Indication of the range of possible estimates (e.g., €10,000 (±10%) to indicate that the item is expected to cost between a range of values), and
  • Indication of the confidence level of the final estimate.

7.2.3.3 Project Documents Updates

Project documents that may be updated include, but are not limited to, the risk register.