Quantifying Project Budget Contingency: A Comparative Analysis
When it comes to managing projects, one of the most critical aspects is the establishment of an appropriate budget contingency.
This financial safeguard is designed to account for the unexpected, ensuring that a project can continue smoothly despite unplanned costs. There are two primary methods for determining a project’s budget contingency: the percentage of the budget method and the risk evaluation method.
Percentage of the Budget Method
The first approach is to allocate a percentage of the total budget as a contingency (i.e. 5%). Clients often request a simple percentage to set aside. The advantage of this method is its simplicity – once a percentage is determined, it’s easy to calculate the contingency amount. For instance, during the design stage, a ten percent contingency might be included, while in the construction phase, five percent could be deemed sufficient.
However, the downside is that this method can be too simplistic. What is the correct percentage to use? And that number often doesn’t account for the specific risks associated with different stages of the project. While a more complete design might imply lower risks, this approach doesn’t consider the quality of the design or the assumptions made in the cost estimates. Furthermore, how would the percentage change as the project progresses?
Risk Evaluation Method
The preferred method among our project managers is to determine the underlying risks of various components and accumulate the project budget contingency. This process requires digging into assumptions and asking critical questions that quantify the potential impacts of various scenarios. Questions might include:
- How was the project budget assembled?
- What assumptions are included or excluded in the construction pricing?
- How clear and complete is the design?
- What is the status of entitlements and approvals, and are they appealable?
- What is the client’s sensitivity to being over or under budget?
- What is the extent of underground knowledge and work required?
Additionally, for new construction projects, confidence in the loan interest, property taxes, and operating deficit projections is crucial. For renovations, the impacts of doing the work, such as replacing sewer lines or the inconvenience and costs of redoing landscaping, must be considered.
The pros for this more detailed method are that it’s based on a thorough risk analysis, reflecting the quality and stage of design and the confidence in the construction pricing. However, it also has its cons as it takes more time and effort to complete; and if not done correctly, it could result in an unnecessary duplication of contingency, like adding 10 percent on top of another 10 percent. Ultimately, the project budget contingency will be viewed as a percentage, but the process to arrive at that figure is more defensible and adaptable.
Conclusion
After comparing both methods, the more detailed risk evaluation method emerges as our preferred approach for quantifying a project budget contingency. Despite being time-consuming, it provides a more accurate reflection of the project’s unique risks and potential cost impacts. By tailoring the contingency to the specific needs and risks of the project, managers can ensure a more precise and reliable budget, ultimately leading to a more successful project outcome. This method, grounded in a comprehensive risk analysis, allows for a contingency that garners more confidence.
