The Project Budget
The project budget is an estimate of the total costs that must be incurred in order to complete the project. Because of the large number of variables involved in any complex undertaking, the accuracy of the budget will inevitably be limited, and therefore represents a risk factor in the sense that you may spend more than anticipated. For this reason, most project budgets include a contingency to cover unexpected costs (this is sometimes referred to as slack). The size of the contingency allowed as a percentage of the overall budget will depend on the degree of accuracy predicted. If the estimate is thought to be accurate within ten percent, for example, then a contingency of ten percent should be added to the initial estimate. Assuming that the project manager is responsible for setting the budget, he or she will often be put under pressure by senior management to keep project costs low. There is little point, however, in reducing the projected costs simply to curry favour with management. A frequently used tactic when seeking approval for a project budget is to put forward a somewhat higher figure than you think you need. This allows you to concede a budget reduction when asked to by senior management without leaving the project dangerously underfunded.
The approaches to budgeting vary from one organisation to another, but there are two general approaches that may be adopted. The first of these is top-down budgeting in which the cost of each high level activity identified by the project's Work Breakdown Structure (WBS) is estimated using estimates of the time required to complete the activity and the resources that must be allocated to it. This approach often relies on historical data from previous projects of a similar nature. The second approach is a bottom-up approach in which the low level activities identified by the WBS (the work packages) are used. The staff responsible for undertaking each task are asked to estimate the time required to complete the activity, and to identify any resources (equipment, materials etc.) required for the task. The cost of labour, materials and any other resources are then calculated and summed to obtain the total cost for the work package. Once the cost for each work package has been calculated, the overall direct cost of the project can be calculated.
There are issues related to both top-down and bottom-up approaches to budget estimating. The reliance of the top-down method on historical data can lead to inaccuracies if the data is incomplete, if there have been significant changes in costs in the intervening period, or if the current project is significantly different in nature from previous projects. The bottom-up method is on the face of it a more accurate one, but places far greater reliance on the experience and estimating skills of individual project team members. There is also more chance of some elements being overlooked. An alternative to relying on only one approach is to use both, and then compare the results. If the figures arrived at are reasonably close, the estimates are probably good. If not, they may need to be re-examined.
Usually, by far the biggest single cost factor in any project is the cost of labour (the time spend by project personnel actually carrying out the work). Bear in mind that project staff will also spend some of their time in planning or review meetings, completing project documentation, or in the execution of other administrative duties not directly related to the project work packages. The time required to plan and manage the project must also be accounted for when creating the project budget. The cost of the man hours for individual work packages will usually be calculated using the hourly rate that applies to the person (or persons) carrying out the task. The rate applied may reflect the salary or wage structure for the individual carrying out the work, or it may be a general hourly rate applied to the project as a whole. Either way, it will include an allowance to cover the additional costs involved in employing a member of staff, such as National Insurance contributions.
The other costs that will be incurred include the costs of purchasing materials and equipment, money paid to subcontractors, staff training and overheads. It may include things like travel and accommodation expenses if any of the work is being done is to be carried out at a remote location. It will be necessary to determine what materials and other resources are required for the various project activities, and allocate a cost to them for each activity. This is normally done for each work package identified by the work breakdown structure and should therefore provide a reasonably accurate estimate of the cost of such resources, providing nothing is overlooked. The term overheads usually refers to costs that will be incurred whether or not work on the project is proceeding, and can include things such as rent and rates, heating and lighting. Some organisations set a fixed contribution to overheads for the project based on the project's estimated turnover as a percentage of the total projected turnover of the organisation during the period over which the project is scheduled to run. The advantage of this method is that the contribution to overheads can usually be accurately determined in advance.
Generally speaking the bigger the project, the less accurate the budget will be. It is therefore important both to build in a contingency and to manage the expectations of the various stakeholders of the costs involved. Making sure that everybody concerned is aware of the potential costs will hopefully eliminate or at least reduce the likelihood of unpleasant surprises in the latter stages of the project. If senior management are intent on trimming the budget they sometimes see the project contingency as excess fat. It will sometimes be possible to argue your case providing you have been careful to document the source of cost information and any assumptions you have made in arriving at the final budget figure. If forced to accept a reduction in the budget, you may need to make some revised cost estimates. If costs cannot realistically be reduced, it may be necessary to negotiate with the project client to amend the scope of the project in order to reduce the amount of work involved. Remember that if you come in under budget you will be seen as having done a good job. If not, you will be responsible for explaining any cost overruns. This is unfair if you have been saddled with an unrealistic budget, but it happens.
The project budget, together with the project schedule, form the baseline for the project and will be used to measure actual progress at various milestones throughout the implementation phase of the project. If changes in the scope of the project result in approved changes to the project plan, new cost and schedule estimates may be required, and a new baseline will emerge. The baseline should not be changed, however, to reflect cost or schedule overruns at a given project milestone. The purpose of the baseline is, after all, to enable project status to be monitored and evaluated. If actual progress is falling behind planned progress, measures should be taken to try and get the project back on track. In terms of both the budget and the work schedule, milestones are selected that represent the completion of each high-level work activity. Intermediate milestones may also be used to allow interim progress reports to be made by the project team, and will represent the completion of work activities at a lower level. Each work activity, at whatever level, should have a cost allocation within the overall budget. It should therefore be possible to detect any significant variation between expected and actual costs before things get too far along.
While the WBS breaks down the project according to work activities, a complementary technique is sometimes used which groups the project costs according to cost centre. This technique, known as a Cost Breakdown Structure (CBS), allocates a different code to the various types of cost, such as labour, materials, and subcontracted work.