There's an old saying that no battle plan survives first contact with the enemy. The same is true for project management: No matter how carefully you plan the project, surprises that cost you money or time are inevitable. Having a contingency reserve is a backup plan to prevent surprises from derailing you. There are several ways to calculate contingency reserves. With the expected value method, you look at potential problems and multiply the probability they'll happen by their potential financial cost.

Add together the results for each risk, and you'll see how much of a reserve you need. Project management is easier when you know what you're dealing with, but sometimes, you don't know what to expect. You can divide information or the lack of it into four classes.

Breaking down potential problems in this way can help distinguish between certainties and assumptions. Identifying assumptions that haven't been confirmed goes a long way toward preventing problems. To protect against risk, you need a contingency reserve and a management reserve.

contingency budget project management

If you're a small firm with a small budget, one reserve may be enough. A contingency reserve of either money or time protects you against known knowns and known unknowns. For example, suppose you're managing a software project. You know the software will have to be debugged before you release it, but you don't know how many bugs it will have or how long the fix will take. You calculate a contingency reserve of two months and work that into the timeline.

A management reserve deals with unknown knowns and unknown unknowns. Unlike a contingency reserve, you don't build a management reserve into the project baseline. The Monte Carlo uses enough data to get excellent results.

However, it also takes time and more effort than EMV, which is one reason the expected value method is popular. For an estimated monetary value contingency reserve example, suppose you're designing and building a high-rise condo for a real estate developer.

You have a tight deadline, so you sit down and draw up a list of known unknowns.

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Construction contingency examples could include:. The management reserve covers the problems you don't see coming.

For example, your construction project strikes an old water pipe that isn't on the city's utilities map, and suddenly the site is flooded, or you discover there's a forgotten cemetery on the site and have to relocate all the coffins and grave markers. Because the management reserve deals with unknown unknowns, you can't apply EMV or calculate the chance of the unknowns happening. Unlike a contingency reserve, you may have to seek approval from people higher up in the hierarchy to authorize tapping the money.

One problem with which you may have to deal for large projects is that they have many more ways that things can go wrong. Even if most of the risks are low probability, a list of 10 to 15 risks could create a very large EMV-based contingency.Budget overruns are a litmus test for project success or failure. Few companies have an unlimited budget, so the first thing project stakeholders look to in determining whether their project was a great success or a colossal failure is the bottom line.

This fact fuels the pressure project leaders and their teams face with each passing day. As such, effective budget management is a primary area of focus for project managers who value their careers. Following are five strategies for maintaining control of your project budget before it succumbs to whopping cost overruns.

This can lead to unidentified goals and expectations on both sides of the table. Be sure to put in as much time as is required to get a deeper understanding of what stakeholders expect. Ultimately everything, including the budget, is defined by stakeholder expectations, deliverables, and other requirements. So the first step to an effectively managed project budget is to ensure project requirements are accurately identified, documented and confirmed with all stakeholders — and that these are communicated to all parties involved.

This crucial step should be completed before budgets are set. Many projects have been initiated around needs but executed around wants, automatically putting projects at risk of budget overruns that leave everyone disappointed.

When it comes time to estimate costs, be realistic. Make sure to get input from all applicable stakeholders. More importantly, build in contingencies. This step is essential.

Make sure vendors can deliver on their promises and prepare a backup plan.

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Getting input from other stakeholders and vetting suppliers and vendors can go a long way to setting a more realistic budget that can be met, even if there are unforeseen circumstances that impact costs. Here are just a few commonly known and used project KPIs that are essential to effective project budget management:.

contingency budget project management

A project left to run without budget management and re-forecasting will lead to failure. Frequent budget oversight is essential in preventing budgets from getting too far out of hand. Your chances of keeping a project on track with frequent budget review are far greater than if you forecast once and forget about it.

Project managers should review the number of people currently working on a project and the project's future resource needs on a weekly basis. Doing so will ensure that you're fully utilizing the resources you have and that you have the right resources ready for the rest of the project. Regularly revisiting the resource forecast will help keep your project budget on track.Written on July 17, by Satya Narayan Dash.

In your city; however, traffic is known to cause delays. If a traffic jam occurs, it will impact your arrival time. In this example, you have identified the risk i. It is a known risk, but the impact on your travel time is unknown. You could call this a known-unknown risk.

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You have not only identified the risk, but accepted it, and proactively added a reserve time to your estimated travel. If you get into bad traffic, this reserve will be consumed. Project management is similar.

A model to develop and use risk contingency reserve

We have reserves for our estimates time estimates or cost estimates. Estimates are many times expressed in rangessuch as rough order of magnitude ROM estimate, budgetary estimate, definitive estimate, etc. By definition, estimates are always uncertain. Ranges indicate the degrees of risk. To address these risks, we use buffers or reserves.

