The process of determining budget for a project
is an activity of aggregating the cost estimates of individual
activities, or a work package, to develop the total cost estimate that
allows setting a formal cost baseline.
The Project budgeting process involves two steps. First, the project cost estimate is allocated to the various work packages in the project work breakdown structure. Second, the budget for each work package is distributed over the duration of the work package so that's possible to determine how much of its budget should have been spent at any point in time.
1. Allocating the Total Budgeted Cost
Allocating total project costs for the various elements, such as Labor, Materials and Subcontractors to the appropriate work packages in the work breakdown structure will establish a Total Budgeted Cost (T.B.C) for each work package. There are two approaches to establishing the T.B.C for each work package. One is a top down approach , in which Total Project Cost (For labor, materials and so forth) are reviewed in relation to the work scope for each work package, and a proportion of the total project cost is allocated to each work package.
The other is a bottom up approach, which is based on an estimate of the costs for the detailed activities associated with each work package. The project costs is usually estimated when the proposal for the project is prepared, but detail plans are not usually prepared at this time. At the start of the project, however, detailed activities are defined and a network plan is developed. Once detailed activities have been defined, time, resource, and cost estimates can be made for each activity. The T.B.C for each work package will be the sum of the costs of all the activities that make up that work package.
Figure 1.0 illustrates the allocation of costs to individual work packages in the work breakdown structure for a $ 600,000 project. The amount allocated to each work package represents the T.B.C for completing all the activities associated with the work package. Whether the top down or the bottom up approach is used to establish the total budgeted cost for each work package, when the budgets for all the work packages are summed, they can not exceed the total project budgeted cost.
Figure. 2.0 is a network diagram for a project to make a specialized automated packaging machine and install it at the Customer's factory. The machine will insert the customer's product into boxes rolling by at high speed on conveyor. The project consists of three activities, and the network diagram shows the duration for each activity.
2. Developing the Cumulative Budgeted Cost
Once a total budgeted cost has been established for each work package, the second step in the project budgeting process is to distribute each T.B.C over the duration of its work package. A cost is determined for each period, based on when the activities that make up the work package are scheduled to be performed. When T.B.C for each work package is spread out by time period, it can be determined how much of the budget should have been spent at any point in time.
This amount is calculated by adding up the budgeted costs for each time period up to that point in time. This total amount, known as the Cumulative Budgeted Cost (CBC), is the amount that was budgeted to accomplish the work that was scheduled to be performed up to that point in time. The CBC is the baseline that will be used in analyzing the cost performance of the project.
For the packaging machine , Figure 4.0 shows how the T.B.C for each work package is spread over the time periods, based on the estimated duration shown in Figure 2.0, also shown is the period by period budgeted cost for the entire project, as well as its cumulative budgeted cost (CBC). Figure 4.0 indicates that $ 32,000 was budgeted to accomplish the work that was scheduled to be performed through week 5.
The Period over which budgeted costs are spread usually are determined by the earliest start and finish times for the activities in the baseline project schedule (adjusted to take into account resource leveling or resource limited scheduling)
With the CBC value's, its possible to draw a cumulative budgeted cost curve to illustrate budgeted expenditure over the duration of project. Figure 5.0 shows the cumulative budgeted cost curve for the packaging machine project. Although the table in Figure 4.0 and the cost curve in Figure 5.0 display cumulative budgeted cost for the total project, a similar table and curve can be made for each work package, if desired.
The CBC for the entire project or each work package provides a baseline against which actual cost and work performance can be compared at any time during the project. It would be misleading to merely compare actual amounts expended to the total budgeted cost for the project or work package, as cost performance will always look good as long as actual costs are below the T.B.C.
Inputs to Project Cost Budgeting
You will want to enter the cost budgeting phase of a project well-equipped. To do this, you will need to know what the inputs to cost budgeting are, and you should understand their importance to the budgeting process.
During cost budgeting, a number of project elements come together to form the project's cost baseline. The following four inputs are used in the cost budgeting process.
During cost budgeting, a number of project elements come together to form the project's cost baseline. The following four inputs are used in the cost budgeting process.
1. The project's work breakdown structure (WBS)
The project's work breakdown structure is important in cost budgeting because it organizes all project activities into work packages. Cost budgeting involves assigning a budget, or cost account, to each work package.
Can you imagine trying to assign budgets to project elements if the work was not organized in some way? Without reference to the WBS, vital costs may be overlooked. Any omissions would cause variances later on between planned and actual costs, and cost performance may be reported as "poor."
Part of creating the work breakdown structure is assigning accounting codes to project tasks and activities based on the organization's chart of accounts. Budgeting is simplified when the cost accounts are integrated in this way.
Can you imagine trying to assign budgets to project elements if the work was not organized in some way? Without reference to the WBS, vital costs may be overlooked. Any omissions would cause variances later on between planned and actual costs, and cost performance may be reported as "poor."
Part of creating the work breakdown structure is assigning accounting codes to project tasks and activities based on the organization's chart of accounts. Budgeting is simplified when the cost accounts are integrated in this way.
2. The cost estimates for the work
You have made predictions about the costs of the resources required to complete your project's activities. These cost estimates are another important input to cost budgeting.
The budget for each work package is based on the estimates you have prepared. For budgeting purposes, you should be using budget or control estimates with a range of 15 percent or better. The budgeting process may increase an estimate's range by adding an appropriate allowance or contingency to cover the risk of overruns.
The budget for each work package is based on the estimates you have prepared. For budgeting purposes, you should be using budget or control estimates with a range of 15 percent or better. The budgeting process may increase an estimate's range by adding an appropriate allowance or contingency to cover the risk of overruns.
3. The project schedule
The third input to cost budgeting is the project schedule. In fact, it is the application of the schedule to the project budget that produces your main tool for cost control: the project's cost baseline.
Once budgets have been assigned to work packages, use the schedule to distribute the predicted costs over time. The project schedule includes the expected start and finish dates for each activity to which costs will be allocated. This information is important to the cost budgeting process because allocated funds must be assigned to the time period in which the costs will be incurred.
As you develop the control budget for your project, you'll find that a bar-chart diagram can be useful. Use it to measure the total costs that fall within each week for planning or comparative purposes. You can easily measure the cumulative costs as the project progresses.
Time-phasing the budget in this way provides the project's cost baseline. Information about cumulative costs over time is also used to determine the project's "burn rate"—that is, the rate at which funds are expended.
Once budgets have been assigned to work packages, use the schedule to distribute the predicted costs over time. The project schedule includes the expected start and finish dates for each activity to which costs will be allocated. This information is important to the cost budgeting process because allocated funds must be assigned to the time period in which the costs will be incurred.
As you develop the control budget for your project, you'll find that a bar-chart diagram can be useful. Use it to measure the total costs that fall within each week for planning or comparative purposes. You can easily measure the cumulative costs as the project progresses.
Time-phasing the budget in this way provides the project's cost baseline. Information about cumulative costs over time is also used to determine the project's "burn rate"—that is, the rate at which funds are expended.
4. The risk management plan
Finally, the risk management plan is an important input to cost budgeting. It outlines strategies for dealing with potential risks that could cause project cost overruns. It also can include cost contingencies that are based on the reliability of your cost estimates. You will build contingencies into the budget to compensate for potential cost overruns.
An accurate and appropriate budget is one of a project manager's greatest assets when it comes to cost management. Understanding the inputs to cost budgeting will help you to create such a budget.
An accurate and appropriate budget is one of a project manager's greatest assets when it comes to cost management. Understanding the inputs to cost budgeting will help you to create such a budget.
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