accuracy & contingency in estimating

8/14/2019 Accuracy & Contingency in Estimating

1/23

Contingency, Allowances & Escalation

in Estimating


2/23

CONTINGENCY

Introduction three basic types of contingency

tolerance in specificationfloat in schedulemoney in budget (Thi s topic deals with thi s)

most misunderstood, misinterpreted, misapplied word in projects. Contingency means differentthings to different people

is highly subjective , inconsistently interpreted,inadequately estimated


3/23

e n t ons "amount of money added to the estimate to allow for changes

that experience shows will likely be required "

"specific provision of money in estimate for undefined itemswhich statistical studies of historical data have shown willlikely be required"

allowances added to an estimate to represent the best judgement of undefined or uncertain items of work which it isconsidered should be provided for.... They are 'areas of space'in an estimate which help a PM to meet the project costobjectives, as they face exposure to project risk anduncertainty"


4/23

Attributes

It is a reserve of a sum of money. It is part of the project cost estimating process

It is linked to the existence of risk - caters forevents unknown, undefined, uncertain, orunforeseeable.

It is a risk management tool - reduces impact ifrisks eventuate

Inclusion means estimate represents totalfinancial commitment :

increases probability that final cost will not exceed ourestimate


5/23

Coverage a) Incomplete Scope Definition

Allows for incomplete scope definition.

Order-of-magnitude & budget estimates developedearly in PLC. With more scope definition, estimate

invariably increases. Contingency sum caters for increases in costs due to

present incomplete definition


6/23

Coverage (cont.) b) Inaccuracy of Estimating Methods & Data

no method or data is perfect

Contingency is added to the estimate to cover forthese inadequacies

But Contingency should not be an excuse for poorestimating


7/23

Coverage (cont.)

c) Identified risks Contingency may be created for identified risks. - eg.

contractor tendering, allows Contingency for: scope error interpretations, minor design changes, inaccuracy in quantification, abnormal construction problems, liabilities in the contract, unforeseen regulations, safety requirements,

equipment breakdowns, weather interruptions, labour productivity, technological change


8/23

Coverage (cont.) d) Unidentified risks

to allow for unidentified risks: excludes unforeseeable major events (see below).

d) Items not part of contingencies Contingency should cover for scope development butnot scope changes.

Other items not considered appropriate for inclusion inContingency:

escalation, unforeseeable major events (extreme weather, earthquakes,

riots, acts of war, new government regulations, economiccollapse, .terrorist activity)


9/23

Contingency Calculation MethodsA) Calculation by percentage add-on

C calculated as % of base estimate, based on experience& historical data. For example:incomplete scope definition in early estimates: 30% - 50%once scope fully developed: 3% - 5% inaccuracy of estimating method &/or data: 5% - 10%

Level of contingencies will depend on :organisation and the type of businesstype of estimate . (eg. order-of-magnitude estimate demands ahigh C to cover for the inherent inaccuracies of this method)PLC phase (eg estimate at concept phase = high C to allow forlimited information used to prepare an estimate)

type of project . (eg new/unproven technology High Ctype of work - eg underground work = uncertainty = High C

Variation to single % additional to base estimate is toapply different % to each major component of theestimate.


10/23

Contingency Calculation Methods

B) Calculation by Risk Analysis contingencies by % mark-up not recommended:

dealt with in an arbitrary way (simply adding a 10%)contingency should definitely be based on an experienced reviewof uncertainties of estimate details

Allocating % insufficient unless linked to a confidence level.(i.e. level of probability that final cost will be within estimate,including C).

Nowadays, more rigorous & defendable approaches forcalculation of C typically derived from probability analysis , egCentral Limit Theorem and Monte Carlo simulation.


11/23

Contingency Management Level of Contingency constantly monitored

& reassessed through PLC

Success of contingency management:establish procedures for proper use of Cestablish information system showing eachmanager & C under their control, C used,trends, when possible to transfer balances toother less successful areas or general reserve


12/23

Contingency Management

2 basic ways to manage ContingencySingle account single line item account.

