Project Management chapter 7 - Budgeting New.pptx
- 1. 1 Project Management: A Managerial Approach Chapter 7 – Budgeting and Cost Estimation
- 2. 2 Budgeting and Cost Estimation • The budget serves as a standard for comparison • It is a baseline from which to measure the difference between the actual and planned use of resources • Budgeting procedures must associate resource use with the achievement of organizational goals or the planning/control process becomes useless • The budget is simply the project plan in another form
- 3. 3 Estimating Project Budgets • In order to develop a budget, we must: – Forecast what resources the project will require – Determine the required quantity of each – Decide when they will be needed – Understand how much they will cost - including the effects of potential price inflation • There are two fundamentally different strategies for data gathering: – Top-down – Bottom-up
- 5. 5 Top-Down Budgeting • This strategy is based on collecting the judgment and experiences of top and middle managers • These cost estimates are then given to lower level managers, who are expected to continue the breakdown into budget estimates • This process continues to the lowest level – Aka: BBS – Budget Breakdown Structure
- 6. 6 Top-Down Budgeting • Advantages: – Aggregate budgets can often be developed quite accurately – Budgets are stable as a percent of total allocation – The statistical distribution is also stable, making for high predictability – Small yet costly tasks do not need to be individually identified – The experience and judgment of the executive accounts for small but important tasks to be factored into the overall estimate
- 7. 7 Bottom-Up Budgeting • In this method, elemental tasks, their schedules, and their individual budgets are constructed following the WBS or project action plan • The people doing the work are consulted regarding times and budgets for the tasks to ensure the best level of accuracy • Initially, estimates are made in terms of resources, such as labor hours and materials • Bottom-up budgets should be and usually are, more accurate in the detailed tasks, but it is critical that all elements be included
- 8. 8 Bottom-Up Budgeting • Advantages: – Individuals closer to the work are apt to have a more accurate idea of resource requirements – The direct involvement of low-level managers in budget preparation increases the likelihood that they will accept the result with a minimum of aversion – Involvement is a good managerial training technique, giving junior managers valuable experience (??)
- 9. 9 Budgeting • Top-down budgeting is very common • True bottom-up budgets are rare – Senior managers see the bottom-up process as risky – They tend not to be particularly trusting of ambitious subordinates who they fear may overstate resource requirements – They are reluctant to hand over control to subordinates whose experience and motives are questionable
- 10. 10 Work Element Costing • The actual process of building a budget - either top- down or bottom-up - tends to be a straightforward but tedious process • Each work element in the action plan or WBS is evaluated for its resource requirements, and then the cost • Direct costs for resources and machinery are charged directly to the project. Labor is usually subject to overhead charges. Material resources and machinery may or may not be subject to overhead. • There is also the General and Administrative (G&A) charge
- 11. 11 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
- 12. 12 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
- 13. 13 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
- 14. 14 Program Budgeting • Project Budget by Task and Month Task I J Estimate 1 2 3 4 5 6 7 8 Monthly Budget (£) A 1 2 7000 5600 1400 B 2 3 9000 3857 5143 C 2 4 10000 3750 5000 1250 D 2 5 6000 3600 2400 E 3 7 12000 4800 4800 2400 F 4 7 3000 3000 G 5 6 9000 2571 5143 1286 H 6 7 5000 3750 1250 I 7 8 8000 2667 5333 J 8 9 6000 6000 75000 5600 12607 15114 14192 9836 6317 5333 6000
- 15. 15 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
- 16. 16 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 organization’s “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
- 17. 17 Learning Curves • Studies have shown that human performance usually improves when a task is repeated • In general, performance improves by a fixed percent each time production doubles • More specifically, each time the output doubles, the worker hours per unit decrease to a fixed percentage of their previous value • That percentage is called the learning rate • The project manager should take the learning curve into account for any task where labor is significant