Chapter (3) and (4)

Defining the Project

Task
Estimating Project
Cost
 The importance of initial Project
definition:
1. An investor or customer needs to
be clear on what to expect in return
for the investment.
2. Before a contractor can offer to
carry out the project, it must know
its total commitment.
• How much work and materials will
be needed?
• What are the risks?
• How much of the project shall we
 The importance of initial Project
definition:
• Project definition starts when the idea
of a project is first conceived, at the
very beginning of the project life
history. Strictly, it does not end until
the last piece of information has been
filed to describe the project in its
finished.
• The Project definition includes:
• Describes the project
• Specifies the project deliverables
• Sets out the scope of what we have to do
• Provides the basis for our business plan.
 The importance of initial Project
definition:
If you've just been appointed project
manager, you will need answers to the
above questions.
• General project description: what's it all about?
• What is the required performance specification?
• Scope of supply: how much shall we have to do?
• What are the contract conditions?
• What will be our project strategy?
• How much will it cost?
• How long will it take?
• Where is the project to be done?
• What’s that location like?
 Feasibility Study to improve early
project definition
• The investor may commission a feasibility study from a consultant
or professionally orientated contracting company to obtain more
facts and expert advice. This approach is frequently used to
examine and appraise the technical, logistical, environmental,
commercial and financial aspects of all kinds of projects that
require a high level of investment.
• Feasibility study is necessary for the following reasons:
– Banks and other institutions asked to finance or otherwise
sponsor ill-defined projects may require a satisfactory
feasibility study report before committing funds.
– Government departments o en demand study reports for
projects which are of significant public or international
importance.
– a good feasibility study report can do much to point a project
in the right direction, recommend the most effective strategy
and define the risks and achievable objectives.
 Checklists
• Checklists are a very useful way of
ensuring that no important task or cost
item is forgotten when a new project is
being evaluated.
• Contractors who have amassed a great
deal of experience in their particular field
of project operation will learn the type of
questions that must be asked to fill most
of the information gaps and they can
develop comprehensive checklists for use
in project cost estimates and proposals.
 Checklists
• Example of a construction project check list:
– Is the scope of work includes (basic design only?
Full Design, Procurement responsibility?,
construction responsibility?, commissioning and
customer training? All these must be specified.
– Is the accommodation for workers is available in
the work site.
– Data about the climate, safety at the work site is
also important… etc.
 Inquiries and Proposals for New
Projects
• Sensible contracting company rules should
operate to ensure referral of customers’
inquiries/bidding invitations to the sales or
marketing department so that all enquiries
can be ‘entered into the system’ for effective
handling and response. This will ensure that
every enquiry received from a potential
external customer can be subjected to a
formal screening process that will assess its
potential project scope, risk and value.
 Inquiries and Proposals for New
Projects
A) Receipt and registration of project
enquiries:
- Every enquiry must be registered and
given a reference name or number that
identifies it uniquely.
- In the inquiries Register a space in
which the name and address of the
potential customer can be written,
together with the name and job title of
the person calling. There must also be
space for a summary of the work
required.
 Inquiries and Proposals for New
Projects
B) Screening enquiries from external
customers and clients:
• The work involved in responding to an
enquiry and preparing a tender can
constitute a small project in itself,
sometimes needing significant preliminary
engineering design work plus sales and
office so this effort that must be properly
authorized and budgeted.
• Screening can be based on:
– The reputation of the client in payment.
– The capability that the company has
relative to the inquiry.
Finally and based on the screening the
company will be able to decided whether
 Inquiries and Proposals for New
Projects
Customer’s Project Specifications:
• Initial enquiries from customers can take
many different forms. Perhaps it can be a
written description of the project
objectives will be provided.
• Further communications between the
customer and contractor, whether written
or spoken, can be long and protracted,
o en resulting in subsequent qualifications,
changes or additions to the original
request.
• All of these elements, when taken together
and documented, constitute the ‘customer
 Defining the Scope of work
• In more precise terms, the scope of work required from the
contractor (that is, the size of the contractor’s contribution to the
project) must be made clear.
• At its simplest, the scope of work required might be limited to
making and delivering a piece of hardware in accordance with
drawings supplied by the customer. At the other extreme, the
scope of a large construction or process plant project could be
defined so that the contractor handles the project entirely, and is
responsible for all work until the purchaser is able to accept
delivery or handover of a fully completed and proven project
• If a project contract is eventually agreed, the contractor will have
to ensure that the customer’s specification is satisfied in every
respect. The contractor’s commitments will not be confined to
the technical details but must also encompass the fulfilment of all
specified commercial conditions.
 Defining the Scope of work
• Example : Answers to all of these questions must
be provided, as part of the project task definition
before cost estimates, tenders and binding
contracts can be considered.
