Project financial success is one of the critical goals for any project manager or organization to achieve. In this article, I will discuss the use of budget contingency as a tool that can be used to safeguard this target.
What Is Project Budget Contingency?
Budget contingency is a cost allowance in the project cost plan added to the scope activities estimate.
The purpose of the contingency is to compensate for two main events, one, any shortfall or omission in the project estimate, and two, any future risks that would result in a cost impact on the project.
What Are The Types Of Project Contingencies?
Budget contingency is the most referred to when discussing project contingency. However, it is also essential to realize the importance of time contingency to mitigate project delays and manage the project schedule.
As the project time, cost, and risk plans are interconnected; it is essential to consider all three collectively. For example, a risk event could impact both time and cost, and a delay to the project schedule would have, in most cases, a cost impact.
Does The Project Budget Include Contingency?
Yes, it does. However, some organizations can have specific rules for accessing the project contingency, which I find a very effective cost-control measure of differentiating between regular spending on the costed scope activities and any other risk-related expenditure that needs to be funded by the budget contingency.
How To Calculate Budget Contingency?
From my project management experience, organizations often use one of two methods to calculate budget contingency.
1. Pre-Set Percentage Of The Budget Total:
This method applies a percentage of the total budget bottom line as a contingency, for example, 5% or 10% of the budget.
It is a quick and easy way of calculating contingency hence why it is commonly used. However, the percentage applied has to be calculated based on the project scope definition status and type of estimate used.
In one of my projects, the budget needed to be set very early before the scope definition activities, including the site investigation and detailed design, could progress.
That project budget included 50% contingency which looks high. However, as the project was completed and the final project cost report was issued, the 50% contingency was about the correct percentage to apply. Any contingency short of that would have meant the project exceeded the budget.
This leads us to the conclusion that applying a certain contingency percentage to a cost estimate is a valid methodology. However, that percentage should be directly related to the scope’s maturity and the estimation efforts’ level.
2. Risk-Based Budget Contingency:
This approach is based on performing a project risk assessment by identifying, evaluating, and mitigating the risks.
As the risk mitigation process is based on reducing the risk probability and its impact, an excellent measure to reduce the impact is to allow for budget contingency for any risk event resulting in an added cost.
For example, if there is a 70% probability of project scope creep, which is estimated to cost $100K. A sound risk mitigation would be to allow (70% * 100) = $70K as a budget contingency for this particular event.
That same concept applies to all other risks in the risk register.
The total budget contingency becomes the total sum of all risks’ mitigation.
This method is more accurate in calculating the budget contingency for complex projects. It is built on the foundation of risk management, which is a must-do for such a project.
Project Contingency Versus Project Reserve
The project budget contingency aims to mitigate the risks directly associated with the project work. On the other hand, the project management reserve is a contingency for risks that couldn’t be identified or, in other words, the ‘unknown-unknown.’
The other difference is the management reserve is set and controlled by the management, whereas the project manager is generally in charge of the budget contingency.
Conclusion
To achieve successful project delivery, it is imperative to have a contingency in place for both time and budget. By accurately allocating the required amount of contingency and closely monitoring the project budget and schedule throughout its execution, project managers can confidently make informed decisions to keep the project on track and within budget.
