Chapter - 6 Pricing Estimates and Cost Control

7/31/2019 Chapter - 6 Pricing Estimates and Cost Control.

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PRICING ESTIMATES

AND

COST CONTROL


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COST ESTIMATES Cost estimation is prediction. Little deviation in cost estimating

is certain. There is an inherent need for accurate forecasts ofcosts in all of the business activities for obvious reasons. The usesof a cost estimate are:

1. From a cost estimator point of view, the cost estimaterepresents an estimated required expenditure for the

project/activity under consideration, based on the agreed scopeof work.

2. From the management point of view, the cost estimatedetermines whether a project or activity goes forward or not.

3. From contractors point of view, the cost estimate determineswhether or not they can be successful in bibbing and winning acontract and in making a profit on the work.


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The project cost usually contains:

1. Labour cost.

2. Materials cost.

3. Subcontractors.

4. Equipments.

5. Indirect cost(travel/training)

6. Over heads.


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PROJECT COST SYSTEM(PCS) PCS aims at controlling the project cost, by keeping acheck on actual cost as compared to the estimatedcost.

Since PCS cover the costs incurred at various stages inan integrated form, the total cost incurred at any given

point of time can be easily computed.

Cost records including duration are maintained activity

wise in the form of cost cards with particulars ofestimated time to start, completion time.

The memorandum cards require upgradation atfrequent intervals.


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The project manager or the authorized person isrequired to authorize the use of resources at every stageof consumption. This should be updated from time totime.

The project manager should constantly check theactual expenses against the budget for each stage.


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RISK ANALYSISRisk analysis is the process of separating the

whole of risk into its component parts by

assessment of the risk and relateduncertainties for the purpose of efficientmanagement of the risk, facilitated by

effective communication about the risks.A risk analysis of costs therefore necessitates

assessing the risk, managing the risk and

communicating about the risk to others.


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The three components of risk analysis are:

1. Risk assessment: is a systematic process for quantifyingand describing the nature, likelihood of risk associatedwith some situation, event or action.

2. Risk management: is a process of identifying, evaluating,selecting, implementing and monitoring actions taken toalter levels of risk while taking all considerations.

3. Risk communication: is a open two way exchange ofinformation and opinion about risk leading to betterunderstanding of risk and better management decisions.


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TYPES OF COST ESTIMATES Order of Magnitude Estimate: it marks the

beginning of the budget and project management

process. It is an approximate estimate madewithout detailed data. This type of estimate is usedduring the formative stages of an expenditureprogram for initial evaluation of the project.

Feasibility study estimate: is normally prepared bythe operating contractor for the proposed projectprior to completing conceptual design.


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Preliminary estimate: is prepared to ensureproject feasibility and attainable

performance levels, to develop a reliableproject cost estimate consistent withrealistic schedules, to use it to establish

baseline project definitions, schedule andcosts.

Detailed estimate: are the final estimates of

the assessment phase.


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TYPES OF CLASSIFICATION OF

ESTIMATESThe cost estimates can be divided into two

broad classifications:

1. Project Capital cost: which refers to theproject cost for capital assets of the project.

2. Project Operating cost: which refers to the

cost incurred for operation of the projectassets which lead to income generation.


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TOOLS IN MANAGING COST Total Quality Management (TQM): It is an

approach that tries to achieve and sustain long-

term organizational success by encouragingemployee feedback and participation, satisfyingcustomer needs and expectations, respectingsocietal values and beliefs and obeying government

rules and regulations. It provides the overallconcept that fosters continuous improvement in anorganization.


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Value Analysis and Value Engineering: Valueanalysis is the study of relationship of design,

function and cost of any material or serviceswith an objective of reducing its cost throughmodification of design or materialspecifications, manufacture by more efficient

process, changes in sources of supply,elimination or incorporation into anotheritem.


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Value engineering is an analysis of the functionsof a program, project, system, product, item ofequipment, building, facility, service or supply ofan executive agency, performed by qualifiedagency or contractor personnel, directed atimproving performance, reliability, quality,safety, and life cycle costs.


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CONTROL OF PROJECT COST The following steps, if implemented properly, will help in

controlling the project cost to a great extent:1. Set a target for cost of the project. This should be allotted

as per work package and closely monitored.2. The major heads of accounts, adopted as per norms of

accounting, may be subdivided as per requirement.3. Each cost point of the project should be run as a profit

centre.

4. The management must call for periodic statements andreports about the progress of work and they should keepan eye on variance.

