Estimated Cost

Article byWallstreetmojo Team
Reviewed byDheeraj Vaidya, CFA, FRM

What Is Estimated Cost?

An estimated cost is an approximate projection of future expenses incurred in goods production or completion of a project. It includes both fixed and variable costs like labor, material, and capital.

Estimated Cost

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For project-based businesses, cost projections become crucial; once quoted, the party has to adhere to the fixed-price contract. Every project incurs various planned and unplanned expenses. Therefore, businesses undertake a rough estimation before quoting prices. Similarly, in goods manufacturing, the evaluation of manufacturing expenses is paramount. Only then selling price and profit margins can be determined.

Key Takeaways

  • An estimated cost is the overall expected future expenses incurred by a project or manufacturer. 
  • It is the statistical sum of fixed and variable expenses, including the labor, material, and capital employed in a project or goods manufacturing.
  • It seems similar, but. It is completely different from the standard cost. The latter is determined scientifically, it is not an estimate.
  • If Y is the total estimated cost, f is the fixed expense, v is the variable expense per unit, and X is the total number of units, then the formula for estimation is as follows:

Y = f + vX

Estimated Cost Explained

Estimated cost refers to the computation and evaluation of all expenses that has been incurred during a particular production process of execution of project or any other activity undertaken by an organization. It is a very important step, which helps in production planning, budget estimation and various other decision making.

The process of preparing an estimated cost sheet involves quantifying various expenses related to overheads, raw material, labor, etc, which makes use of several techniques and procedures depending on the nature and complexity of the operation or project.

Determination of estimated cost helps in understanding long-term expenses, feasibility, returns, and risk in project management and capital budgetingCapital BudgetingCapital budgeting is the planning process for the long-term investment that determines whether the projects are fruitful for the business and will provide the required returns in the future years or not. It is essential because capital expenditure requires a considerable amount of funds.read more. In construction, software and project-based companies use it as a crucial evaluation technique before quoting prices in front of clients. In such scenarios, the estimation becomes crucial; once quoted, the party must adhere to the fixed-price contract.

For firms that produce goods or render services, the estimated cost of manufacturing becomes the bottom line for pricing. It helps manufacturers ascertain profit margins and a competitive selling price for various goods or services.

However, it is to be noted that the concept of total estimated cost may not always be very precise and accurate because it may be influenced by other external factors like changes in the scope of the project, unforeseen situation, etc. The concept may give as much accurate result as possible provided the company does regular monitoring and control and stay within the planned budget.  

How To Calculate?

The estimated cost sheet includes both fixed and variable overheads paid by a company—for manufacturing a product. It includes direct and indirect expensesIndirect ExpensesIndirect expenses are the general costs incurred for running business operations and management in any enterprise. In simple terms, when you want to buy grocery from a supermarket, the transportation cost to get you to the supermarket and back is the indirect expenses.read more incurred—labor, material, equipment, vendors, and facilities. Therefore, to determine the estimated cost, the following formula is used:

 Y = f + vX

Here Y is the total cost.

  • f is the fixed expense.
  • v is the variable expense for each unit.
  • X is the number of units produced or sold.

With a realistic, dependable, and precise estimate, an expense overrun or a budget overrun can be averted. The person who prepares the estimate is known as a cost estimator. There are a variety of estimators, further classified into construction estimators, electrical estimators, or chief estimators.

Expense estimation is necessary for computing the break-even point of a new undertaking—to analyze future profitsProfitsProfit refers to the earnings that an individual or business takes home after all the costs are paid. In economics, the term is associated with monetary gains. read more or losses before investing. It is also used for decision-making—whether a project is worth investing in. It is used to determine when the initial investment will be recovered. Simply put, this method gives an overview of the projected future expenses for a project or product. It is important to note that this is just a projection; the actual expense incurred by a business might differ.

Example

Let us understand the concept of total estimated cost with the help of a suitable example.

Let us assume that ABC Pvt. Ltd. is engaged in the manufacturing of calculators. If the company plans to add a new feature to the product, expenses will also rise. If the new fixed expense is $12000 for manufacturing 8000 calculators and the variable expense is $2 per calculator, what would be the estimated cost?

Solution:
Given:

  • f = $12000
  • v = $2/calculator
  • X = 8000 calculators
  • Y = f + vX
  • Y = 12000 + (2×8000)
  • Y = $28000

Thus, for manufacturing 8000 calculators, the estimated expenses will be $28000.

The above example shows in a very simplified manner, the calculation and estimation of the cost of producing a calculator. However, the actual process of estimated cost basis is quite complex and involves more complicated data gathering and calculation, depending on the size of the business or project , complexity of the operation or range of products and services produced.

Estimated Cost Vs Standard Cost

Often, people get confused between standard cost and estimated cost basis—end up using the terms interchangeably. But, there are considerable differences between the two:

BasisStandard CostEstimated Cost
MeaningIt is a scientifically drawn method that charts overall future expenses involved in a project, goods production, or service.It is an approximate estimate of future expenses borne by a project or production plant.
ConsidersFor evaluation, It acknowledges the production technique and level of efficiency.For evaluation, It considers the historical cost of a project or product.
Part of Cost AccountingStandard costing is a well-defined stream in cost accounting.It is not a part of cost accounting.
Evaluated ByIt is ascertained by the production team.It is determined by the accounting personnel.
Depends UponIt works on the efficiency parameter.In order to evaluate expenses, this method assumes efficiency.
NatureStableFlexible
Applied WhenIt is used when the organization follows the standard costing approach.It is applicable where the historical costing approach is undertaken.
PurposeIt facilitates control of expenses.It provides a basis for pricing—selling price and profit margin.
ValidityThe expense remains valid long-term—until revised.It is determined for a particular period or project, or product and cannot be reused for another project or product.
RevisionSince it is useful for the long-term, it requires revision from time to time.It is designed for one-time use for a particular product or project; revision is not required.
Aims at Expense ControlYesNo

Frequently Asked Questions (FAQs)

What do you mean by estimated cost?

It is a culmination of fixed and variable expenses incurred by a company—for manufacturing a product or accomplishing a project. It includes various financial expenses—resources employed for material, labor, and capital.

How do you find the estimated cost?

The following formula is used:

Y = f + vX

Here, Y is the total estimated expense, f is the fixed expense, v is the variable expense per unit, and X is the total number of units.

What is some common cost estimating methods?

Following are the different techniques of expense estimation in project management:
#1-Analogy Method
#2-Engineering Method
#3-Parametric Method
#4-Actual Costs Method

Why is cost estimation important?

Businesses evaluate the expenses involved in the manufacturing of a product or service. Estimation helps set a profit margin and sales price. In project management, this method gives investors an idea of the approximate expenses incurred in the completion of the project.

This is a guide to what is Estimated Cost. We explain it with example, differences with the standard cost and how to calculate it. You can learn more about it from the following articles –