– Payment and invoicing terms for the work
done.
– Inspection and quality standards.
– well-defined statement of delivery
requirements.
– provision for penalties to be paid by the
contractor should the agreed project
completion date not be met.
– which responsibility for the work is to be
shared between the contractor.
– Will the contractor be responsible for any
training of the customer’s staff and, if so, how
much (if any) of this training is to be included
 Chapter 4
Estimating Project Cost
 Why Project cost estimating is
Important
• Without a cost estimate it would be
impossible to carry out:
– financial appraisal.
– prepare a business plan.
– establish detailed budgets.
– control spending.
– Assess manpower requirements.
 Terms commonly used in project cost
accounting
• Absorption costing – a method that attempts to recover indirect
costs (overheads) by apportioning them over all the company’s
direct costs.
• Below-the-line costs – a collective name for the various allowances
that are added once a total basic cost estimate has been made.
Below-the-line costs typically include allowances for cost
escalation, exchange rate fluctuations, contingencies and
provisional cost items.
• Cost escalation – increases in all costs above their original
estimates owing to national cost inflation and increases in wages
and salaries. Usually expressed as a rate per cent and only
significant in times of high inflation, or for projects planned to
last for several years.
• Direct costs – costs that can be directly attributed to project work.
These are also ‘variable costs’, because their rate of expenditure
depends on the intensity of project activity. When no work is
being done on the project, there are no direct costs.
 Terms commonly used in project cost
accounting
• Cost of sales – equivalent to the sum of all the
above-the-line costs shown in Figure 4.1.
• Indirect costs – costs that must be incurred by
the organization to provide heat, light,
accommodation, insurances, maintenance,
accountants, secretaries, welfare,
management salaries, and other general
running costs of the business that cannot
be attributed as costs to be charged to a
specific project. Because these costs do not
vary from day to day they are also ‘fixed
costs’. Also known as ‘overhead costs’.
However, the administration and
accommodation costs of a construction
site are a special exception because they
 Terms commonly used in project cost
accounting
• Labour burden – an amount, usually a percentage of wages or salaries,
that is added to the basic hourly or weekly rate for employees to
allow for non-working time and various additional expenses such
as the cost of paid holidays, amounts payable by the employer as
employee benefits, either voluntarily or as a requirement of the
national legislation (social insurance, medical coverage).
• Materials burden – an amount added by some contractors to the
actual cost of bought out materials to recover their purchasing
administration costs. This might be charged at 10 per cent or less
for very high-cost but at (say) 25 per cent on small low-cost items
that have relatively high handling and administration costs. A
common all-round rate used for the materials burden is 15 per
cent.
• Overhead rate – more properly called the overhead absorption rate,
this is a rate calculated by accountants that expresses the company’s
total expected overhead costs for a given period (usually a year)
as a proportion of the expected direct costs over the same period.
It is used to calculate the overhead recovery amount included in
Typical summary layout of a project cost estimate
Cont.
 CLASSIFICATION OF ESTIMATES
ACCORDING TO CONFIDENCE
• The classifications of project cost
estimates depend on the quality of
information available to the estimators,
the time allowed for preparing the
estimates and the stage reached in the
project life history.
• The following estimating methods are
ranked based on the level of confidence
of the estimates from law confidence to
high confidence, therefore, All those
using estimates for pricing decisions,
setting budgets, financial planning or
 CLASSIFICATION OF ESTIMATES
ACCORDING TO CONFIDENCE
1. Ballpark estimates: are based on informed
intuition of the estimator in the situations
where: The detailed information necessary
for a more detailed estimate is available
but there is insufficient time allowed for its
proper consideration.
• They are particularly valuable for carrying
out preliminary checks on possible
resource requirements, for screening
enquiries for tenders and for other early
decisions.
• Ballpark estimates are unlikely to provide
sufficient accuracy for other purposes and
 CLASSIFICATION OF ESTIMATES
ACCORDING TO CONFIDENCE
2. Comparative estimates: The
estimator looks for cost records of
similar past projects and adapts
those to estimate the current project
cost.
• Comparative estimates are
commonly used as the basis for
tenders when the time available for
tendering is very short, but many
allowances should be added for
 CLASSIFICATION OF ESTIMATES
ACCORDING TO CONFIDENCE
3. Feasibility estimates: Conceptual
design is done and quotations have
been obtained for major
components and materials.
• Mainly used for construction
tendering.
 CLASSIFICATION OF ESTIMATES
ACCORDING TO CONFIDENCE
4. Definitive estimates cannot be made
until most design work has been finished,
all significant purchase orders have
been placed at known prices and
work on the project is well advanced
or nearing completion.
• Definite cost estimate are created by
updating the original comparative
or feasibility estimates with the
actual costs routinely as part of the
 CLASSIFICATION OF ESTIMATES
ACCORDING TO CONFIDENCE
Conclusively; All those using estimates for
pricing decisions, setting budgets, financial
planning or any other purpose need to be
aware of how much confidence can be placed
in the figures put before them. If the
organization’s estimating procedures
recognize and define different categories,
such as ballpark, comparative, feasibility,
definitive or whatever, then managers can
make their decisions accordingly.
 Estimating accuracy in relation to
prices and profits
• It is difficult to lay down rules on the
degree of estimating accuracy
needed for setting fixed prices.

