ProjectManagementcost estimates.docx
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ProjectManagementcostestimates
Chapter4Costestimates,Part1:
DefinitionsandPrinciples
Agoodestimateofprojectcostsisnecessaryforsubsequentmanagementdecisionsandcontrol.Themostobviousreasonforproducingcostestimatesistoassistinpricingdecisions,butthatisbynomeansthewholestory.Costestimatesareusuallyneededforallprojects,includingin-housemanagementprojectsandthosesoldwithoutfixedprices.Timescaleplanning,pre-allocationofprojectresources,theestablishmentofbudgetsforfunding,manpowerandcostcontrol,andthemeasurementofachievementagainstexpectedperformancealldemandtheprovisionofsoundestimates.
Costdefinitionsandprinciples
Itisgenerallyunderstoodinaccountingcirclesthattheword'cost'shouldneverbeusedalone,withoutaqualifyingadjective.Itmustalwaysbemadeclearexactlywhatkindsofcostsaremeant.Therearemanywaysinwhichcostscanbedescribed,butwithinthespaceofthischapteritisnecessarytooutlinesomeofthetermswithwhichcostestimatorsandprojectmanagersshouldbeacquainted.Thereisnoneedtoclarifyself-explanatoryterms(suchaslabourcosts,materialcostsandsoon),andthefollowinglisthasbeenlimitedtoafewtermsthatmaynotbefamiliartoallreaders.Thelistisinalphabeticalorder.
Absorptioncosting
SeeOverheadrecovery.
Below-the-linecosts
Acollectivenameforthevariousallowancesthatareaddedonceatotalbasiccostestimatehasbeenmade.Thesecanincludeallowancesforcostescalation,exchangeratefluctuationandothercontingencies.
Costescalation
Costescalationistheincreaseinanyelementofprojectcostswhenthecostofthatelementiscomparedbetweentwodifferentdates(forexample,nowandtwoyearshence).Causedbywageandsalaryawardsandinflationarypressuresonpricespaidformaterialsandpurchasedcomponents,costescalationisusuallyexpressedatanannualratepercent.
Directcosts
Costswhichcanbeattributeddirectlytoajoborprojecttaskaretermeddirectcosts.Thusifapersonspendstwohoursinthemanufactureofacomponentwhichisidentifiableasbeingrequiredforaparticularproject,thenthattimecanbeclassedasdirectlabouranditscostcanberecordedasadirectcosttobechargeddirecttotheproject.Similarly,materials,componentsandexpensesdirectlyattributabletoaparticularprojectcanbeclassedasdirect.
Factorycost
Applicabletomanufacturingprojects,thefactorycostisthetotalcostofajoborprojectbeforetheadditionofmark-upforprofit.Itcomprisesalldirectandindirectcostsforlabour,materialsandexpenses.AverysimpleexamplewhichshowstherelationshipoffactorycostinthepricingstructureisgiveninFigure4.1.”
Designcostsareoftentreatedasindirectinroutinemanufacturing,toberecoveredasoverheadsagainstbulksalesoftheresultingproduct.TheexampleinFigure4.1,however,isforaspecialproject.Althoughthisisaverysimpleproject,itcanrankasaprojectnonethelessbecauseitisforthedesignandone-offmanufactureofacomponenttosatisfyacustomer'sspecialpurchaseorder.Allthedesigncostsinthiscasecanberecordedandattributeddirectlytotheproject,andtheyhavethereforebeentreatedasdirectcosts.
Fixedcosts
Costsaresaidtobefixedwhentheyremainvirtuallyunchangedandmustcontinuetobeincurredeventhoughtheworkloadmightfluctuatebetweenzeroandthemaximumcapacity.Thesecoststypicallyincludemanagementandadministrativesalaries,rent,businessrates,heating,insurance,buildingsmaintenanceandsoon.Fixedcostsusuallyformbyfarthebiggestcomponentofacompany'sindirectoroverheadcosts(seeIndirectCosts).
item
£
£
£
Perhour
Directmaterials
Brasssheet
Brassrod
Other
Totalcostofdirectmaterials
1000.00
1500.00
1250.00
3750.00
Directlabour(standardcostrates)
Design
10hoursseniorengineer
25.00
250.00
15hoursdesignengineer
15.00
225.00
1hourchecker
17.00
17.00
Manufacture
200hourssheetmetal
13.00
2600.00
30hoursturner
13.00
390.00
10hourassembly
13.00
130.00
1hourinspection
16.00
16.00
Totaldirectlabourcost
Primecost
820.00
4570.00
Overheadsat130%ofdirectlabour
Factorycost
Mark-upat50%
Indicatedsellingprice
1066.00
5636.00
2818.00
8454.00
Figure4.1Costandpricestructureforasimplemanufacturingproject
Indirectcosts(overheadcostsoroverheads)
Theprovisionoffacilitiesandservicessuchasfactoryandofficeaccommodation,management,personnelandwelfareservices,training,costandmanagementaccounting,generaladministration,heating,lightingandmaintenancegivesrisetocoststhatmustgenerallybeincurredinrunningabusiness.Thesecostscanincludesalariesandwages,materialsandotherexpenses,but(exceptintheunusualcaseofanentireorganizationsetupspeciallytofulfilonlyoneproject)thesegeneralcostscannotbeallocateddirectlytoonejoborproject.Theyarethereforetermedindirectcosts,oftencalled'overheadcosts',orsimply'overheads'.
