This series of articles is extracted from a similar series I wrote for Projects@Work a couple of years ago. I’m posting it here in reaction to my review of Josh’s articles on Earned Value where he (in my opinion) used the term “estimate” when he should have said ”budget.” Many of the terms related to estimating are used either inconsistently or imprecisely. Future items will address some “how tos,” but first, let’s take a minute to establish some common terminology.
Estimate. An estimate is an informed assessment of an uncertain event. Informed means that you have an identified basis for the estimate. Uncertain recognizes that multiple outcomes are possible. For example, if I tell you that there are two people standing outside the door, that one is male and the other female, and that one is 6’ 6” (200 cm) tall and the other is 5’ 2” (158 cm) tall, which would you guess is the female?
Most people will predict that the tall person is male. Most people will make an informed assessment of this uncertain event based on their knowledge that men tend to be taller than women, that few women are as tall a 6’ 6”, and that few men are as short as 5’ 2”. But what if I said the woman was a professional basketball player and the man was a jockey? Most people will now predict that the tall person is female.
Guess. A guess is a special kind of estimate—one where we do not have enough information to make an informed assessment. Note that in the above examples I used predict rather than guess since you do have enough information to make an informed assessment. For example, if I asked you to predict which person outside the door was taller, the person on the right or the one on the left, you would be forced to guess. In my experience, it is rarely necessary to make a true guess when working on a project.
Effort. Effort is an expenditure of physical or mental effort on the part of a project team member. We almost always measure effort in terms of staff hours. In many application areas (IT, NPD, pharma, consulting, architecture), most project estimates will be effort estimates. If you purchase resources from outside your organization, you may not see the effort estimates that were used to develop the cost estimates, but they’re there somewhere.
Cost. Cost is a measure of resource usage—employees and contractors must be paid, equipment must be bought or rented, and so on. Cost is usually expressed in monetary terms (dollars, euros, renminbi, etc.), but it can also be expressed in terms of hours of effort. One advantage of using monetary units instead of effort hours is that it should make comparisons between projects or among activities on the same project easier.
Another advantage of using monetary units to express cost is that the financial people in your company understand the language of money. One disadvantage is that monetary units can distort the numbers if the hourly rates are not reasonable. For example, if you use a rate of $100 per hour for an employee making $50,000 per year, and the same rate for someone making $150,000 per year, your cost estimates will misrepresent the actual cost of any project that has a preponderance of effort from one or the other.
Price. A price is what you charge someone for something. Prices are always (well, almost always) expressed in monetary units. Prices can reflect rates (e.g., $100 per hour) or totals ($500,000 for the entire project). Pricing is a business decision. It is usually derived from the estimate, but the estimate is not the price—if we are selling products or services to someone, we can charge more or less than our estimated costs. Even if we know for certain what the costs are or will be, we can still charge a different price.
For this series of articles, I’m going to assume that most readers are either managing internal projects or developing estimates in order to support a pricing decision that will be made by someone else (as is often the case for project managers working for a consulting firm). As a result, I am not going to cover pricing past the point of defining it.
Budget. A budget is a management control or metric (I prefer the term metric since control has negative connotations to some). A budget is a type of plan. Most people use the term only with regard to monetary metrics, but you can have effort budgets or schedule budgets as well. Project budgets should be derived from the project estimates.
Project budgets are not absolutes! Or at least they shouldn’t be. If a project is budgeted for $1,000,000, all of the stakeholders should understand that that number is a target. It is what the team expects to spend based upon what it knows today. If the team can find a way to spend less and still deliver the full scope, it should do that. If it needs to spend more, that should generate a discussion with the funders to decide what to do.
The project budget is not the same as the project price, even for a project done under contract. The seller can price the work for an amount that is different from its internal management metric.
Baseline. A baseline is very nearly a synonym for budget. There are two subtle differences. First, project baselines are normally time-phased. While I might say that the budget for my project is $500,000, I wouldn’t really have a baseline unless I had also defined when I expected to spend that money—how much in week 1, week 2, and so on. Second, the term baseline implies some level of formal approval. I can prepare a budget for an activity or a project, but it isn’t really a baseline until the relevant stakeholder(s) have agreed to it.