• Different companies will

undoubtedly have their own rules
or traditions.

• For pricing purposes much depends

on the size of the intended profit
margin, since a large margin will
 Vulnerability of Profit Margins To
Estimating Errors And Cost Variances
• Planned profits can fall victim to
many risks.

• Some of these can be predicted but

others o en come as unpleasant
surprises.

• The aim must be to reduce the

number of unknown variables or
risks as far as possible, and then
 Version Control of Project Cost
Estimates
• It is not unusual, especially for large capital projects, for
protracted technical and feasibility discussions to take
place between the contractor and the potential client
before agreement and authorization of a final version of
the project specification and its associated cost estimate.
• The client’s ideas on project scope might change during
these discussions, and some versions could envisage
different roles for the contractor.
• Each different version of a proposed project is certain to
require its own, unique, cost estimate.
• For example, suppose that a project specification were to
be developed and given the serial number X1234. As
different strategies and solutions are investigated, the
relevant versions of the project specification would be
numbered X1234 case A, X1234 case B, X1234 case C and
so on. Each cost estimate can then carry the same serial
 Top – Down Or Bottom – Up?
• There are two fundamentally
opposite ways of approaching cost
estimating for a large project.

• The approach taken depends upon

the time available, the degree of
accuracy expected and, above all,
the level of project definition.
 Top-down
• Very early in the project life history, there will be
outlines for the nature and scope of the project, but
certainly no detailed task list or comprehensive work
breakdown.
• Thus cost estimates can be made only on a global
comparative basis. That means trying to assess the cost
of the whole project by comparing it with similar
projects that have been completed in the recent past
and for which their actual cost records can be accessed.
• If the project can be divided into a few major parts at
this early stage, it should be possible to distribute the
total estimate over those parts, remembering to leave
something in reserve in the form of a separate
contingency item.
• Thus all estimates originate from the whole, or top of
the project, which is why this approach is called top-
down.
• Disadvantage: not based on detailed Specification.
• Disadvantage: The estimation is less riskier as it’s
compared to bottom-up estimation as it is based on
 Top-down
.
Considers
the
whole
project
first.

