Projects and other undertakings require cost estimation to determine their resource requirements. These estimates are not definitive. Their accuracy depends on the project stage in which they are undertaken and the sources of data used in estimation. Nonetheless, there are three types of cost estimation classified according to their scope and accuracy. These are order of magnitude estimate, budget estimate, and 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. It is sometimes called a ballpark estimate. 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 use historical data from 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
A budget estimate is also referred to as a preliminary cost estimate. It 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 a top-down estimate in which the 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. Some standards even have an accuracy of around -5 percent to +15 percent. This type of cost estimation is not only more accurate than an order of magnitude estimate and budget estimate but is also more detailed. This is the reason it is sometimes called detailed cost estimates.
Reports generated from a definitive estimation include an extensive itemized list of project activities and deliverables with brief descriptions either for explanations, validations, or clarifications. It is still important to note that performing a definitive estimation is only possible with a fully developed project plan and a work breakdown structure.
A Note on the Different Cost Estimation Methodologies
It is important to underscore the fact that the accuracy of cost estimation depends on the availability of data, the quality of the data, and the stage in which the estimate is performed. More tenured and developed undertakings often generate more data that can be used to perform more accurate types of cost estimation like budget estimates and even detailed estimates.
Nonetheless, irrespective of the methodology used, cost estimation helps in pinpointing both resource requirements and resource capabilities, setting priorities, and allocating resources for 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.
