What is Project Budget? Creating, Principles, Contingencies, Challenges, Importance

  • Post last modified:11 July 2021
  • Reading time:10 mins read

What is Project Budget?

The project budget is a plan that identifies the allocated resources, the project’s goals, and the schedule that allows an organization to achieve those goals.

Effective budgeting always seeks to integrate corporate-level goals with department-specific objectives, short-term requirements with long-term plans, and broader, strategic missions with concise, needs-based issues.

Principles of Project Budget

  1. Iterative process
  2. Total lifecycle
  3. Time Phased
  4. Comprehensive
  5. Include a buffer
  6. Document assumptions

Iterative process

Budget development is an iterative process just like all project planning. The various facets of project planning all interrelate and have natural feedback loops. With the project budget, there are strong dependencies on organizational policies and on the schedule development process.

Total lifecycle

The budget should address the total project lifecycle. This is a common oversight, especially for the operational phases of the project.

Time Phased

Not only do we need to budget cost totals, but we need to know when these costs will be incurred for both cash flow management and project control reasons. The goal of the project budgeting process is to establish a cost baseline.

Comprehensive

The budget should account for all project costs. There is a tendency to only account for obvious resources needed for the project (labor, new equipment). As part of our focus on making the budget (like the schedule) complete and realistic, we’ll cover all the costs that need to be considered later in this chapter.

Include a buffer

A buffer, normally referred to as management reserve, should be allocated to the project budget. The management reserve is primarily there to deal with known risks (a risk response), the estimating uncertainty factor, and the overall planning uncertainty factor (hidden work, re-work, hidden costs, change requests).

Document assumptions

Budget assumptions are documented like all other project assumptions. Any assumption made as part of the budgeting process should be documented and clearly communicated.

As with all assumptions, you can document them within the targeted deliverable, or add them to the designated repository for project assumptions.


Creating a Project Budget

  1. Sources of Project Costs
  2. Develop Initial Budget
  3. Finalize Budget

Sources of Project Costs

The first step in building a project budget is to identify your costs.

Labor costs

One of the key budget cost items. Budget should reflect a line item for each person or role—whichever makes the most sense for your project. Costs are based on resource rates and estimated work durations.

Equipment

This category generally includes the tools that the project team requires to complete the work of the project.

For budget purposes, the keys with the equipment category are twofold:

  • Completeness
  • Expense versus capital

Materials

This category includes those items that are needed to build the product. The information is generally found in the product specifications document. In dealing with vendor relationships, you would either acquire or confirm material costs by reviewing vendor responses to the formal procurement documents.

Licenses and Fees

This category includes costs such as software licenses, building permits, and so on.

Training

This category includes the cost of any training your project team will need to do their work and any training your users may need to use the final product.

Travel

This category includes the travel and lodging costs to be charged to the project that will be incurred by any project team member while doing the work of the project.

Operational costs

This category includes the costs associated with the maintenance and support of the final product. In addition, there may be costs to dispose of whatever the project is replacing.

Disposal costs

This category includes the costs associated with the disposal or removal of whatever the project is replacing.

Overhead costs

This category includes the common overhead costs incurred by any project. Items typically included are facilities, administrative assistance, security, and technology infrastructure.

Costs of change

A focal point of project planning is to consider the “change” impact that the project will have. This category would include any costs (change management programs, initial productivity loss) that can directly attribute to the change factor.

Develop Initial Budget

By taking a bottom-up approach, you are in the best position to identify all your resource needs and develop a more realistic budget. In addition, many industries and organizations have cost estimate models that can be leveraged, too.

These models are best used during initial planning activities and as a cross-reference and validation tool for your detailed planning efforts.

We recommend the use of spreadsheet software (such as Microsoft Excel) for your project budget. I favor the spreadsheet approach for three principal reasons:

  • Capture all costs: The spreadsheet approach allows you to easily capture all your project costs (and not just labor costs, which is the primary cost element captured by your schedule).

  • Flexible: The spreadsheet approach offers flexible options in how you set up and organize your budget. It can also be used to track your project costs during project execution.

  • Easy analysis: The spreadsheet approach comes with built-in analysis and reporting capabilities that can be easily leveraged.

The two keys for setting up your project budget are to set a line item for each cost source and to use columns for each time phase (period) that will be tracked.

Finalize Budget

Once the schedule nears completion and the actual resources have been identified, we can finalize the project budget. Besides firming up rates on resources and estimates on other cost factors, there are several objectives to accomplish in this step.

