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Chapter 4

CGMS450- Chapter 4-Budgeting The Project.docx

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Global Management Studies
GMS 450
Stan Katz

CGMS450– Chapter 4- Budgeting The Project  A budget must be developed in order to obtain the resources needed to accomplish the project’s objectives  A budget is simply a plan for allocating organizational resources to the project activities  Also has another purpose: it ties the project to the organization’s aim and objectives through organizational policy  Once the budget is developed, it acts as a tool for upper management to monitor and guide the project Methods of Budgeting  Budgeting is simply the process of forecasting what resources what resources the project will require, what quantities of each will be needed, when they will be needed and how much they will cost  See Table 4-1 and 4-2 for reference  Most businesses and professions employ experienced estimators who can forecast resource usage with amazingly small errors -- for instance a bricklayer can usually estimate within 1 or 2 percent the number of bricks required to construct a brick wall of given dimensions  Budgeting a project such as the development of a control system for a new computer, however, is often more difficult than budgeting more routine activities  Organizational tradition also impacts project budgeting – every firm has its ethical codes e.g. Sarbanes-Oxley Act (SOX) and Health Insurance Portability and Accountability Act (HIPAA)  The PM must be completely familiar with the organization’s accounting system *** Top-down budgeting  The top-down approach to budgeting is based on the collective judgments and experiences of top and middle managers concerning similar past projects  These managers estimate the overall project by estimating the costs of the major tasks, which estimates are than given to the next lower level of managers to split up among the tasks under their control, and so on until all the work is budgeted  Advantages:  Fair accuracy  Errors in funding small tasks need not be individually identified because the overall budget allows for such exceptions Bottom-Up Budgeting  In bottom-up budgeting, the WBS identifies the elemental tasks whose resource requirements are estimated by those responsible for executing them (e.g. programmer-hours in a software project)  This can result in much more accurate estimates, but it often does not do so  Bottom-up budgets are usually more accurate in the detailed tasks, but risk the chance of overlooking some small but costly tasks  Common in organizations with a participative management philosophy and leads to better project team  Also good managerial training technique for aspiring project and general managers  Bottom-up budgeting is rare – upper managers are reluctant to let the workers develop the budget, fearing the natural tendency to overstate costs, and fearing complaints if the budget must later be reduced to meet organizational resource limitations  Also the budget is upper management’s primary tool for control of the project Work Element Costing  Each work element is evaluated for its resource requirements, and its costs are then determined. Example: 16 labour hrs Indirect labour - 50% of direct labour $10 per hr Required materials $ 235 $235 + [(16hr x $10/hr) x 1.5] = $475  In some organizations, the PM adds the overhead to the budget.  Direct costs such as materials and machinery needed solely for particular project are usually charged to the project without an overhead add-on o If machinery from elsewhere in the organization is used, this may charge at a certain rate that will include depreciation charges, and then will be credited to the budget of the 1 CGMS450– Chapter 4- Budgeting The Project department owning and paying for the machine. Also GS&A (general, sales and administrative costs) may be included  The overhead and GS & A effect can result in a severe penalty when a project runs late, adding significant additional and possibly unexpected costs to the project  ** the overhead and GS&A effect can result in a severe penalty when a project runs late, adding significant additional and possibly unexpected costs to the project ***Impact of Budget Cuts  In the previous chapter on planning we described a process in which the PM plans Level 1 activities, setting tentative budget ad duration for each. Subordinates then take responsibility for specifying the Level 2 activities required to produce the Level 1 task.  We assume that both the boss and subordinate are reasonably honest that allows for win-win negotiation, and it will fail if either party is dishonest Activity vs. Program Budgeting  Traditional organizational budgets are typically activity oriented and based on historical data accumulated through an activity-based accounting system. Individual expenses are classified and assigned to basic budget lines such as phone, materials, fixed personnel types, or to production centers or processes  Project budgets can be presented as activity budgets -- Table 4-3  When multiple projects draw resources form several different organizational units, the budget may be divided between these multiple units in some arbitrary fashion, thereby losing the ability to control project resources as well as the reporting of individual project expenditures against the budget  Program-oriented project budget is divided by task and expected time of expenditure, thereby allowing aggregation across projects  Budget reports are shown both aggregated and disaggregated by “regular operations,” and each of the projects has its own budgets 4.3 Estimating Cost Estimates  This section deals with a number of ways for improving the process of cost estimating and an easy way of measuring its accuracy.  Can be applied to almost all the areas in project management that call for estimating or forecasting any aspect of a project that is measured numerically e.g. task durations, the time for which specialized personnel will be required, or the losses associated with the specific types of risks they should occur  These improvements range from better formalization of the estimating/forecasting process, using forms and simple procedures, to straightforward quantitative techniques involving learning curves and tracking signals Forms  Figure 4-2  The information can be collected for each task on an individual form and then aggregated for the project as a whole  Forms help PMs collect accurate estimates, not only of direct costs, but also when the resource is needed, how many are needed, who should be contracted and if it will be available when needed Learning Curves  Has been found that unit performance improves by a fixed percentage each time the total production quantity doubles  Or each time the output doubles, the worker hours per unit decrease by a fixed percentage of their previous value called learning rate  The higher values are for more mechanical tasks, while the lower, faster-learning values are for more mental tasks such as solving problems  Common rate in manufacturing is 80%  The time to required to produce the nth unit can be calculated as Tn = T1n^r  Where Tn is the time required to complete the nth, T1 is time required to complete the first unit, and r is the exponent of learning curve and is calculated as the log (learning rate)/log (2).  The use of learning curves in project management has increased greatly in recent year 2 CGMS450– Chapter 4- Budgeting The Project Tracking Signals  PM and others involved with projects spend much tie estimating – activity costs and durations, among many other things. There are two types of errors 1. Random Error  Errors are random when there is a roughly equal chance that estimates are above or below the true value of a variable, and the average size is approximately equal for over and under
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