Disadvantages:use C first-come, first-serve basis with potentialexhaustion well before project is overcontrol likely to be responsibility of PM - but othercommitments are intense and may lead to neglect ofcontingency management.

Individual Allocations - & responsibility assignedfor their control. If expenditure exceeds C, negativevariance reported. Unexpended C can be transferredto a general contingency account.


13/23

ALLOWANCESContingency = unforeseeable and undefined items

Allowance is for known and undefined items, foreseento be spentredefined each time an estimate is revisedallowance should only be made if "there is a better than50% chance of it happening"document the basisFollowing NOT allowances:

major scope changesweather extremes, earthquakesaccidentsacts of Godstrikes

because "these items are unpredictable, both in terms of probability and magnitude of cost impact if they do occur".


14/23

ESCALATION

Escalation = "provision in estimated costs for continuing price level increase over time"

Often receives less attention than other smaller

items Escalation a result of two factors:

general inflation in costs, invariably upwards. specific market factors

selling price of an item is determined more by thelevel of economic activity (i.e., competition) than bythe actual costs of making the item"


15/23

ESCALATION

Estimates may or may not allow for inflation of costs:Ignore Inflation - Estimate for feasibility - costs & revenues expected toinflate at same rate, then inflation ignoredInclude Inflation - Contractor must allow for inflation in fixed pricetender.

If significant items with volatile price patterns, seek advice

Escalation can be

1 amount for project or individual elements.

Can break down estimate into cost elements , (labour,materials), & escalation factors for each component.

Furthermore, each element broken down eg labour intovarious trades & apply escalation rates to each trade.


16/23

ESCALATION

Two Phases2 main time periods for cost escalation

consideration:

i. From the Past

ii. Into the Future


17/23

ESCALATION

i. From the Past Escalate historical costs to the present date of estimate. Relatively easy, typically applying cost indices

ii. Into the Future Escalation from date of estimate up to project

completion

1 simple approach: annual escalation rate x time period = total escalation rate; then total escalation rate x present estimate = total escalation costs total escalation costs + present estimate = predicted final cost.


18/23

ESCALATIONSHORT DURATION

escalate cost estimate from base year of the estimate to, say: the date of the award of the project; or, mid-point between award & completion; or, two-thirds through project's life (allows for S-Curve profile)

LONG DURATION dissect project into annual cashflows Project estimated to cost $10M in 1991 dollars. Projected cashflows: 1993-$1m; 1994-$6m; 1995-$3m. Escalation rate of 5% pa is expected, escalated costs are:

1993 $1m x ((1.05) 2 - 1) 102,5001994 $6m x ((1.05) 3 - 1) 945,7501995 $3m x ((1.05) 4 - 1) 646,519

TOTAL ESCALATION 1,694,769


19/23

ESCALATION

Cost IndicesIndices - use & limitations

Several cost indices exist eg. Consumer Prices Index. Limitations: Indices = averages . Unlikely to represent exact escalation of

projectIndices lack sensitivity to allow for short-term swings

report time-lag in formulation - may not be representative

Indices - example Estimate required for building a house at December 1992 : Cost of a very similar house in June 1990 was $100,000 Building Price Index: Jun 90: 102.49 Dec 92: 106.04 Estimated cost: (106.04/102.49) x $100,000 = $103,500.


20/23

orestimating

project = uniqueness = lack of suitable precedents.

project changes due to scope changes & newknowledge

poorly defined scope = incorrect estimates.Often due to time pressure

long projects - further project extends fromoriginal estimating base, less accurate originalestimates likely to be


21/23

PRACTICES

Do'sestimating method must fit purposeconcentrate on large-cost itemsuse a standardised approachdefine the scopeconsult other interested partieslist assumptions and exclusionsindicate the base

prepare a complete, not partial , estimate provide all relevant back-up informationallow sufficient time to prepare the estimate .


22/23

PRACTICES

Don'ts

no arithmetic errors . Check calculations

do not work towards a preconceived number

do not accept outside estimates at face value

do not be influenced by interested parties

do not claim higher accuracy than is really available


23/23

End of topic

accuracy & contingency in estimating

Documents