Laury has taught in professional adult education settings for over 10 years and is currently working on a PhD in Organizational Psychology.
Financial planning is key to making smart project budget decisions. In this lesson, we'll learn about the two major types of budget estimates and how to develop a project budget.
Project Financial Planning
Sue owns a growing landscaping company. For years, she's developed and managed budgets for her customers' projects, but she now has more than she can handle alone. Today, Sue is interviewing Sam, her first employee, and she is asking about project financial planning.
Project financial planning is the process of determining project costs and developing a budget. Good financial planning has many benefits, including estimating profit, reducing financial risk, and planning for unexpected costs. For Sue's business, project financial planning starts with estimating how much it will cost to complete a project, using either top-down or bottom-up estimating.
Sue wants to make sure that Sam will be able to provide her customers with accurate project cost estimates, so she begins the interview by asking him to explain the difference between top-down and bottom-up estimating methods. Sam is very familiar with both and begins by describing top-down cost estimating.
Top-down cost estimating starts with a final project cost and estimates which project features can fit within those costs. In the landscape business, top-down estimating means a customer has a final budget in mind and wants to know what designs can be done within that budget number. Sam explains top-down estimating using a previous customer that had a budget of $5,000, which allowed for new flowerbeds, a rock retaining wall, and a small water feature. Top-down estimating is usually done without going into details by relying on previous data of similar projects; it is the 'first pass' at a project budget.
By comparison, in bottom-up cost estimating, the features a customer wants determine the final budget. In other words, a project manager first determines the desired features, creates a detailed plan, and then adds up all the costs. Again, Sam uses a recent project as an example when explaining this method to Sue. Here, the customer wanted a yard surrounded by flowerbeds, a large pond, and a swimming pool with a wooden deck. Adding all those costs together, Sam came up with a final project cost of $75,000.
Advantages and Disadvantages
Each method has advantages and disadvantages. Top-down estimating has the advantage of being quick and simple to create. Additionally, top-down estimates are easy to understand. Disadvantages of this method include a lack of accuracy, which happens because detailed input is overlooked. Because of this, top-down estimating has a higher potential to mislead and given costs could vary widely.
Bottom-up estimating has the advantage of being much more accurate in estimating costs, which means less variance in the final budget. As it requires more customer input when gathering requirements, clients are more engaged in the process. However, Sam warns, bottom-up estimating takes a lot longer to accomplish and is less flexible when it comes to making any changes down the road.
Top-Down vs. Bottom-Up Estimates
Creating a Project Budget
Regardless of how you get to a project budget, whether top-down or bottom-up, the major steps involved in creating one are the same:
List the expenses
Quantify the expenses
Create an expense schedule
Let's see how Sam demonstrates each step to Sue.
List the Expenses
The first step in creating a project budget, Sam explains, is to list both the obvious and hidden expenses of a project. Obvious expenses, like labor and materials, are not often missed but should be detailed enough to capture all of the actual tasks and materials that will be needed. Even small tasks add cost and need to be included.
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Hidden expenses are often overlooked. According to Sam these include costs for inspections, permits, and overtime wages. In landscape work, hidden costs such as equipment rental, removal fees, and city permits should be considered. Sam also talks about planning for contingencies: he tells Sue that 10% - 15% is usually added to a project budget to cover any emergencies or missed expenses.
Quantify the Expenses
Once all project expenses are listed, budget numbers must be attached to each one: this is known as quantifying the expenses. With experience in a specific industry, project managers can quantify expenses without any outside help. In some instances, though, it is a good idea to get an actual quote for things like city inspections, removal services, or equipment rental. A good rule of thumb is that if you have to pay someone to perform a service to complete your project, you should get a quote to include in your budget estimate.
Impressed with Sam's knowledge of project financial planning, Sue continues the interview by asking about expense schedules.
Create an Expense Schedule
Armed with all the information about a project budget, the next step is to create an expense schedule. An expense schedule is simply a timeline of when expenses will be incurred during a project. An expense schedule can be calculated on a daily, weekly, or yearly basis, depending on the length of the project and reporting demands. In most landscaping projects, Sam explains, a weekly expense schedule is sufficient.
Many project managers include expense schedules in an overall project plan; others use a separate expense schedule. Expenses can be shown in a draw-down manner, or a sum-up manner.
Example of an Expense Schedule
Project financial planning, the process of determining projects costs and developing a budget, is essential to making smart decisions. The benefits of project financial planning are estimating profits, reducing financial risks, and planning for unexpected costs. Key concepts in financial planning include:
Top-down estimating: a method of project budget planning where the starting point is the final cost of a project and the features are determined by what can fit into a budget
Bottom-up estimating: a method of project budget planning where the features serve as the starting point of a project and their costs determine the final budget
Expense schedule: a timeline of when expenses will be incurred during a project
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