7.9. Understanding Budgets

A budget is part of the overall plan in a project.  A budget is a decision made on the amount of money that will be spent on a project and how it will be spent.

A Project Budget is a combination of all the activities milestones and tasks in the project plan; and the costs that the project must accomplish. Simply stated, it is the money the team needs to complete the project.  It is important to the project to:

1. Secure the funding:  it tells the stakeholders exactly how much is needed to complete the project
2. Financial viability in a direct way to the company: increase the operating margin and improve overall project success
3. Cost control can be maintained:  the project can be measured through actual costs versus the approved budget.  This shows how the budget is progressing (ahead, behind, on budget.)

It helps the Project Manager keep the spending of the money in check.  It must be realistic, flexible (where possible), clearly communicated and well planned for all stakeholders to agree.  A budget is generally approved by a person of authority in the organization.

Budgeting is an exercise in refining your focus. You start with a wide-angle estimate, in which the details are necessarily fuzzy, and bit by bit zero in on a sharper picture of project costs. You might be temperamentally inclined to try to nail down every figure in an early draft of a budget, but in fact you should only develop a budget when decisions are made what the budget costs are for the project.  Your overall precision can and should advance as the project advances.

This is especially important in the earliest stages of the budgeting process, when you are working out rough estimates. Take care to estimate at the appropriate level of precision: Don’t make the mistake of thinking you can estimate costs to the exact penny or dollar. $378,333.27 is not a realistic or intelligent estimate. Ultimately, overly precise budgets represent a communication failure. By proposing a budget to the customer that contains overly precise figures, you risk giving a false sense of accuracy regarding your understanding of and knowledge about the project.

In the early stages of the budgeting process, when you are still working out estimates, it’s helpful to include an uncertainty percentage. A typical approach is to include a +/- percentage, such as $400,000 +/- 10%. The percentage may initially be large but should gradually decrease as the project progresses and the level of uncertainty declines.

For IT projects, which are notoriously difficult to estimate, consider going a step further and adding an uncertainty percentage to every line item. Some items, such as hardware, might be easy to estimate. But other items, such as labor to create new technology, can be extremely difficult to estimate. These line item variances can influence the total estimate variance by a significant amount in many projects.

But even when you have a final budget in hand, you need to prepare for uncertainty by including an official contingency fund, which is a percentage of the budget set aside for unforeseen costs. Contingency funds are described in more detail later in this chapter.

Successful project managers use the budgeting process as a way to create stakeholder buy-in regarding the use of available resources to achieve the intended outcome. By being as transparent as possible about costs and resource availability, you’ll help build trust among stakeholders. By taking care to use the right kinds of contracts—for example, contracts that don’t penalize stakeholders for escalating prices caused by a changing economy—you can create incentives that keep all stakeholders focused on delivering the project value, rather than merely trying to protect their own interests. The relationship between costs and contracts is discussed in more detail later in chapter 7.

Attribution

“6.4. Understanding Cost” from Essentials of Project Management by Adam Farag is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 4.0 International License, except where otherwise noted.