Estimate effort first, project costs last

There are three main areas to estimate before your project starts--effort, duration, and cost.

Of the three, you must estimate effort first to understand the total amount of work. The duration can be estimated once you have the effort and the resources that you can apply. For example, if you have a project that you are estimating to be 800 effort hours, the duration will depend on the resources that you can apply. If you only have one person, the duration might be six months. If you have three people, the effort might be three months or less.

Once you understand the resources that you can apply to the project, you are in a position to create the cost estimate. At a high-level, project costs are estimated by looking at labor and non-labor items.

Labor costs
The cost of labor is derived by looking at the effort hours of each resource and multiplying by the hourly cost of each resource.

External
If you are using external contract or consulting resources, the costs always needs to be estimated and budgeted. You have to determine the type of external resources you need and the hourly rate of the resources. If the final staffing has not been determined and you are not sure the actual resource cost, you need to make some assumptions based on the general type of resource you need. For instance, there may be a standard hourly cost (or a standard range) for accountants, programmers, office administrators, etc.

Internal
Calculating the costs of internal employees varies from company to company. In many companies, estimated labor costs for internal employees are assumed to be zero, since their costs are already accounted for in a departmental budget. This does not imply there is no cost. Rather, it assumes there are no incremental costs over and above what the company is already paying for.

In other companies, you may have an average hourly cost per employee that you need to account for in your project budget. Sometimes this is a general average cost per hour for all employees. Sometimes companies try to get a little more sophisticated by calculating different hourly costs based on the role. In other words, a project manager would have a different internal rate than a programmer.

Non-labor costs
Non-labor costs include everything not directly related to salary (and benefits) and contractor costs. Some of these costs, like training and team-building expenses, are related to people. However, they are still considered non-labor since they are not related to employee salary or contractor hours. Each project manager must be aware of the accounting rules in his or her own company to make sure the labor and non-labor costs are allocated correctly. Generally, however, non-labor costs include:

• Hardware and software
• Equipment
• Material and supplies
• Travel expenses
• Training
• Team building
• Facilities

In addition, if you outsource parts of your project, these costs are usually considered non-labor. This makes sense since you're usually paying for deliverables and you're not worried about the vendor costs for labor. That's up to the vendor to worry about.

When creating your estimate for project costs, take into account the resources that will work on your project, the estimates cost per resource, as well as all non-labor and outsourcing costs. These should give you a total picture of the anticipated costs of the project.