Calculation of costs

Project management requires methodological competence. What is generally true also applies to cost calculation. In practice, an unstructured approach regularly leads to unrealistic budgets, cost overruns or even the loss of contracts. It is therefore important to proceed systematically in order to obtain as realistic a picture as possible of the estimated total costs in advance.

In this article, we explain the most important basic terms, the role that cost calculation plays in the project for every company, and which prerequisites must be met in order to carry out a reliable cost calculation. We also show which types of project costing exist and what kind of approach makes sense and when. In the last section, we look at some typical mistakes that commonly lead to incorrect values in the calculation process.

Costing is a fundamental, extremely important tool that every businessperson must master. In business administration, the term appears in various places – for example in the form of quotation costing, order costing, offer costing, price costing, commercial costing, determination of cost of goods sold or production costs, overhead costing, preliminary costing and final costing. In the context of projects, costing serves to estimate, structure and calculate costs for a defined service. The primary goal is to calculate the required meaningful project budget.

A professional cost calculation is one of the most important components of successful projects. Even before the project begins, it provides information about all the expenses that will be incurred during the course of the project. On this basis, it is possible to quote a price to the customer. On the other hand, it gives the project team in your own company a monetary framework to orient themselves by. Of course, cost calculation also has the task of determining the profitability of a project. Unprofitable projects can thus be avoided from the very start. During project implementation, the costing runs along with the project. It enables the project manager to carry out a continuous comparison of planned and actual values. This is a central element of project control and enables corrections to be made at an early stage in the event of deviations. Finally, the so-called project post-calculation provides information about which actual costs were actually incurred. This allows the budgeting to be evaluated retrospectively, whereby improvement measures for the future approach can be derived.

Making an accurate cost calculation is essential in every project phase. By definition, projects deal with the realisation of something new. It can be concluded that only a limited number of reliable empirical values can be used to calculate the probable project costs, which is why estimates have to be made at some points. For small projects, the risk of false estimates is still within limits. However, the more complex the project, the more time-consuming it is to precisely plan the numerous expenses in advance. In practice, employees from different departments such as controlling, purchasing, development and sales are often involved.

The costing phase can only begin once the project plan has been created. Without transparency regarding the necessary work steps, it is simply impossible to calculate the material, personnel and overhead costs that are likely to be incurred. Following this thought: The more detailed the project plan, the lower the risk of miscalculating the project costs.

There are basically two different approaches to the question of how costing is typically conducted in projects:

• Cost determination according to cost types
• Cost determination according to work packages

Let’s take a closer look at these methods below.

This method is particularly suitable for small or medium-sized projects with manageable costs. The costs are divided into cost types (project cost categories). Following this it is possible to present the total costs according to characteristics and originators. A typical classification are the following categories:

• Personnel expenses (salaries incl. additional costs such as bonuses, allowances, etc.)
• Material costs (material, work equipment, etc.)
• Costs for equipment and machinery provided
• Costs for external services (e.g., consulting, planning services, subcontractor services)
• Auxiliary costs (e.g., travel, training, insurance, room rental)

As a rule, the same cost types are used for cost calculation in projects as in general operational cost accounting. In order to realise an efficient control of project costs, a further structuring can therefore be useful. For example, a subdivision into direct and indirect costs (overheads) is feasible. In projects, this procedure is recommended in order to separate project costs that can be actively influenced from factors that cannot be controlled (e.g., allocation of IT or operating costs). Furthermore, a division into fixed and variable (performance-dependent) project cost types can be made, which allows, among other things, more precise forecasts of further development of costs. If make-or-buy decisions are relevant, it is also sensible to divide the costs into internal and external costs.

In larger projects with numerous planning sections, it is common to carry out the cost calculation for each individual work package. Here, too, an allocation is made to the categories mentioned above. However, this is not done on a monthly basis, but separately for each project section. By adding up all the work package costs, the total costs of the project can be determined. In order to create an accurate cost calculation for work packages, a resource plan (from the work breakdown structure) must be available for the project. This must show for each package how many personal costs (usually in person days) and other expenses (material costs, external costs) are likely to be.

In contrast to pure cost determination according to cost types, the evaluation of work packages makes it possible to monitor the running costs for each project stage. Deviations from the planning can thus be detected earlier and more precisely. If the costs of a certain package get out of hand, direct corrections and measures are possible.

Basically, cost calculation for projects is not complicated, but the complexity increases exponentially with the size of each project. There are established methods and numerous templates. In addition, good project management software nowadays has planning tools that support users to fulfil the task. But why is it that project costs in practice regularly deviate from the planned values? The most common mistakes are:

• Inaccurate cost calculation
• Too conservative cost calculation
• Too optimistic cost calculation
• Lack of expertise

The basis of every project calculation is the project plan. If this is incomplete or inaccurate, it is simply impossible to precisely determine the expected expenditure. It is therefore important to describe the necessary resources for each project phase and each work step in as much detail as possible.

Every project calculation needs a certain buffer of risk. However, if too high reserves are planned consciously or unconsciously, this will unnecessarily push up the total costs. This may even lead to projects being assessed as uneconomical, even though they could be realised at a profit. In addition, bidding prices that are too high can lead to the loss of contracts. An excessively cautious approach is therefore not recommended. Rather, realistic planning should be in the spotlight.

The opposite of “over-cautious” project and order costing is cost optimism. Personnel costs in particular are often underestimated in the preliminary calculation. This happens, for example, when risks such as absentees due to illness or parental leave are not taken into account. The time (schedule) required is sometimes estimated too optimistically, therefore the number of staff planned is lower than necessary. Realistic assessments based on reliable empirical values are also appropriate.

The cost calculation should not be carried out by a single person, neither in the preliminary costing nor in the final costing phase – especially in larger projects. Especially in the case of cross-departmental projects, it is advisable to involve employees from the departments concerned. These can be, for example, development, purchasing, sales or production. Involving experts usually increases the accuracy of the calculation significantly.

By using appropriate methods and tools, it is quite feasible to achieve a solid cost calculation for projects and products. Throughout entire project, costing is a significant step, although cost management also includes other tasks. In particular, it is important to implement an efficient cost controlling system right from the beginning that continuously compares target and actual costs. A final comparison (post-cost calculation) also provides important insights into how the calculation can be further improved.