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What is a cost estimate? The importance of accurate estimating for your service business

July 22, 2020

Producing accurate estimates is one of the most important aspects of job management and key to successfully executing projects.
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Not only are estimates essential to winning new business, they also determine your project budget, your job schedule, and how you manage your resources.

However, businesses often underestimate what’s required to complete a job and experience the pains associated with cost overruns, including eroded profit margins, overworked staff, and missed deadlines.

In this blog post, we provide an overview of cost estimates for service businesses and explain why accurate estimates are so important to improving business results.

What is a cost estimate?

A cost estimate is the service provider’s approximation of what the job is likely to cost.  

The purpose of cost estimation is to predict the quantity, cost, and price of the resources required to complete a job within the project scope. Cost estimates are used to bid on new business from prospective clients and to inform your job and budget planning process.

Cost estimation is done by breaking the scope of the project down into manageable parts and using all information available (previous experience, similar jobs, expertise in the industry) to arrive at a total expected cost.

Using software (such as a job management system) to manage and track your projects enables you to automatically collect data as you complete work, which you can use to accurately estimate future jobs. For example, tracking employee time with time tracking software gives you precise information about how long employees take to complete specific tasks, so you’re able to estimate those tasks in the next job more reliably.  

Estimating is done at the beginning of new projects to arrive at an original cost estimate, but should be frequently reviewed and updated as new information becomes available or conditions change.

What’s the difference between an estimate and a quote?

Oftentimes, the terms ‘estimate’ and ‘quote’ are used interchangeably within an organisation, as they both serve a similar function and require a similar job costing process to complete; however, they have one key difference which is important to outline:

A quote (or a price quote/quotation) outlines the exact price that the client will pay for the job being offered. Upon acceptance, the service provider is contractually obligated to complete the work at the specified price based on the terms that are outlined in the quote (unless the scope of the work changes and a new quote is presented and agreed upon.)

An estimate, on the other hand, is not contractually binding. Clients understand that the prices outlined are subject to change as the project progresses to reflect a greater level of detail about required resources, scope, or timelines.

When should I use an estimate vs. a quote?

Whether you use an estimate or a quote will depend on your industry and the types of jobs you’re offering. Generally speaking, estimates are particularly useful when:

  • The work is not yet fully defined (often in the early stages of scoping out the project, on an initial call with a prospective client, or on a preliminary site visit)
  • The job is novel for your business and you don’t have previous experience to rely on
  • You’re working with uncertain conditions (new relationships with vendors/subcontractors, fluctuating prices of required materials, etc.)

Alternatively, quotes might be preferred between you and your clients if:

  • The work is routine and you’ve completed it several times before
  • The work you’re quoting has clear and predictable requirements and costs (time, labour, materials, etc.)
  • You’re confident that you won’t encounter unforeseen events or costs

Even though you are not contractually obligated to deliver services at the price outlined in your estimate, it’s important to ensure that your estimates are as accurate as possible.  

Why are accurate estimates so important?

A recent study of transport infrastructure projects cited by the Project Management Institute found that actual costs were, on average, 28% higher than estimated costs. Due to lack of visibility into job performance data on previous projects, eagerness to win a client bid, or internal pressures to get a project approved, it’s commonplace for businesses to underestimate the amount of time and resources that will be required to complete a project.

Seeing that cost estimates provide the foundation for planning the job’s schedule and budget, the accuracy of an estimate can determine if the project is able to meet its objectives.

Some of the benefits associated with producing accurate cost estimates include:

  • More accurate planning: When you’re able to accurately predict what tasks and resources are required to complete work, you’ll be able to efficiently produce a work breakdown schedule, assign work to staff, and adhere to projected timelines.
  • Improved profit margins: Several factors (such as unexpected events, poorly scoped work, and inflation) can cause job costs to increase throughout a job’s life cycle, which presents a risk to completing the work within budget and hitting profitability targets. Accurate estimating accounts for expected and unexpected costs and helps protect your profit margins.
  • Improved resource management: With greater insight into the tasks and timelines required to complete work, you can ensure you have the specific skills needed to complete each deliverable, identify resourcing gaps, hire additional people as needed, and take on new projects with confidence.
  • Stronger client relationships: When clients understand the ‘why’ behind a project's cost, they’re more likely to trust your expertise and expect changes to the cost estimate as the project progresses, resulting in better working relationships.
  • Better reputation and repeat business: When projects are delivered on time and on budget, you’re likely to create happy customers, win repeat business, and gain more referrals.

What should be included in an estimate?

An estimate is much more than a simple list of project costs. Cost estimates detail every component of work that is required to bring the project to life by outlining the assumptions that underlie each cost, inclusions and exclusions, and associated risks.

What you decide to include on the estimates you provide to clients will depend on your unique business, but generally estimates for service businesses should include the following:

Cost breakdown

Your estimate should include a breakdown of all costs involved in the project. There are two main categories to classify costs:

  • Direct costs: Costs directly associated with the job (such as, labour, materials, equipment)
  • Indirect costs: Costs incurred by the company as a part of doing business (such as, utilities, office space, insurance)

Cost elements included in estimates will vary from business to business, but the most common costs to consider for service businesses include:

  • Labour: The cost of human resources that are working on a project, both in terms of salary and time
  • Materials & equipment: The cost of buying and maintaining any materials and equipment required for a project
  • Facilities: The cost of using any working space that is not owned by the business
  • Vendors & sub-contractors: The cost of hiring third-party contractors to complete work
  • Software: The cost of software programs
  • Hardware: The cost of physical computer programs
  • Risk/Contingency costs: Costs added to the estimate to address specific risks or unforeseen additional costs to the project (such as admin, technical support, travel, and client visits)

When presenting an estimate to a client, ensure you account for your service markup.

Additional project information

Your estimate should also include all relevant information about the project that provides context for the costs listed and the project deliverables. Consider including the following when preparing your estimate:

  • Job description: Clear description of the work that will be completed
  • Work breakdown schedule: Details of what work will be carried out and when
  • Your company information: Your business details (including company branding and letterhead)
  • Customer information: The customer’s details, the address/location of where the work will be carried out, and a reference number (if applicable)
  • Cost disclaimer: Your clients should always know they are receiving an estimate (instead of a quote). Estimates should include a disclaimer that the price is subject to change.
  • Date & expiry date: The period for when your estimate is valid (setting a time limit helps protect your business from fees and costs increasing over time)
  • Applicable taxes: Your estimate should outline relevant taxes
  • Terms & conditions: Any terms of doing business specific to your company, including normal payment terms, deposits required, and penalties for non-payment

Estimating software provides a quick and easy way to create detailed estimates so you can respond to queries efficiently and provide prospects with the right information from the outset.

Accurate estimates start with accurate data  

The key to creating accurate estimates is leveraging previous job data and learning from past projects.

Throughout a job, it’s important to be diligent about tracking all employee time and costs, as well as job progress, so you can measure job performance and team productivity.

With a better understanding of how your team is actually performing compared to how you’re estimating, you’ll be able to identify issues, prevent underestimation, and create more accurate cost estimates for future jobs.

Why leave it there?

To learn more about WorkflowMax

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