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Estimating is used when planning and budgeting business costs or revenues. The estimate needs to include both the amount and the timing of the transaction.

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Quick reference

Estimating

Estimates are used for planning business costs.  The estimate needs to include both the amount and the timing of the transaction.

When to Use Estimating

Estimating is used when planning and budgeting business costs or revenues.  This is normally done as part of the annual planning process.  However, estimates will be created at other times in the year, whenever it is necessary to plan, or replan, the costs or revenues of the business.

Instructions

  • Estimates of business revenues and expenses are “educated guesses” of what will happen in the future.
  • You must first determine your assumptions about future business behaviour:
    • What will customers buy and when?
    • What will suppliers charge for materials and services in the future?
    • What locations will the company have operating and what activities will occur at each location?
    • How will the business be organized and staffed?
    • What projects will be approved and which ones will be cancelled?
    • How will government and regulatory agencies attempt to control or stimulate an industry?
    • Others?
  • When you have your assumptions, you can then plan the business activities associated with those assumptions.
  • Two different approaches are often used for estimating depending upon whether you are estimating a business function or department or you are estimating a project.
  • Functional/department estimates:
    • Start with the previous year’s budget or actual costs.
    • Based upon your assumptions, make any changes to account for planned business locations in operating location or organizational structure.
    • Based upon you assumptions, make any changes to account for planned product changes and sales forecast or process changes and operating efficiencies.
    • Based upon your assumptions, make any changes to account for business initiatives stopping and the impact of those initiatives.
    • Review the changes, both amount and timing of transactions and revise them until you are confident in the numbers (based upon the assumptions),   
  • Project Estimates: 
    • Project estimates are heavily impacted by the project boundary conditions (scope, schedule, and resource boundaries).  Often the project boundary conditions are revised if the estimate is considered unacceptable, so this may be an iterative process.
    • Project estimates normally start with a high level estimate that was created at the time the project was authorized – this estimate is usually a very rough estimate based upon past projects.
    • The project team is then asked to estimate the project based upon what they must do to meet the project objectives for scope and schedule.
    • This estimate is reviewed with the senior management stakeholders and many times the project boundaries are shifted and the team must do a new estimate with the new boundaries.
    • The estimate for most departments is a combination of the department estimate and their department’s portion of approved project estimates.