Greater
detail
might
not be
possible
 Bottom-up estimating
• The opposite extreme to the top-down
approach is bottom-up estimating.
• This method can only take place when a
good project specification exists and a
fairly complete task list has been compiled.
• Bottom-up estimating begins at the lowest
level of detail, and is gradually extended
up through the hierarchical structure of
the project until the total estimated project
cost is reached at the top of the tree.
• Advantages: More accurate it is based on
an identified project specification.
• Disadvantages: Some Cost items maybe
ommitted.
Bottom-up estimating
• .
Builds up
in detail
from the
bottom
of the
task list
or work
breakdown
structure
 Bottom up estimating Methods
A) Compiling The Task List
• The first stage in the bottom-up cost
estimating process is to compile a
complete list of every known item that
is going to cost money.
• This can prove difficult. But any item
unintentionally le out of the cost
estimates will result in an
underestimate for the project as a
whole.
• And, of course, if the project has been
sold for a fixed price, any items
forgotten by the estimator must be
 B) Work breakdown structure as a
starting point
• Preparation of a work breakdown
structure complete with cost codes, is a
logical way of considering the total
project and should reduce the risk of
errors of omission in cost estimates.
• Many of the smaller cost items will be
unknown or ill-defined at this
estimating stage and it would be
difficult or impossible to compile a
work breakdown structure in sufficient
detail for bottom-up estimating.
• many important decisions usually
depend on these estimates, including
fixed-price quotations and project
 C) Using checklists
• One very useful way of helping to
prevent forgotten tasks is to use
checklists, such as those used for
early project definition .
• Every company with sufficient
experience candevelop these.
• A full checklist would include all
possible factors – technical,
commercial, environmental, and so
on – that might eventually have a
bearing on the work and its costs.
 Level of Detail in Project Cost
Estimating
• Some difficulty might be experienced in
deciding how much detail to show in the
task list. What is a ‘task’ for this purpose?
• Each task should be selected so that it is
small enough to be visualized easily, for
estimating purposes.
• On the other hand, the task must be large
enough to represent a measurable and
significant part of the whole project.
• The design and manufacture of each
subassembly from a main piece of
equipment might rank as a task, while the
final assembly of all these subassemblies
 Estimating Format
• Completion of a task list has established the basis
for project cost estimating.
• When the estimates have been collected they will
contain a large amount of data.
• These data should be presented in a format that will
allow easy reference, detailed analysis and extension
into total amounts – whether for departmental costs
or for packages at any level of the project work
breakdown.
• Estimates should be tabulated according to a
standard company procedure, itemized where
possible by cost codes within the work breakdown
structure.
• Some cost estimates, especially national
government projects, may be liable to investigation
by external auditors at one or more stages. These
investigations can be exhaustive and taken into
considerable detail. Paying careful attention to logic
 Estimating Format
• The general purpose format in
Figure 4.3 allows for six labor grades
to be shown and assumes that all
hours will be costed at standard cost
rates.
Estimating Format
Figure 4.5 General purpose format for indicating the price of a small
project
Cont.
 Estimating Project Labor Cost
• Application of standard costing to
labor cost estimates Standard costs
make the life of the cost estimator
relatively easy, because there is no
need to consider differences in wages
or salaries paid to different people of
equivalent staff grade.

• For a standard costing system, the first

step in determining standard labor cost
rates is to classify people according to
some convenient rules (usually based
 Estimating Project Labor Cost
• Generally speaking, while wages and their
related standard cost rates change from
year to year, the time needed to carry out
any particular job by a given method
should not.
• Wherever possible, estimates for project
labor times should be obtained from
managers or senior individuals of the
departments that are going to be
responsible for carrying out the project
tasks later.
• If the labor estimates for a project are to
be obtained from a number of different
departmental managers or their senior
representatives, it follows that the set of
Personal Estimating Characteristics
• Project cost estimating is never an exact
science. Much of the process, particularly
when estimating labor times, has to rely
on the subjective judgment of individuals.
• In fact, just as it is possible to classify
estimates according to confidence in their
accuracy, so it is possible to classify the
estimators themselves.
• Optimistic estimators
• Pessimistic estimators
• Inconsistent estimators
• Accurate estimators
 Estimate For Material And Equipment
Costs
• Materials always need two types of estimate. For each
purchase these are as follows:
– total expected cost, including all charges and taxes payable in
transporting the materials to the project location;
– total lead time, which is the time expected to elapse between
issuing the purchase order and receiving the consignment
(failure to get materials on time is a common cause of delays
and late project completion).
• The responsibility for estimating materials, therefore, lies
in two areas. The engineers or other design
representatives must specify what materials are going to
be used. The purchasing department should be expected
to find out how much those materials will cost and how
long they will take to obtain.
• Another cautionary word concerns the period of validity for
quotations received from potential suppliers. Project cost
estimates are o en made many months – even years –
before a contract is eventually awarded. Suppliers’
quotations are typically valid for only 90 days or even less,
so that there could be a problem with the materials cost
budget or the availability of goods when the time eventually