Notethattheprovisionoffacilitiesatthesiteofaconstructionproject,althoughthesemightincludeaccommodationandservicesthatwouldbeclassedasindirectbackatthemainorhomeoffice,canbeclassedasdirectcosts.Thisisbecausetheyareprovidedspecificallyfortheprojectinquestion,andcanthereforebeidentifiedsolelywiththatprojectandchargeddirectlytoit.
Thereareconsiderabledifferencesbetweencompaniesintheinterpretationofdirectandindirectcosts.Somefirmschargetoprojectsthecostsofprintingdrawings,forexample,andrecoverthosecostsdirectlybybillingthemtotheclientorcustomer.Otherfirmswouldregardsuchcostsasindirect,andchargethemtooverheads.Sometimestheclassificationofcostsasdirectorindirectcanvaryevenfromprojecttoprojectwithinthesamecompany,dependingonwhateachcustomerhasagreedandcontractedtopayforasadirectcharge.Costestimatorsandprojectmanagersmustbeclearonwhatconstitutesdirectandindirectcostsintheirparticularcompany,andmustalsopayattentiontoanyspecialprovisionscontainedintheproposalorcontractforeachproject.
Indirectcosts,althoughtheyarepredominantlyfixedcosts,cansometimesincludeanelementofvariablecosts.Maintainingapermanentheadquarterswouldbeafixedindirectcost,sinceitmustbeincurredirrespectiveofnormalworkloadfluctuations.Hiringtemporaryofficestafftoworkinadministrativedepartmentswouldbeavariablecost,becausetherateofexpenditure(thenumberandtypeoftemporarystaffhired)willvaryaccordingtofactorssuchasworkloadandavailabilityofpermanentstaff.Managementcandecidetoincreaseorreducethenumberoftemporarystaff(andhencetheircost)atwill.Classificationofoverheadsintofixedandvariablecostsisnotrelevanttomuchoftheargumentinthisbook,butitisimportantinthemanufacturingandprocessindustriesasacontrolinrelatingprices,profitabilityandthevolumeofproduction.
Whatevertheindustry,managementmustalwaysstrivetokeeptheoverheadexpensesaslowaspossibleinrelationtothedirectcosts,becausehighoverheadscankillacompany'schancesofbeingcompetitiveinthemarketplace.Itisinthevariableoverheadcostswheretheeasiestandquickestsavingscanbemade(shortofrelocatingthecompanyordismissingsomeofthepermanentadministrativeandmanagementstaff).
Labourburden
Thelabourburdenisanamount,usuallyexpressedasapercentageofwagesorsalaries,thatisaddedtothebasichourlyorweeklyrateforemployeestoallowfornon-workingtimeandvariousadditionalexpenses.Theconstituentsofatypicallabourburdenmightbethecostofpaidholidays,illnessorotherabsence,andpercapitaamountspayablebytheemployerasemployeebenefits,eithervoluntarilyorasarequirementofthenationallegislation.IntheUK,forexample,thesewouldincludeemployers'NationalInsurancecontributions.
Materialsburden
Materialspurchasedforaproject,whicharethemselveschargeableasadirectcost,aretypicallymarkedupbycontractorsinordertorecovertheiradministrativeandhandlingcosts.Thesemark-upsgenerallyrangefrom15percent(orless)forverylarge,costlyitemsshippeddirectlytositeto25percentorevenmoreonsmall,low-costitemsthathavehighhandlingandadministrationcostsrelativetotheirvalue.Acommonall-roundrateusedforthematerialsburdenis15percent.
Overheadcosts
SeeIndirectcosts.
Overheadrecovery
Mostprojectcostingsystemsworkonthebasisofchargingdirectlabourcosts(includingthelabourburden)astimerecordedonthejobmultipliedbythestandardhourlycostapplicabletothegrade.Anamountcanthenbeaddedtothislabourcost(usuallyasaratepercent)torecoverapartofthecompany'sindirect,overheadcosts.ThesimpleexampleinFigure4.1illustratesthisprinciple.
Thesameoverheadrate(130percentinFigure4.1)wouldnormallybeappliedoverallsimilarprojectscarriedoutbythecompany.Insomeindustriestheoverheadratecanriseto200percentorevenhigher(as,forexample,incompanieswithaveryhighlevelofresearchanddevelopmenttofund).Inlabour-intensiveindustries,withlittleresearchanddevelopmentandnohigh-gradepremises,theoverheadratemightbe50percentorevenless.Itisnotpossibletoindicatenorms,sincethecircumstancesofcompaniesvaryconsiderablyfromonetoanother(evenwheretheyarecarryingoutsimilarwork).Obviously,acompanywhichmanagestokeepitsindirectcosts(andoverheadrate)toaminimumenjoysacompetitiv