A successful project outcome is a result of doing three things well; delivering what the customer needs (scope) when they need it (time) and within the cost (budget). The scope and time aspects also boil down to cost eventually. Project Budgeting is a process that helps you understand the cost boundaries for your project and how well you are doing to stay within those boundaries. In this article, we will understand what project budgeting is, how to best go about it, and why it is a critical process for success.
What is Project Budgeting?
Project Budgeting is a process and tool to estimate all possible expenditures that the project will incur. The project management budgeting process involves estimating the costs for all resources and activities required to complete the project successfully. Such resources and activities may include manpower costs, cost of materials and equipment, training costs, and other such direct or indirect expenses.
The budgeting process continues beyond estimating the cost and also lays down a time-based expenditure plan. This plan allows the project managers to handle the project cash-flows better.
Why Project Budget is Important?
Project Budget is a valuable tool for project managers to ensure the successful completion of projects. It allows them to plan the project activities and resource acquisition and deployment effectively, provides a benchmark against which the progress needs to be measured, and makes informed decisions for controlling deviations. Below is an indicative list of different benefits of the project budgeting process.
- Better planning and decision-making around resource allocation, activity prioritization, and possible avenues for cost control.
- Provides clear guidance for the project team and visibility for other stakeholders on financial and cash-flow requirements.
- The process enables the project team to identify risks and uncertainties and develop effective response and mitigation plans.
- Ensures optimized resource utilization by establishing boundaries and limits on expenditure.
- It also provides a benchmark against which project performance is monitored.
Basic Elements of Project Budgeting
A reasonable project budget includes every possible way the project will incur expenditure. There will be many factors and items to consider for inclusion in the project budget. You can learn about those elements in detail in courses that allow you to learn Project Management online. However, for now, let's see some critical elements you must consider while developing the project budget.
1. Labor Costs
Labor costs form the most significant chunk of your expenditure. Hence, while developing the project budget, you must ensure you have calculated all the manpower, internal, external, full-time, and part-time.
2. Procurement Costs
If your project involves purchasing any material during the project execution, that cost must be considered during project budgeting. Your organization may have guidelines to determine the extent of expenses you need to budget for and whether you can use a lumpsum amount combining multiple small expense items. However, ensure you have considered the maximum material needed for your project.
3. Fixed Costs
Both labor costs and material procurement costs can be either fixed or variable. Fixed costs do not change in response to consumption or usage during a specific period. For example, if you pay rent for project office space, the rent will not change during the contract period. That is one example of a fixed cost.
4. Variable Costs
Variable costs are the costs that increase or decrease depending on consumption, usage, or output. For example, if you hire a consultant at an hourly rate, you may pay more if they spend more time on the project.
While working on project budgeting, ensure that you have included all fixed and variable costs. In addition, there are other dimensions to the project budgets, including capital expenditure (CAPEX) and operational expenditure (OPEX). These dimensions are helpful for cash flow identification and should be considered for the representation of the budget.
Project Budgeting Techniques
Your project consists of many activities, each requiring various resources to complete. Therefore, the project budget is inclusive of all such activity costs. To arrive at a sound project budget, you can use many techniques to determine such costs.
1. Analogous estimating
The analogous cost estimation technique involves determining the costs based on experience and historical projects. For example, suppose you have done a similar project in the past. In that case, you take the actual costs from that project and adjust them to reflect the current project's size, complexity, and time differences to arrive at a budgeted cost figure.
2. Three-point Estimate
The three-point estimation method considers multiple scenarios to adjust the budget appropriately, including the risks and inherent estimation biases. This approach is simple yet practical. First, the estimation team or the project manager considers the most likely, optimistic, and pessimistic scenarios to estimate the likely budget in each case. Then a mathematical formula is applied to determine the final budget figure.
Two formulas can be used.
Let's assume that "O" is the optimistic budget, "M" is the most likely scenario, and "P" is the pessimistic scenario. Finally, let's say "E" is the final budget figure.
The first is the triangular distribution. The final budget using this method is derived as follows;
E = (O + M + P)/3
The second alternative is to use the Beta distribution. In this case, the final figure is derived as follows;
E = (O + 4M + P)/6
In general, the Beta distribution is observed to be more precise.
3. Earned Value Analysis
The Earned Value Analysis (EVA) monitors and adjusts the budget based on the project's progress. This method compares the actual work done and costs against the plan. Based on those observations, the budget required to complete the remaining work is calculated continuously.
4. Parametric Estimating
The parametric estimation method combines the historical data from previous projects with variables governing the current project by establishing a statistical relationship between them. So, you use analogous estimation first to determine the budget based on previous projects and then adjust it for the change related to the current project parameters.
5. Bottom-up Method
The bottom-up method for project budgeting involves first identifying the cost for every single activity. Once that is done, the next step is to roll up the activity budgets to milestone budgets and then cumulatively roll it up till you have the entire project budget. For the bottom-up estimations, the assumption is that all the activities are known sufficiently to the project team to arrive at a meaningful estimate.
