In today's competitive environment, success of an organization, be it a manufacturing or a service organization, depends to a great extent on its ability to estimate costs as accurately as possible. For timely and economical completion of an engineering or business project, it is essential to accurately estimate costs associated with different stages of the project. In engineering projects, the estimation of costs is considered to be more important than revenue estimation. Therefore, different aspects of cost estimation are discussed in this chapter.
Out of two types of costs, i.e., direct costs and indirect costs, it may be noted that indirect costs are not associated with a specific function, department or process. Hence, some logical basis should be used for allocating indirect costs to the different functions. For this purpose, both traditional as well as Activity-Based Costing (ABC) are also discussed in this chapter.
HOW DOES AN ORGANIZATION ESTIMATE COST?
Organizations are involved in either producing tangible products or providing services for customers for which serious efforts are made by them. In order to perform the required activities to produce goods or provide services, capital is required. In other words, for every activity there is an associated cost and, therefore, the organizations need to make cost estimates of the activities. The estimates should be as accurate as possible, so that the organization can arrange the capital required well in advance. Generally, cost estimations are required to be made in the initial stages of implementation of a project or a system. Maintenance and upgradation costs are estimated as a percentage of the first cost and they are subsequently added to make the trial cost estimates. Typical examples of a project include physical items such as building, bridge, manufacturing plant etc.
On the other hand, a system refers to an operational design involving non-physical items such as processes, software, etc. Typical examples of a system include ERP software, GPS system etc.
Cost comprises direct costs and indirect costs. Direct costs refer to costs that are incurred due to the involvement of several resources, such as people, material and machines, in the activities. Indirect costs are mainly incurred due to the factors that support the activities.