How to calculate your project cost
Calculating your project cost is crucial to project success. If you don't want to come in way over budget, you have to take different aspects into account and learn the skill of reliable project cost estimation.
How to create a solid project cost plan? Which elements are crucial for a successful cost management?
Cost management consists of different disciplins which come into play depending on the project phase your project is currently in: cost planning, budgeting and cost controlling. At the beginning of each project, you need to follow a process for cost planning.
Definition: cost planning
First, you have to identify the different (estimated) project costs. This is called project calculation and it consists basically of different detailed cost plans.
The cost plan itself is only defined very loosely: A cost plan states which estimated costs will be necessary to complete the different work packages of a project and therefore must be taken into account for the overall project cost.
The term cost baseline refers to a cost plan with approved positions which also takes into consideration the cost for risk and opportunities management.
A cost plan should be part of the project manual. It is a tool to help the project manager to make sure his calculation will work. In other words: Planning, estimation, budgeting and controlling will remain in the defined budget.
You can choose from different methods of cost planning. Often, project managers use visual or tabular presentations.
Methods of cost planning
The workbreakdown structure is the basis for any cost plan. There are two different methods to calculate project costs.
You can either start calculating the different costs for each work package. The sum will then indicate the overall budget (bottom-up planning). Or you can define a budget for the project as a whole and then divide it to the needed work packages (top-down planning). That’s the difference between top-down vs. bottom-up planning in a nutshell.
You might wonder how you reach a realistic cost estimation for specific project activities? There are different options to consider:
1. Use historical project data
If you have completed similar projects in the past, you can use plan values of the past for your new project. For this method to deliver great results the framework conditions of the projects in question must be very close which is the main downside of this approach. As in the end, each and every project is different. Besides, you have to consider price volatility. After all, this method mainly leads to satisfying results when you operate with stable cost like rent or insurance.
2. Deduce trends
If there are enough past values, you can use them to deduce trends which will show as a linear or exponential function of time. This approach leads to better accuracy than simply using historical data for current planning. Another plus, this method is cost efficient and fairly quick. However, the results are not as reliable as they could be.
3. Do the maths
Many costs vary over time and depend on other planning steps. The better you capture each parameter, the better your overall cost calculation. Space rent, for example, will vary depending on the size of area you need. Try to get as much information as possible about every cost position to develop a valid formula for cost calculation.
4. Ask experts
Gathering expert opinions can help avoid unrealistic planning. Prices are influenced by a lot of different factors, i.e. developments and trends in financial markets, commodity prices or collective negotiations. If employees of different company departments and external experts share their knowledge it will lead to a much more reliable forecast.
You can combine those different methods in a single project. Depending on which costs you want to calculate it makes sense to combine trend analysis, expert opinion and mathematical calculation.
Common mistakes when creating a cost plan
The methodology of creating a cost plan, as we described above, is not complicated. If you use templates, it gets even easier. However, reality shows that most projects come in way over budget. Why is that? There are three systematic errors which are responsible for miscalculations time and again.
- Cost optimism: Some project manager tend to underestimate staff costs. Biased by motivation and a wish for productivity they estimate too little time and resources.
- Fear based budgeting: Other project manager practice the opposite. In fear of tight calculation, they work with extensive buffers which raises the project costs unnecessarily.
- Lack of knowledge: If you manage to neither calculate too tight nor add unnecessary buffers, don't fall into the trap to only rely on your own expertise. The more expert knowledge you integrate, the better your planning.
How to find the right tools to create a cost plan that actually works
Successful cost and resource planning needs the right software. Excel is still one of the most popular choices, especially for small projects. There are lots of templates available to make working with this tool easier. And excel might be a good fit for private projects. But as soon as you manage professional projects you should make a different choice and use software which has more to offer and reflects current technological standards.
Most project management applications integrate tools for project calculation which is convenient as cost planning is based on the work breakdown structure. If you use integrated tools you can plan and control your project costs much more comfortable as if you used a separate software. Professional project management software offers for example a simulation of different project scenarios and shows consequences for budget planning.
Developing a cost plan ist no rocket science. With a methodical process and the right software you can develop a solid cost plan and deliver results in time and budget.
Cost planning is however only the first step of cost management. For a project to be considered financially successful, you also need to master cost controlling.