What Is a Budget Estimate? (Plus 5 Common Types and Importance)
Having a financial plan is key for any projects' successful completion. This plan applies in company settings, as well as in individual life tasks. Developing budgets and budget estimates are an integral part of project planning. In this article, we explain the types of budget estimates, estimation techniques and the importance of project budgeting.
What is a budget estimate?
A budget is a financial plan created for a specified duration of time to achieve set goals. Budget estimation falls under the field of project management. The budget estimate approximates the time and resources needed to plan and complete a project and develop and implement a viable budget.
You can classify budget estimates into:
Rough estimates: These are the values a company generates in the early stages of project commencement to determine the approximate expected costs and whether it is well-equipped to undertake the venture.
Contract estimates: Project developers also obtain these values in the initial stages of project initiation. They are, however, more accurate as one derives them from records of previous projects, similar to the prospective ones. Developers typically add these values to project proposals.
Definitive estimates: These are the most accurate estimates as they are the closest ones to actual costs. They are, however, the most time-consuming ones as they require detailed information on all the project activities to come up with a figure.
Related: Budget: Definition and Types
5 most common types of budget estimates
Consider these 5 most common types of budget estimates:
1. Revenue estimate
A revenue estimate is the amount of money a company can presumably spend on a project. This value is a derivative of the company's annual earnings and is independent of any money borrowed and assets owned.
2. Cost estimate
A cost estimate is an approximation of the capital necessary to complete a project or program. It involves considering all the elements of a project and coming up with a total figure essential for budget development. Depending on the project, this may include labor costs, material and equipment costs and management costs.
3. Return estimate
A return estimate forecasts the income likely to be generated from an investment or a project. Professionals subtract the estimated costs from the revenue estimate to obtain this value. It aids developers in choosing between investments, as projects with higher potential returns are generally more attractive.
4. Risk estimate
A risk estimate is a forecast of the likelihood of risks occurring in a project and the expected consequences, including the calculation of risk exposure. You can use a technique known as "reference class forecasting" to predict these risks. This technique involves using records of historical risks incurred in similar projects. These estimates are crucial as companies can financially prepare for risks by including them in the budget. Organizations may also decide to disqualify high-risk projects based on these values if they are not well-equipped to handle them.
Related: What Is Risk Analysis in Business?
5. Cash flow estimate
This estimate is the approximate amount of money going into and out of a project, based on cost and revenue estimates. This estimate is vital as it confirms that a firm's funding and budget are sufficient for the project at hand.
Related: Guide To Cash Flow
5 Techniques Used In Budget Estimation
The following are the five methods commonly used in budget estimation, as well as their advantages and short-comings:
Experts base this estimation technique on costs incurred on similar projects undertaken in the past done by the same company or from external sources. It is a quick and simple technique, but the information presented tends to be inaccurate. This is because despite having a few similarities, all projects are individually distinctive and there is a very small likelihood of the costs being the same.
This technique uses known parameters to determine the cost of a specific project task. It employs measurable factors from previous similar projects to generate values. It is, for this reason, more accurate than the analogous estimation technique. Not only that, but it also may be hard to find data points for some tasks since not all factors are scalable.
This is an approximate estimation technique that a project manager uses in the initial stages of a project after establishing a rough estimate of the project cost. This budget is then broken down and allocated to different project tasks to determine if the client's budget is viable. This technique gives inaccurate values, but is quick.
This technique involves breaking down the entire project into individual tasks, allocating funds to each activity, then summing up all the costs to come up with a total budget estimate. It is the most accurate method, but the most time-consuming one and leaves room for cost inflation.
5. 3-point estimation
This estimation technique involves finding the average of three values. The value is obtained by summing up the project's cost estimates in the best-case scenario, worst-case scenario, the most probable cost and dividing this value by three. This method is beneficial as it puts potential risks into consideration, but is time-consuming.
Related: How To Make a Budget Plan in 6 Steps
What's the importance of budget estimation?
Budget estimation is fundamental in planning any successful project. The following are some reasons why it is necessary:
Budget estimation allows the organization to meet all its objectives for the project at hand without exceeding available funds. When drawing up a budget estimate, developers have to consider all the project tasks and allocate funds for each one of them. This helps the organization track its progress against these estimates.
It allows the developers to prepare for any risks throughout the project. Risk estimates are part of the budget estimates and these values aid in developing a contingency fund for the project.
It enables developers only to use the available capital and not exceed this amount in the course of the project. This prevents companies from terminating projects halfway or becoming bankrupt.
Professionals who carry out budget estimation
The following is a list of some professions where budget estimation is required:
Construction project manager: These professionals develop, coordinate, budget for and oversee the entire construction process. They ensure deadlines are met and calculate labor and material costs.
Financial advisor: This professional helps organizations create a financial plan, develop and review financial strategies, including budgets.
Accountant: These professionals help organizations operate efficiently by analyzing their financial records, reports, budgets and accounts.
Project engineer: This professional develops, coordinates and monitors all aspects of an allocated project, including the budgets.
Difference between a budget estimate and a budget
A budget estimate is a forecast of the capital needed for the project activities or a program. A budget is the maximum amount of money an organization or an individual is willing to spend on a project. It is a more detailed and specific financial plan for the project. Sometimes, budget estimates become the actual project budgets after approval by the project developers.
Types of budgets
The ultimate goal of budget estimation is to enable companies to develop a strategy for the current project and eventually develop a detailed budget once the project is approved.
The following are the most common types of budgets:
Static budget: The figures in this budget are fixed regardless of the changes that may occur during the period of its implementation. All the original details remain the same throughout the time it's being used.
Flexible budget: This budget is pliable. Changes can be made by developers even after it is implemented, based on relevant factors.
Contingency budget: This is money set aside to accommodate any unanticipated costs in the project's course, thus ensuring the organization is prepared for such situations.
Strategic budget: This budget plans for the expenses of a company for more than a year. Typical financial budgets are formulated annually, but strategic budgets accommodate a longer period to achieve more complex objectives.
How to create a budget
The following are five simple steps to developing an efficient project budget:
Divide the project: Break down the project into individual tasks to understand its scope and determine everything that the team needs to do for its completion.
Cost estimate for each task: Establish and allocate an approximate value for each activity on the list. The budget developer should consider the cost of labor, materials, equipment and all other resources when estimating.
Add up the estimates: Calculate the sum of the task estimates and come up with a total figure.
Include contingencies: Add an estimate of losses likely to be incurred within the project's duration, to have a budget that caters to potential risks.
Seek approval: Obtain the total figures and present them to the board responsible for the project for concurrence and implementation.
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