Validate procurement tasks scheduled

Make sure that all the tasks dealing with procuring resources (labor, equipment, materials) are accounted for in the project schedule (and WBS). Common tasks include ordering, delivery, setup, and payment.

Reconcile task costs versus resource costs

In most cases, there will be gaps between resource assignments on the schedule, or resources will not always be scheduled at maximum capacity.

Nevertheless, if your resource costs are based solely on assigned tasks, your budget may not reflect the actual resource costs you will incur.

Finalize management reserve

Based on all known risk factors, finalize the buffer amount to be added to the project budget. The specific amount will vary depending on risk level, industry practices, and management philosophy.


Developing Project Budget Contingencies

There are several reasons why it may make good sense to include contingency funding in project cost estimates. Many of these reasons point to the underlying uncertainty that accompanies most project cost estimation:

  1. Project scope is subject to change
  2. Murphy’s Law is always present
  3. Cost estimation must anticipate interaction costs
  4. Normal conditions are rarely encountered

Project scope is subject to change

Many projects aim at moving targets. That is, the project scope may seem well articulated and locked in, but as the project moves through its development cycle, external events or environmental changes often force us to modify or upgrade a project’s goals.

Murphy’s Law is always present

Murphy’s Law suggests that if something can go wrong, it often will. Budget contingency represents one important method for anticipating the likelihood of problems occurring during the project life cycle. Thus, contingency planning just makes prudent sense.

Cost estimation must anticipate interaction costs

It is common to budget project activities as independent operations. Thus, in a product development project, we develop a discrete budget for each work package under product design, engineering, machining, and so forth. However, this approach fails to recognize the often “interactive” nature of these activities.

Contingency budgets allow for the likely rework cycles that link project activities interactively.

Normal conditions are rarely encountered

Project cost estimates usually anticipate “normal conditions. However, many projects are conducted under anything but normal working conditions.

Some of the ways in which the normal conditions assumption is routinely violated include the availability of resources and the nature of environmental effects.


Project Budget Challenges

  1. Based on weak foundation
  2. Missing cost categories
  3. No profit margin
  4. Budget is pre-allocated
  5. Labor costs not tracked

Based on weak foundation

The budget is built on the planning foundation created by the WBS, resource estimates, effort estimates, and the project schedule. An inadequacy in any of these elements is directly reflected in the budget.

Missing cost categories

The budget needs to reflect all the costs that will be incurred or at least all the costs that the project is accountable for by the sponsoring organization. See earlier section for the list of cost sources that should be considered.

No profit margin

For projects that are sold to clients, do not forget to include the profit margin in your project budget and in your pricing decisions.

Budget is pre-allocated

In many organizations, due to the nature of their budgeting cycles and level of project management maturity, the budgets for projects are established (from high-level estimates) before the complete work of the project is defined.

Labor costs not tracked

More of an issue for internal projects, but in many organizations, it can be difficult for the project manager to define and track labor costs, especially for internal staff. The most common reasons for this include:

  • Organizational policy that project managers do not track internal labor costs
  • Organizational policy to treat internal labor as “sunk costs”
  • A mismatch between time reporting system/procedures and needs of the project.

This last reason is important to understand and may limit your cost tracking options, or at least the level of detailed information you can obtain.


Importance of Project Budget

  1. Planning validator
  2. Performance measurement
  3. Managing expectations
  4. Cash flow management tool
  5. Justifying project investment

Planning validator

Because the project schedule is a main driver for the project budget, the budget can serve as an excellent cross-reference for the validity of the schedule and vice versa. By looking at the schedule from a cost perspective, you may see resource or budget issues that were not obvious before.

Inversely, the schedule input is key for validating the project budget, because the budget needs to account for all the time a resource is required on the project.

Performance measurement

By measuring project progress against a cost baseline, you can better measure the true performance of your project along the way, and in most cases, identify issues and risks much sooner. This is the basis for an advanced project controlling technique called earned value management,.

Managing expectations

The budget impacts stakeholder expectations in several ways. The initial budget sets the expectation on what the total project costs should be. If the budget is not developed properly then you are bound to have an expectation issue.

If the project budget is predefined and serves as a cost ceiling for the project then it helps you to set stakeholder expectations regarding project schedule and project scope.

Cash flow management tool

Your schedule drives the timing of your resource needs. Especially in organizations where resources are shared across projects or centrally managed, the accuracy of the schedule is key to efficient resource management.

Justifying project investment

With more projects accountable to a project selection process and to financial return on investment expectations, it is increasingly important to establish the cost baseline for the project and monitor closely.


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