Typically, these are contingency reserve and management reserve. Contingency reserve is allocated for an activity, work package, or a project. It is applicable to both time and cost estimates, which can lead to individual project risks. Contingency Reserve is also applicable to the overall project when overall project risk is concerned i. It is sometimes referred to as contingency allowance when you consider cost estimates, or schedule reserve when you consider time estimates.

A project is always executed in an uncertain environment, leading to many risks. It is unlikely that you can address all possible risks and have risk responses for all of them. In fact, for some risks, you just cannot do anything. You have to accept them. You know some deliverables in your project may require rework because of defects, issues, or bugs, but do you know the amount of rework needed? This is a known-unknown.

Another example is this: resource churns will happen in any project. Do you know when a team member might decide to leave, or what impact it will have on the project? Here again, we have a known-unknown. For such risks, there is nothing to do but actively accept the possibility of the occurrence. What you CAN do is assign a buffer or reserve—a contingency reserve. Unlike contingency reserve, which is for known-unknown risks or simply known risksthe management reserve is for unknown-unknown risks or simply unknown risks.

In your project, there will be some risks which will be unknown or unidentified when you begin. For example, a sudden increase in material prices due to economic turbulence. Do you know about that risks in advance of the project?Imagine that you are asked to estimate the total cost of a project.

You have measured the quantities, and estimated the cost and price of each resource required for executing the scope of the project. After all the hard work that you have put into developing the cost estimate, you are asked how confident you are on the estimate? What is the probability of achieving this cost at the end of the project?

contingency budget project management

Have you considered risks and uncertainties on the project? Well, to account for cost uncertainty and to guarantee that the budget is not exceeded at a certain confidence level, a reserve fund needs to be added to your base cost estimate. This reserve amount, known as the contingency, is an estimated amount added to the project base estimate to cover the known-unknown risks in the project and to prevent cost overrun.

More details about what cost contingency is in a cost estimate can be found in this post. There are several different ways to quantify the uncertainties and measure the contingency reserve in a cost estimate. In fact, in the past two decades, many practitioners and researchers have come up with different methods of calculating cost contingency. These methods range from simply applying a predetermined percentage of total project cost to considering complex mathematical and statistical methods.

In this post, I am not going to cover all contingency calculation methods out there. My focus is only on the most common methods for calculating contingency.

contingency budget project management

In practice, the deterministic methods are the simplest and most common methods for establishing the cost contingency reserve fund. In deterministic methods, contingency is estimated as a predetermined percentage of base cost depending on the project phase. In this technique, you take a percentage of the cost of the project and calculate the contingency amount. To do so, you need to have an expert judgment or use some predetermined guidelines or both.

In this method, an expert, or a group of experts with a strong basis in experience and competency in risk management and analysis, determine the percentage of contingency for the project.

Therefore, this method cannot provide the confidence level for the adequacy of the estimated contingency. Although calculating contingency using predetermined guidelines is simple, understandable, and consistent, it cannot effectively address the impact of risks that are unique to a specific project. Therefore, these deterministic methods are usually used by organizations that are not interested in applying a formal risk assessment and analysis on the project for various reasons such as lack of time, insufficient funds, and the type or size of the project.

The typical use of the determinist methods is on small and non-complex projects. In the probabilistic methods of calculating contingency, uncertainties are modeled in the cost estimate using statistical distributions. The outcome of the probabilistic methods is an estimate range distribution rather than a single point estimate, as illustrated in the graph below:.

The contingency budget is determined according to the desired level of confidence that the owner would like to have on the project. The probabilistic risk assessment methods require more time and budget to conduct, and as a result are used on large and more complex projects.This paper describes a simple model that project managers and risk team members can implement immediately to begin using risk contingency reserve in their projects.

Using a risk register and an expected monetary value EMV approach, project managers can easily develop a contingency reserve for their project and begin realizing the benefits of this powerful tool. With a contingency reserve, project managers can address risks that occur on the project, communicate the level of risk exposure to stakeholders, and increase the predictability of project outcomes.

contingency budget (cost contingency)

The purpose of this paper is to describe EMV and data representation tools that you can use to spread awareness of the use of risk contingency reserve effectively. This approach is relevant for any size project and is especially useful to communicate the value of risk management to sponsors and other stakeholders. Limitations of the model are discussed, along with guidelines and best practices for getting started with risk contingency reserve.

An important part of project risk management is developing the contingency reserve. Many quantitative analysis tools exist to calculate contingency reserve, including the Monte Carlo method. Once the contingency reserve has been developed, it is useful for communicating risks, addressing them, and improving the predictability of a project's outcome. This paper will demonstrate how to develop and use a contingency reserve model and what limitations exist with it. The model will rely on the EMV technique, which is about finding the product of a risk's probability of occurrence and the impact its occurrence is expected to have.

