- Identify the three major components of your budget
- The Base Cost Estimate
- Contingency Fund
- Management Reserve
- Forecast Expenditure
- Monitoring expenditure
- Checking against the “S-Curve”
- Establish Key Performance Indicators
- Forecasting Expenditure
- Getting it right in the first place
- Watching the pennies avoids losing the pounds
What’s the difference between a good project manager and an excellent project manager? From your team’s perspective, it might be how well you balance workloads or bring everyone on board by listening to their input. But from a client’s point of view most of the project management skills that matter all relate to how well you handle project management budgeting.
Everyone knows that some projects are going to be expensive, and the client will be well aware that, for some projects, they are going to need big pockets. But for most projects big does not mean infinite and a client that knows upfront that their project will be expensive will be more satisfied than one that ends up with additional costs through scope creep and improperly managed costs.
Identify the three major components of your budget
A project budget has three main components:
- Base Cost Estimate
- Contingency Fund
- Management Reserve
Your first task is to sketch out an idea of how much each component will need to be allocated.
The Base Cost Estimate
The biggest component is the Base Cost Estimate. Intuitively this is how much, in an ideal world, the project will cost to complete. Estimates need to be made for each of the known costs based on the work required to meet the project goals.
- Labour costs
Some projects will require hundreds of workers with various skills and abilities, plus administrative staff to manage the workforce. There may be a need to recruit new staff, and this should also be factored into the labour costs part of the base cost estimate. Extra training that existing staff require is another cost which needs to be identified and included.
Other projects will be easier to cost as existing staff will be utilised, and a simple calculation based on known staff costs and man-hours required for completion is what is needed.
An estimate of the materials required is necessary for creating your base cost estimate. For some projects, there are clearly defined methods for working out the materials required. For others, there may be unknowns, such as the amount of materials that will be wasted or damaged. In some projects, there may be a trade-off between materials costs and labour costs – lower-skilled workers may bring down labour costs but increase wastage, for example.
Not all projects incur travel costs, but for any project where the project site is remote, or where frequent visits to the client’s offices are required, a travel budget must be estimated and agreed. If this seems inordinately high, then video conferencing, at least for some of the meetings, may be more cost-effective.
- Project Office
List the expenditure of your staff separately to the costs directly incurred by the project. The project office area includes your and your team’s salaries, time, office materials, and so forth. If a remote office needs to be established then include those costs in the project management budgeting as well.
- Software Costs
You may need to increase the number of licenses for your project management software, or purchase alternative software to meet the demands of the client. There may be other software that you need to use which you need to buy or licence in order to be able to liaise with the client. If the project is expected to require licence renewal, then a percentage should be allowed for fee increases in line with inflation.
- Administrative Costs
Larger projects may require dedicated admin staff to support the project management team or the project workers. These costs need to be estimated, together with office costs and hiring costs as required.
- Equipment Costs
Certain projects require large amounts of equipment which needs to be purchased or hired for the duration of the project. Even smaller projects may have equipment costs if you do not already have access to the required items or need to upgrade in line with client demands.
Not only do you have to account for the 7 different areas listed above in project management budgets, but you also have the further complication that costs may have four possible attributes.
A fixed cost is one which does not change, regardless of how much work is put into the project or how large the scope of the project. Purchasing a piece of equipment would be a fixed cost.
A variable cost is dependent on the amount of resource used. Salaries and some software licenses are variable costs, as the more you use the employee or software, the more you need to pay.
Costs incurred by the project in delivering and managing the work are direct costs. As project manager, your time or salary would be a direct cost, as would hiring a site manager to supervise workers on the project.
Overheads and similar charges shared across multiple departments or activities may be considered to be indirect costs.
All projects should have clearly defined risks to project completion. The cost of these risks occurring needs to be estimated to give an indication of how much needs to be allowed for contingencies. There will be an amount of balancing between the likelihood of a risk occurring and the ensuing result.
The sponsor will remain in control of the contingency fund and any application to tap into the funds should be presented to them along with details of why the contingency fund needs to be accessed.
Sometimes things go wrong, which couldn’t be foreseen, and the more uncertainty there is in the project costs, the larger the reserve should be in order to deal with the aftermath. Innovative projects typically have more substantial management reserves because it is impossible to predict the outcome of the work without undertaking it.
The other case where the management reserve may be needed is if the scope of the project changes. Scope creep should, of course, always be avoided but often a change in scope will be agreed with the sponsor.
The sponsor remains in control of the management reserve.
Once the Base Cost Estimate, Contingency Fund and Management Reserve have been agreed a forecast of expenditure against project duration should be drawn up. Typically this forms an “s-curve” and is used to guide project budgeting and funding. From this chart, a cash flow forecast can be developed, and a schedule for the drawdown of funds put in place.
