Components of a Project Management Budget

06 December, 2013

Budgeting is a scary concept for project managers, even for those with PMP® certification. There is a perception that finance is incredibly complex and that you really need to be an accountant before dipping your toe in the water. But get out the Guide to the Project Management Body of Knowledge (PMBOK® Guide), or your PMP® course notes, and study the Project Cost Management section. There really is not much to it.

The two planning processes are Estimate Costs and Determine Budget. On other words: find out what you are going to spend money on and add up what they are going to cost you. That is all a budget is – a list of planned expenditure. It is something we all have to do in our private lives – when we plan trips or consider large purchases like houses or cars. Essentially, we want to know if we can afford it!

A very similar rationale pertains with project budgets. Can we afford to take on this project? Will the cost outweigh the expected benefits? Are there other projects with better cost-benefit ratios?

To commence the budgeting process, we need to develop our schedule. It is not an accident that Project Time Management comes before Project Cost Management in the PMBOK® Guide and in PMP® courses. From your PMP® training you will remember the Estimate Activity Resources process from schedule planning. This will give you a list of the resources – people, materials, equipment – you will need for the project. The Estimate Activity Durations process will indicate how long you need these resources for.

The next step is the tricky one: converting the “what” and “how long” figures into monetary values. To calculate staff costs, a visit to the finance department should give you the answers. They should know how much an hour of any staff member’s time costs the company in total. Staff costs have to include wages, but also overheads, such as light and heat and office space. What you get paid per hour and what you cost per hour are two different figures. When totalling the staff costs, do not forget to include yourself, the project manager.

Material and equipment costs might be very straightforward. Some projects, such as software development ones, rarely involve much in the way of materials (maybe some software licenses) and equipment (maybe a new PC). However, other projects, such as construction ones, require so much material and equipment, that specialists, called quantity surveyors, are needed to calculate them. As we saw in our previous article, obtaining equipment that is used over a long timescale is tricky - rent or buy decisions have to be made. Similarly, should we go off and buy materials now, or order them throughout the project? Price fluctuations, inflation and interest rates all have to be taken into account. If your organization has a purchasing department, pay them a visit - they will have useful advice to offer.

All PMPs® should have risk firmly in their thoughts during a project and budgeting is no exception. How confident are we in the schedule? That can often be seen in the amount of contingency built in – a lot of contingency suggests a lot of uncertainty. In terms of equipment and materials, how volatile are prices for these things?

The level of uncertainty should be reflected in our preliminary budget. A rough order of magnitude cost estimate will provide a range where the final figure is likely to lie. This can range by plus or minus 50% of the estimated figure. It is useful though to provide an initial evaluation of the project.

However, after we have done our project planning, a more accurate estimate – called the Budget Estimate – needs to be provided. While a range is acceptable here too, we are looking at figures ranging from -10% to +25%. Even the final, definitive, estimate can range from -5% to +10%.

During the scope definition exercise (see the Project Scope Management notes from your PMP® course) we broke down the scope first into Work Packages and then broke the Work Packages into Activities. Now, in budgeting, we need to start aggregating these back together again. So we need to estimate the cost of each activity and allocate contingency for each.

It is always a good policy to make contingency explicit – padding estimates disguises errors in our estimation process and hides risks. Some companies will allocate the same contingency percentage to each activity. However, it is better to base the activity contingency on the level of confidence we have in the activity estimates. Some activities will need lots of contingency, while others might not need any.

These total activity estimates (estimate plus contingency) are now added together to form the Work Package estimate. Again, at this level, we need to add a contingency overhead. This might seem strange, particularly to novice project managers, those without the PMP®. Surely we have enough contingency included in the activity estimates? Students of formal logic will be aware of the statistical fallacy of composition. This is explained by the example of assembling a machine out of very light components. Just because the components are light does not mean that the machine will be light in turn. Similarly, all the activities might have been carefully estimated, but there is always the possibility that some minor integration activity was forgotten that requires additional resources to complete the Work Package.

The Work Package estimate, together with its contingency overhead is called a Control Account. These figures will be used during the project to assess how well the actual Work Package cost compared to the estimate. All the Control Account estimates are now aggregated to form the Cost Baseline. This is the budget for the entire project.

The project sponsor will also add what is called a Management Reserve to the Cost Baseline. This, as PMP® exam students will recall, is to deal with “unknown unknowns”. The sponsor will assess the risk level of the overall project and add another layer of contingency to allow for unforeseen circumstances.

For more information on budgeting, please consider one of our project management training courses. By running our project management courses in Dublin, Cork, Limerick and Galway, we seek to reduce your travel and accommodation budgets. Find out more about our Blended Learning Solution by contacting us.

By Velopi Seamus Collins


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