Hints and Tips

  • Estimates are normally based upon previous experience, so use previous year’s budgets and previous project plans and actuals to assist in creating the estimates.
  • Some organizations have estimating departments with specialists who have databases and formulas that can provide estimates.  When using that approach, check closely to ensure they are using data from sources with similar assumptions to those you have developed.
  • Spend some time working with your subject matter experts, including cross-functional experts, to identify and document all assumptions.  When the assumptions are documented, the estimates are fairly easy to calculate.  When the assumptions are not documented, everyone will have their own set of assumptions they are using for generating the estimates and heated discussions will often arise around the numbers due to unstated or unrecognized assumptions.
  • An estimate is a guess.  Hopefully it is close, but it is almost always wrong at some point.  Don’t get so invested in your estimate that you are not willing to acknowledge that it is wrong and change it when a clearer understanding of the assumptions can be made. 
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  • 00:03 Hello, I'm Ray Sheen.
  • 00:05 I'd like to talk with you about one of the most frustrating, confusing,
  • 00:09 and irritating of financial topics and yet a very important one.
  • 00:12 And that is cost estimating.
  • 00:16 >> Developing estimates is a key part of any manager's job.
  • 00:19 Budgets are comprised of estimates.
  • 00:21 To create a budget, a manager must estimate what they think will happen.
  • 00:25 But keep in mind, estimates are just educated guesses.
  • 00:28 Assumptions must be made about the future.
  • 00:31 But no one has perfect for knowledge.
  • 00:33 The managers must guess what they think will happen and
  • 00:35 what financial transactions will occur because that happened.
  • 00:39 The estimates that are the result of these educated guesses
  • 00:42 are then built into a budget.
  • 00:43 There are two types of budgets that must be estimated by operational managers.
  • 00:48 One is the department budget.
  • 00:49 The budget is the management's plan for sustaining the business operations.
  • 00:52 It is the budget for running what already exists.
  • 00:56 The other type of budget to estimate is the project budget.
  • 00:59 This is the estimate for implementing new objectives, new systems, new products or
  • 01:03 new facilities.
  • 01:05 Projects create something different than what currently exists.
  • 01:08 If the work is just to maintain the status quo, it's part of the department budget.
  • 01:12 The project budget is for something new.
  • 01:15 So let's look at how to estimate the budget the for each of these.
  • 01:18 I will start with estimating the department budget.
  • 01:20 The estimate is normally created annually as part of the annual
  • 01:23 budget planning process.
  • 01:25 I recommend you start this process by looking at what it took
  • 01:28 to run the department during the current year.
  • 01:30 Use the actual spending if it is available.
  • 01:32 That helps to reduce some of the guesswork in estimating.
  • 01:35 Although there are often still a few months left in the year when you do this.
  • 01:39 So use the budget for those remaining months,
  • 01:41 making any educated guesses about that budget that you think are appropriate.
  • 01:45 With this year's numbers as the starting point, add or subtract any costs based
  • 01:50 upon changes in the business operating locations or size of the department.
  • 01:54 If combining departments,
  • 01:56 add in the appropriate costs from the other department.
  • 01:58 If opening a new office, add in an estimate for staffing and
  • 02:01 operating that office.
  • 02:03 Next, look at any planned changes in how the department will be doing it's work.
  • 02:07 Are there new processes that speed up and simplify some of the work?
  • 02:11 How does that change the staffing plan?
  • 02:13 Are there new products that need a different level of support?
  • 02:15 Or possibly, a new skill set?
  • 02:17 What is the impact on systems?
  • 02:19 These are estimated effects of the known changes in how the work will be done
  • 02:23 next year.
  • 02:25 I then look at the planned business initiatives and
  • 02:28 the estimated level of support that will be required.
  • 02:31 Maybe there is an initiative to increase customer support and customer focus.
  • 02:34 In that case, estimate additional travel to support the customer visits.
  • 02:38 There may be an initiative to speed processes.
  • 02:41 So estimate additional costs for system upgrades.
  • 02:44 There may be an initiative to improve employee morale.
  • 02:47 In that case, estimate additional money for training and development.
  • 02:50 In this area more than any other, the estimates will be guesses.
  • 02:54 You probably won't now exactly what will be required.
  • 02:57 But something will be needed, so get an estimate in place and
  • 03:00 modify it as needed once the details of the initiative are understood.
  • 03:05 Okay. Put all those together and
  • 03:06 you have the new department budget.
  • 03:08 Except for the projects, which we will talk about next.
  • 03:11 There have been an enormous number of books and
  • 03:13 blogs written on project estimating.
  • 03:15 I've even written a few of them myself.
  • 03:17 But let's just cover the high points here.
  • 03:20 There are several major differences in project estimating as compared to
  • 03:23 department estimating.
  • 03:25 One of those is the scope of the project.
  • 03:27 A project is creating something new.
  • 03:29 It often includes many loosely defined deliverables, so there are many unknowns.
  • 03:34 In contrast, a department is sustaining something already in place.
  • 03:38 So estimating assumptions for departments are usually more accurate.
  • 03:42 A project's schedule is from project start to project end.
  • 03:46 Both of which are variable when the estimates are being created.
  • 03:49 The department budget is normally for a fiscal year, which has a known start and
  • 03:52 a known end date.
  • 03:54 Project resources are often cross functional and dependent upon suppliers.
  • 03:59 There may be limits on what they can do that the project manager does not know or
  • 04:03 understand.
  • 04:04 Whereas the department manager is usually very familiar with their departments
  • 04:07 resources and limits.
  • 04:08 They know what they can and can't do.
  • 04:10 While there are many different approaches, for
  • 04:12 us to bring the cost of an individual project task,
  • 04:15 at the summary project level the approach usually follows these three steps.
  • 04:19 First, when the project is authorized, Senior Management sets a total project
  • 04:23 budget value that was used during project justification.
  • 04:27 The project team then creates a bottoms up estimate, based upon their interpretation
  • 04:32 of the project requirements and the approach for meeting those requirements.
  • 04:35 The two estimates are compared, and if there is a difference, and
  • 04:38 there usually is, a revision is made on one of the project boundaries.
  • 04:43 The product scope may change.
  • 04:44 The total resources may change, or the timing of the resources may change.
  • 04:49 In fact, this iteration may happen several times
  • 04:51 until the estimated project budget is finalized.
  • 04:56 >> Whatever type of budget you're preparing, whether department or
  • 04:58 project, it's still a guess, so don't agonize over it.
  • 05:03 Do your best and document your assumptions.
  • 05:05 Recognizing that something is probably wrong.
  • 05:09 When you have better insight,
  • 05:10 change your budget based upon the new information or knowledge.

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