6. Top-down Method
The top-down cost estimation approach is typically used with a fixed-price project. You already have the total budget constraint in place. Now, you need to determine the allocation to activities and the timeline for funding requirements. The team needs to break down the predefined budget and then estimate the portion allocated to which activity. You can take up PMP virtual training to learn these techniques in greater detail, thus acquiring the knowledge and skills to apply to your real-life projects.
How to Keep Your Projects in Budget?
Budgets provide a benchmark using which you can control your projects and ensure they are successfully executed in terms of cost. You can take multiple steps to ensure the projects remain within the budget.
- Ensure you create a reasonable and realistic budget considering all project requirements and related indirect expenses. The cost estimation should be done at an appropriate level of detail so you can take advantage of critical aspects.
- Ensure you have prioritized the most critical activities while developing the budget.
- No matter how good your plan is, every project encounters unforeseen situations. Therefore, ensure that you have considered contingencies on your project and have kept sufficient reserves to deal with such contingencies.
- Manage risks proactively to ensure you don't spend your budget on unplanned events. Develop a robust communication plan considering all stakeholders so that any issues can surface early.
- Ensure that scope creep does not happen on the project. The scope creep will impact the cost. It can consume all contingency and management reserves if it goes beyond a threshold, resulting in cost overruns.
- Use a project management and budget tracking tool to ensure you always stay on top of the spending and progress. The visibility will enable you to take proactive steps in case of any deviations. In addition, such tools can significantly help track resource usage and billing times in case of variable costs.
How to Create the Right Budget for Your Project?
Creating a realistic budget requires you to consider all the cost areas carefully. You must understand and consider the following aspects to determine the costs.
1. The Project Scope Baseline
The scope baseline will provide you with an understanding of an agreed-upon scope that needs to be delivered by the project. All the activities required to complete this scope must be considered for developing the project budget.
To understand the details of the scope of activities, use a Work Breakdown Structure (WBS). The WBS allows you to define all the project activities in increasing levels of detail.
2. Activity Cost Estimates
The final level of your WBS nodes represents activities. To determine the budget, start with those last-level activities. Starting with individual activities will help you ensure that you can estimate costs realistically.
3. Basis of Estimates
Every project will have certain assumptions and constraints that will influence the funding availability and expenditure. Such assumptions, constraints, and organizational guidelines on how project budgeting should be developed are called the basis of estimates. Using such a basis of estimates will help you ensure that your cost estimates are reasonably accurate.
4. Project & Resource Schedule
Paying attention to the schedules will help you determine what kind of expenditure is required at what of the project and the timeframes associated with such outlays.
5. Risk Register
The risk register will help you ensure that you are calculating enough contingency and management reserves to deal effectively with the project risks if they realize.
Both the PMP course and PRINCE2 training courses cover these aspects clearly, as the PRINCE2 training reviews would tell you. Utilize such courses to acquire greater clarity on techniques for effective project budgeting.
Project Budgeting Best Practices
A well-developed project budget allows you to keep the project within budget and ensure its success. You must follow a few best practices to create a realistic budget.
- Consult all the project stakeholders to uncover nuances that a single person might otherwise miss. Involving the stakeholders will also ensure buy-in and due consideration in case of any change requests.
- Break up the project activities into an appropriate Work Breakdown Structure (WBS) level. Too shallow WBS will keep the details hidden. At the same time, a deep WBS will unnecessarily drill down into micro-level tasks and details.
- Consider all indirect expenses like taxes and currency conversion fees.
- As with other project artifacts, the budget should align with project and organizational goals and objectives.
- The endeavor should be to create the best project budget from the beginning. However, you should ensure that it is continually updated to reflect the progress of the project and the changed situation.
Project Budget Examples
We have already discussed a few critical elements of the project budget. A complete budget should include the cost estimates for the scope of work, plus contingency and management reserves. In addition, it should tell you the funding requirements. KnowledgetHut's Project Manager training can give you many such examples. But for this article, let's consider the following two images that represent these aspects for more clarity.
There are many templates and software tools available that you can use to create your budget. Following is one example of a simple project budget.
Benefits of Project Budgeting
The process of project budgeting in project management helps project managers and other stakeholders track the project's progress and take proactive measures as required. Let's see some of the other benefits it brings.
- Sets clear expectations and parameters of success for every stakeholder in the project. The project budget helps you identify all expenses and funding requirements and efficiently allocate resources.
- It also helps project managers secure project funding and required resources for the project execution/
- It helps project managers and other stakeholders make appropriate decisions by providing clear reference points and assumptions and enables data-driven decision-making concerning project priorities, resource allocation, and risk management.
- Project budgeting process helps establish the foundation for monitoring and controlling project performance. In addition, it helps in the early identification of possible deviations.
You’re All Set to Budget Your Projects!
The process of deriving a project budget in project management helps you manage your project execute effectively by establishing the requirements, assumptions, and risks. A good project budget will include all direct and indirect costs, including the costs for labor and materials. There are many qualitative and quantitative techniques available for project budgeting, and you can use those effectively in alignment with your project context to arrive at a clear and effective budget for your projects.