Projects and other undertakings require cost estimation to determine resource requirements. Of course, estimates are not definite and their accuracy depends on the project stage in which they are undertaken and the sources of data. Nonetheless, there are three types of cost estimation classified according to their scope and accuracy. These are (1) order of magnitude estimate; (2) budget estimate; and (3) definitive estimate.
The difference among the three types of cost estimation
1. Order of magnitude estimate: An order of magnitude estimate is a rough estimation of costs used at the very early stage of a project, particularly during the evaluation and planning stages. The purpose of this type of cost estimation is to have an idea about general and total expenditures instead of itemizing expenses based on project activities and deliverables.
Managers and planners can us historical data of a related project or an aggregate of data from different projects to perform an order of magnitude estimation. There are situations when no data is used at all. The accuracy is around -50 percent to +100 percent of the actual cost. Figures generated from this method of estimation are sometimes called ballpark figures.
2. Budget estimate: Also referred to as preliminary cost estimates, budget estimate is more accurate than an order of magnitude estimate. Accuracy is around -10 percent to +25 percent. The purpose of this type of estimation is to generate a preliminary itemized list of expenditures based on the major components of the project. Therefore, this is done within the actual planning stage of the project.
There are specific types of cost estimation under budget estimate. One example is top-down estimate in which costs of the major components of the project are estimated using historical data of a related project or obtainable data using the project plan. Another example is an estimation of expected labor cost or a summative costing of equipment and materials requirements.
3. Definitive estimate: A definitive estimate has an accuracy of around -10 percent to +15 percent and in some standards, around -5 percent to +15 percent. Sometimes called as detail cost estimates, this type of cost estimation are not only more accurate than order of magnitude of estimate and budget estimate but are also more detailed.
Reports generate from a definitive estimation include an extensive itemized list of project activities and deliverables with brief descriptions either for justifications and clarity. However, note that conducting a definitive estimation is only possible with a fully developed project plan and a work breakdown structure
A note on cost estimation methodologies
It is important to reiterate the fact that the accuracy of cost estimation depends on the availability of data, as well as the project stage in which it is particularly conducted. Take note that as the project plan becomes more developed, more data can be generated and thus, budget estimates or detailed estimates become more possible.
Nonetheless, regardless of the methodology used, cost estimation is a standard process observed in project management all the way down to portfolio management. It helps identifying resource requirements and capabilities, setting priorities, and allocating resources for project planning and controlling. Costing and valuation are often the immediate byproducts of cost estimation and a review of generated reports can help guide decision-makers.