Cost Forecasting

Cost forecasting is a process where a company estimates future costs. It involves comparing initial estimates and predicting future needs for a product, service, or job in a manner that helps bring in desired revenue.

The two primary reasons for executing the process are planning for future resources and their allocation. Proper planning and efficient resource allocation are crucial for a company's growth and survival. The data gathered from the process helps in making better decisions regarding the business's functioning and prospects for growth. 

Cost estimating is a process for estimating the cost of completing a project, product, service, or job. It involves planning costs and monitoring and controlling them. It helps check overruns and correct them promptly. 

There are different types of costs, such as fixed, variable, direct, indirect, and opportunity costs. All of them are required for predicting future outcomes. Methods of cost forecasting involve the top-down approach, the bottom-up approach, the historical approach, and the predictive approach. Under the predictive approach, companies use mathematical models, algorithms, and suitable techniques to predict the cost involved. Current data and future estimates are used to evaluate projections. 

The historical approach uses past data to estimate projects, services, or job evaluations. The bottom approach involves estimating the costs of every task, activity, and resource involved. Companies then aggregate these to arrive at an estimation. The top-down approach involves estimating a project or desired element based on objectives, scopes, and desired outcomes.

Several factors influence forecasting the cost to be incurred. They are details required, complexity, time requirement, size of the project and product, industry metrics, and past performance of similar initiatives. Additionally, the economic conditions, changes in customer demands, technology, skilled person availability, adequate resources, and government policies all impact the estimation process.  

Types of forecasting costs are given as follows: 

1. Historical cost forecasting: This type of forecasting uses available past or historical data to estimate future costs. 
2. Projection cost forecasting: Under this type of forecasting, the company uses estimates of future costs to make decisions about allocating resources in the present.
3. Resource allocation cost forecasting: It is the allocation of resources in a way that helps to achieve specific goals. 
4. Benefit-cost forecasting: Under these types of forecasting, management decides how much money to spend on certain benefits to achieve certain goals. 

Let us look at some of the examples to understand the concept better. 

Example #1

Let's imagine the case of a construction company called AC Builders. They are into the construction of residential homes. They are established in place A and want to move to place B. They are two places with similar characteristics. They both are suburbs and have amenities within a 19 km radius. 

The company wants to invest an amount of $1 billion and is skeptical about the project. The management decides to implement construction cost forecasting. Hence, the company gathers data on the previous constructions in place B. They collect data on labor charges, government restrictions, the cost of materials available, etc. The company then compares it to the requirements of place B to understand if the cost will stay within its budget. Fortunately for the company, there is abundant labor available, hence cutting costs in labor estimation, and the returns looked promising. Hence, the company is moving forward with the project. 

Example #2

In a case study that involves a global wind farm developer, a company is faced with deciding whether they have to bid for a long-term contract with fixed or flexible pricing. Accurate cost forecasting was essential in their case. They took into consideration factors such as aluminum, copper, and steel's volatile input prices. Regional price variations as a result of trade barriers were also taken into account. Their solution included comprehensive forecasts of the prices of commodities and analyses of trends, trade barrier scenarios, etc.  These helped the client to make informed pricing decisions. 

Given below are some of the benefits of cost estimation for the future: 

• It helps businesses understand their financial capacity.
• It helps them make better decisions on cost and resource allocation.
• Understanding the costs associated with a project can help in optimizing it and completing it efficiently.
• It helps identify the drawbacks or inefficiencies of the project in the early stages only. 
• It can help companies budget better.
• It helps in tracking projects through criteria of time, cost, efficiency, and resources. 

Given below are some of the challenges involved in the forecasting or estimation of costs 

• The estimation of future trends can be extremely tricky, and companies may not always get it right. 
• A business is subject to constant market changes, and decisions have to be made quickly to adapt to the situation. Regularly updating cost estimates can be tiring.
• Costs can vary from one period to another, and predictions can be difficult to be made in short periods.
• Stakeholder management can also be a difficult thing to execute.