5. Incase of variance beyond a limit, the reasons must beanalyzed.


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APPROACHES TO COST ESTIMATING When we take up the topic of cost and budget, we may

consider two more classification of estimates i.e.,Macro and Micro. Macro estimates are also known as

top-down estimates and Micro estimates are known asbottom up estimates.

Macro estimates are done by an experienced seniormanager. By his experience, the manager generally

predicts the duration and cost of the project. It is notnecessary that the top manager should have a thoroughknowledge of the process involved in the projectexecution or an expert in that field.


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In Micro estimates, the project is defined well inadvance. People at the operating level or even work

package level can estimate the time and cost for aparticular type of work. This turns out to be moreefficient as it comes from the people with hands onexperience at work package level.


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LABOUR DISTRIBUTIONThe labour distribution consist of doing

time-phased distribution of man hours.

These man-hours are then multiplied by theprojected labour rates. Later the labour costarrived at in that way is reviewed for

reasonableness. The labour distribution areused as a basis for Estimate to Complete(ETC) and Estimate at Complete (EAC)reports.


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MATERIAL/SUPPORT COSTS Out of all the prices the material prices are usually the most

forward to be determined. The most reliable source is thesupplier. However the estimator must ensure the following

factors:1. The material quoted is the correct model number, colourand finish.

2. The price includes delivery to the job site.

3. Adequate warranties and guarantees are provided.

4. There is adequate stock available.

5. Payment terms, discounts and credits are welldocumented.


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OVERHEAD This is usually carried as a percentage and includes

costs like office rent or real estate costs, vehicles,clerical staff, top management salaries, marketing,legal and accounting fees.


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BUDGETING It is the determination costs associated with the defined

activities. The steps associated with budgeting are highlydependent upon both the estimated length of tasks and the

resources assigned to the project. Initial budgeting estimates are often based on the

availability of funds. Budget estimates are refined in theplanning process until they are baselined at project start up.

Budgeting serves as a control mechanism where actual costcan be compared with and measured to the budget. Thebudget is often a fairly set parameter in the execution of the

project.


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PROJECT VARIANCE A variance is defined as any schedule, technical

performance or cost deviation from a specific plan. Varianceare used by all levels of management to verify the budgeting

system and the scheduling system. The budgeting and scheduling system variance must be

compared together because-

1. The cost variance compares deviations only from thebudget and does not provide a measure of comparison

between work scheduled and work accomplished.2. The scheduling variance provides a comparison between

planned and actual performance but does not includecosts.


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There are two primary methods of measurement:

1. Measurable efforts: discrete increments of work witha definable schedule for accomplishment, whosecompletion produces tangible results.

2. Level of efforts: work that does not lend itself to subdivision into discrete schedule increments of work,

such as project support and project control.


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EARNED VALUE It is a project management technique for estimating how

much a project is doing in terms of its budget and schedule.It compares the work finished so far with the estimates

made in the beginning of the project. This gives a measureof how far the project is from completion. By extrapolatingfrom the amount of work already put into the project, theproject manager can get an estimate on how muchresources the project will have used at completion.

The simple way to think earned value is to equate it physicalprogress. As name only implies, it is something that isgained through some effort. In project management, thisvalue is earned as activities are completed.


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Earned value analysis is an industry standard way to:

1. Measure aprojects progress,

2. Forecast its completion date and final cost, and3. Provide schedule and budget variance along the way.


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STATUS REPORTING The project manager is required to report the progress of theproject to its stakeholders at intervals, this can be done at thecompletion of milestone or at frequent intervals as desired by themanagement. It is also referred to as monitoring and reporting. It

covers : System for project implementation: It includes defining project organization with responsibilities. It

should have a project manger throughout the project as a teamleader and different groups entrusted with specific workresponsibilities.

Organization should bring clear cut guidelines on systems andpolicies to be followed in execution, exercise of authorities,documentation for quality output as per design, start and finishdate of each work package should be defined with budgets.


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Monitoring with respect to budget cost in respect ofwork package should cover:

Actual progress against the budgeted progress.

Actual cost incurred against budgeted cost .

To record if there is change in design under theauthority of the authorized person.

Possible effect of time and cost overrun if any.


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FEATURES OF

GOOD STATUS REPORTINGAccess: the project tracking and reporting system is

intended to serve agency personnel as authorizedby the person responsible for informationtechnology for the organization.

Contents: it includes project information, overallstatus, current status, milestone progress, financial

status, issues. Ease of use: it is essential that information be

available electronically, at the users initiative.


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Frequency: project status reports should beprepared and submitted quarterly.

Retention: they should maintain all project statusreports and other documents in the project folderfor the duration of the project.

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Chapter - 6 Pricing Estimates and Cost Control