As the project progresses, it is crucial that actual expenditure is compared to the cash flow forecast previously drawn up.
Costs may be tracked directly by the project management team or may be extracted from wider financial systems. It is essential to check that costs are entered correctly – especially if you are relying on third parties to enter data.
Most large organisations have slow and complex purchasing arrangements. This means it can be very difficult to know precisely how much has been spent at any one time. Costs need to be tracked as one of three types:
- Committed Costs
- Actual Costs
Where an order has been placed for goods or services, but not yet paid, a committed cost is incurred. A committed cost shows where funds will be required in the near future and for what they are required.
Accruals are payments yet to be received for work partially, or fully, completed where payment will be due. Where a contractor invoices on a regular basis, there may be multiple jobs listed over the invoice period, which will be paid at the same time.
Once an accrual or committed cost has actually been paid, it becomes an actual cost. It is important to ensure that these are moved across to the actual costs column and that a repeated entry is not created.
Checking against the “S-Curve”
The sum of Committed Costs, Accruals and Actual Costs can be compared to the S-curve to ensure the project is progressing according to the planned budget and cash flow. Where a discrepancy is found, an investigation should take place to determine the reason for the discrepancy. This will ensure that unexpectedly higher costs are not being allowed to eat into the project budget without a good reason.
It also ensures that underruns are spotted early. These could indicate an error has occurred either in the project management – i.e. a forecast cost has not been incurred because it has been missed out – or in the finances – i.e. the cost has not been included in the accounts. In some cases, it may indicate that the base cost estimate was too high initially, but this should not be assumed until proven through investigation as it is unusual for projects to come in significantly under budget.
Establish Key Performance Indicators
When creating the budget, it is vital to agree with the sponsor what KPIs you will report and what you expect to see throughout the lifetime of the project.
Some commonly used KPI’s in project management budgeting include:
- Actual Cost (AC) or Actual Cost of Work Performed (ACWP) – how much money has actually been spent so far
- Cost Variance (CV) – how far above or below a predicted baseline current costs are
- Earned Value (EV) or Budgeted Cost of Work Performed (BCWP) – the approved budget of work completed on the project to a given date
- Planned Value (PV) or Budgeted Cost of Work Scheduled (BCWS) – the cost of completing planned project activities from a given date
- Return on Investment (ROI) – a measure of project profitability and whether benefits exceed costs.
It is vital to re-forecast remaining expenditure as the project progresses. Actual expenditure almost invariably differs from predicted cash flow, but as more information about costs presents itself, the forecast will need to be refined.
While the project manager will have day-to-day control over base costs, there should be clearly defined cases where the sponsors’ involvement will be required – to authorise contingency funds, for example. Where predicted expenditure varies by too great a threshold or tolerance, the issue must be raised with the sponsor to ensure tight control is maintained on the budget.
If a project is running into financial difficulties, then there needs to be a review of viability and project management budgeting. This will detail “sunk costs” – funds already committed or spent on the project – as well as any costs that will be incurred by winding the project up, such as contract cancellation fees.
Not all overspent projects will be deemed viable, but where the eventual benefit of the project outweighs the expected cost to complete it may still be worth continuing.
Getting it right in the first place
The key to ensuring that your baseline cost estimate is accurate is to take the time to fully understand the sponsors and stakeholders needs and desires as regards the project. By pinning down the project requirements carefully, setting expectations on new projects and listening to stakeholders, you can ensure that there is not a disconnect between what they want, what is possible and what they expect. Successful projects deliver what the stakeholders desire, so it is vitally important that time is taken at the very start of the project to agree on what those desires are.
Of course, once the baseline cost estimate is completed, it may turn out to be more expensive than the client had expected. In that case, it is important to take time to carefully isolate parts of the project that could be removed or scaled down and accurately estimate the effect that they will have. This allows you to propose a cheaper project that meets most of the stakeholder’s requirements while being better suited to their budget.
Watching the pennies avoids losing the pounds
The key to good project management budgeting lies in accurate estimating and accurate reporting to ensure that costs are known and not allowed to spiral out of control. Keeping your client informed of the cost of the project is key to keeping them happy and ensuring when unexpected costs occur, they accept the need to draw on contingency funds.
2 Comments Leave a comment
In project management, we all have to care about Cost Estimation, Management Reservation and all. these three things are very important for project management. I like your secretary about project management with the budget. I will share this post with my friends. Keep sharing.
Really useful in-depth guide on project budgeting, which is a topic that others online just skim the surface or make assumptions about prior knowledge. However, I disagree with the section about “getting it right in the first place”. Certainly that is the aim on every project as is taking the time to fully understand the requirements of the sponsors and stakeholders but even when that is doen thoroughly and following all best practise project budgets can and do run over.