First, it is important to establish a brief overview of risk management in order to communicate how the risk contingency reserve falls into it. As opposed to issues, which are incidents that are occurring or have already occurred, a risk is a possible future event with a probability of occurrence ranging between zero and one.

For each known risk that is added to the risk register, some form of risk response should be planned. That way, if risks occur and become issues, there is a plan in place to deal with the impact swiftly and avoid too much damage to the project and its objectives. Contingency reserve and management reserve are options to respond to risks so that these risks do not compromise the project.

The other key difference between contingency reserve and management reserve is who controls each one. As implied by the name, management reserve is typically set by upper management as a buffer against any unknown risks. Along with the cost baseline, the management reserve is the final piece of the cost budget PMI, On the other hand, the project manager is typically authorized to spend what is in the contingency reserve to address risks as they occur.

Therefore, the project manager is accountable for its use. Exhibit 1 shows the cost aggregation technique and illustrates how contingency reserve and management reserve fit together with other project costs PMI, Starting at the bottom, estimates are rolled up into the overall project estimate, and the contingency reserve is added to form the cost baseline.

The cost baseline, with management reserves, is the cost budget for the project. Why should project managers develop a contingency reserve? Primarily, it is a valuable risk response strategy that helps insure the project against debilitating time and monetary costs. This fraction is based on the EMV, or the product of probability and impact. Of course, if all the risks occur, then the pool will run dry, which is one limitation of the model that is discussed later.

The second reason to use a risk contingency reserve is to improve the predictability of project outcomes.Have you ever had a budget crisis due to the lack of a management reserve?

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Unforeseen work comes knocking at your door. There is a better way to handle the unexpected. You can — assuming that your organization supports the concept of reserves — create a management reserve when estimating the cost of your project. Click To Tweet. During the course of a project, you and your project team identify risks which are referred to as known unknown risks.

Project management: 5 tips for managing your project budget

We handle the known unknown risks by creating a contingency reserve using estimating techniques such as the Expected Monetary Value EMV Method.

The contingency reserve is added to the project budget and is part of the cost baseline. Furthermore, project managers encounter unknown unknown risks.

The management reserve is the amount of the project budget reserved for unforeseen work that is within the scope of the project. The project manager adds the management reserve to the cost baseline resulting in the total project budget.

The project manager does not have control of the management reserve. The project manager cannot access or adjust the management reserve without approval from the sponsor. The higher the uncertainty, the higher the percentage. Not everyone agrees with reducing unused reserves. Project managers should determine with the project sponsor whether management reserves will be reduced or eliminated during the project, how this will occur, and when. Include this information in your Cost Management Plan.

Risks can derail projects, resulting in challenged and sometimes failed projects. I make project risk management easy to understand and practical to apply, putting project managers in drivers seat. What is the Management Reserve for Project Budgets? Share 0. Tweet 0. About the author. Harry Hall. You may also like.In other words, a contingency plan in project management is a defined, actionable plan that is to be enacted if an identified risk becomes a reality.

How Cost Contingency is Calculated?

Contingency plans can only be created for identified risks, not unidentified or unknown risks. It should be noted that contingency plans are not only put in place to anticipate when things go wrong. They can also be created to take advantage of strategic opportunities.

If it occurs during your project, you may have a contingency plan on how to incorporate it into the training phase of your project. A mitigation plan attempts to decrease the chances of a risk occurring, or decrease the impact of the risk if it occurs. It is implemented in advance. A contingency plan explains the steps to take after the identified risk occurs, in order to reduce its impact.

Think of a contingency plan as the last line of defense. Project Management guide FAQ. Project management guide overview 1. Project Management Basics 2. Project Management Methodologies 3. Project Lifecycle 4. Project Management Tools 5. Project Management Software 6. Team Collaboration Tips 7.

Agile Methodology Basics 8. Popular Agile PM Frameworks Resources Glossary What is Contingency Plan in Project Management? When to use a contingency plan Contingency plans can only be created for identified risks, not unidentified or unknown risks. The difference between a contingency plan and a mitigation plan A mitigation plan attempts to decrease the chances of a risk occurring, or decrease the impact of the risk if it occurs. How to prepare your contingency plan When preparing your contingency plan, consider these four guidelines:Identify what specific event or events need to happen to trigger the implementation of the plan.

Cover the five bases in each step of your plan: who will be involved, what do they need to do, when does it need to happen, where will the plan take place, and how will it be executed. Have clear guidelines for reporting and communication during the implementation of the plan. How will internal and external stakeholders be notified? Who will draft and send the notice, and how soon after the incident will it be released?

How often will updates be provided? Monitor the plan on a regular basis to ensure it is up-to-date. In addition, you should be aware of these four common challenges that Project Managers face with contingency planning:Contingency planning is viewed as a low priority. Since the plan may never be needed, there can be a tendency to put off the creation of it.

However, not having a properly planned out contingency can lead to project failure.

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