How to Create Project Cost Breakdown
Any project requires careful planning before launch. Creating work scope and estimating time and resources necessary for completing the project are essential parts of the planning process that provide a basis for the next essential step: estimating project costs.
While initial estimates can hardly be absolutely accurate, it’s possible to increase the accuracy by preparing a detailed project cost breakdown. Depending on accuracy level, it can be used on different steps of project planning, from a ballpark estimate to a reliable forecast of the resulting cost.
Project cost breakdown can be used for the following purposes:
- Internal use: estimating work costs, calculating project profitability, etc.
- Coordinating estimated project costs with clients and getting their approval of the final price.
In any case, clarity and logical structure of the cost breakdown is a must. Structuring a cost breakdown clearly and correctly is a tedious task, but it is important for future communication with clients and for better understanding how costs can be managed in the course of the project.
Read on to learn how to structure the project costs or scroll down to download our free template.
Structuring project costs
The first step to creating a clear project cost structure is identifying its key components:
- Cost drivers: items, units, specific works or services, etc.;
- Amounts: numbers of items, amounts of materials, amounts of work time;
- Overhead, or hidden costs: costs that don’t bring any direct value but influence project work processes indirectly.
Depending on the purposes of your project cost breakdown and the project’s nature, you can group the cost data by different parameters:
- By time periods: this data grouping can be used for estimating monthly, weekly, quarterly etc. costs. Usually, it is combined with grouping by workflow steps and includes a total for the entire project;
- By cost types. When no time breakdown is required, structuring cost data by cost types is a common approach. This helps identify key cost drivers and their influence on the final figure. Also, this approach is preferred when the purpose is defining manageability of specific cost components and finding out ways to decrease the total cost.
Speaking of cost types, the following ones are commonly used for structuring the components that build up the final cost of the project:
- Labor costs, also called direct costs, are the costs of employees’ time spent on rendering services or performing manufacturing works within the project. They can incur as work time paid at a specific pay rate, or as a fixed cost per item, unit, or service.
- Subcontracting, or outsourcing costs are sometimes treated as direct costs, and sometimes included in cost structures as a separate category. Again, they can be accrued on the basis of work time spent by an outsourcing team and their pay rates, or as a fixed cost for certain products or services.
- Material costs arise as costs of raw materials, parts and supplies purchased for using in project works or performing them. Sometimes, this cost type also includes insurance, custom clearance and other costs related to purchasing materials and goods.
- Logistics costs are associated with storing and moving purchased materials and include such subcomponents as transportation, storage, distribution, etc.
- Overhead costs cannot be always allocated to a specific cost driver and don’t create profit in a direct way. However, they influence project outcomes indirectly by making business activities possible, or increasing their efficiency.
Common mistakes in structuring project costs
As we see, identifying everything that needs to be included in a project cost breakdown is a meticulous work. Like any work where human errors are possible, structuring project costs can be affected by the infamous human factor. This results in low accuracy of estimation based on the cost breakdown, estimate changes in the course of the project, and high unexpected costs. Here are several common mistakes to be aware of and avoid:
- Omitting some cost drivers. While carefully analyzing components of the final price is an essential part of cost estimation process, some of cost drivers can get omitted – this usually happens to the costs that can be allocated to different categories, or overhead costs.
- Not including routine works like communications, organizational, and administrative works into the final cost estimate. These works are hard to estimate and are rarely considered a direct cost driver, but this doesn’t mean they should not be included in the cost structure. A reasonable way to handle them is including a rough estimate with a comment that the final cost will depend on time actually spent on these works.
- Not including non-billable works if you’re using cost breakdown for internal reference. The proportion between billable and non-billable works defines profitability of a project, so if you’re using cost breakdown for profitability analysis, make sure to take all types of project-related non-billable works into account.
Project cost breakdown and estimation techniques
In various project estimation methods, project cost breakdown can be used for providing more accurate estimates of the final figures. Previously, we’ve analyzed project estimation techniques and how they can be used in project planning. Now, let’s take a look at how project cost breakdown can be applied to them.
- Expert judgment: experts’ opinion used to make up for the lack of clarity in existing cost breakdown can influence cost drivers where more predictability is required. While this method is used to come up with more accurate estimates, significant difference between the planned and the final figure is still possible.
- Analogous estimation: comparing estimates based on cost breakdown for previous projects with new similar ones helps improve estimation technique and get more accurate assessment of project costs, profitability, and general outcome.
- Bottom-up analysis: planned project costs are structured on the basis of the costs of small tasks, services, and product parts. High accuracy is achieved by taking into account all cost drivers, including costs of routine works, overhead, and possible additional costs.
- Top-down analysis: a top-down cost structure can be used for coming up with a ballpark estimate of the final figure. When using it, it’s essential to factor in various additional costs not included in the initial estimate.
- Parametric estimation: this estimation method can be used with cost structures where cost drivers are predictable and measurable. On the basis of existing data, different parameters can be estimated with a high accuracy degree.
Project cost breakdown in different pricing types
There are different approaches to the pricing of projects and services. Pricing types depend on the nature of projects, common practices in particular fields and industries, and market environment. With any pricing type, accurate project cost breakdown is vital for project outcome and customer satisfaction. Let’s take a look at the examples of how it can be used with different pricing types:
- Cost accrued on the basis of provided services and materials: an accurate cost breakdown – both estimated and final – is indispensable for communication with customers, being the best way to explain what exactly they are paying for.
- Cost per package: when this pricing method is used, customers pay fixed price for specific set of works, services and/ or products. That’s why, it is key to provide them with a clear picture of billable works for each package offered to them, and cost breakdown seems to be the most efficient way to show where billable time goes. Cost breakdown structures for each package can also be used internally for analysis and adjustment of current package pricing.
- Fixed price: initially, customers know the final cost only, so you might need to prepare a cost breakdown for them. Customers tend to worry that they’re paying too high price, and exact cost breakdown data helps justify specific cost of the project. What’s more, cost breakdown can be used for internal analysis of project profitability. In this case, it should be centered around pay rates, business costs, operational/ administrative costs, and include all non-billable works.