48 Understanding Budget

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 at the precision needed for current decisions. 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.

Cost Budgeting

The main goal of the cost budgeting process is to produce a cost baseline. This baseline is a time-phased budget that can be used to measure and monitor cost performance after it has been approved by the key project stakeholders. The aggregated budget is integrated with the project schedule to produce the time-phased budget. Costs are associated with tasks, and since each task has a start date and a duration period, it is possible to calculate how much money will be spent by any date during the project. Recognizing that all the money required to deliver the project is not needed upfront, allows the cash flow needs of the project to be effectively managed.

For smaller organizations facing cash flow challenges, this can result in significant savings as the money required to pay for resources can be transferred to the project account shortly before it is needed. These transfers must be timed so that the money is there to pay for each task without causing a delay in the start of the task. If the money is transferred too far in advance, the organization will lose the opportunity to use the money somewhere else, or they will have to pay unnecessary interest charges if the money is borrowed.

Managing Cash Flow

If the total amount spent on a project is equal to or less than the amount budgeted, the project can still be in trouble if the funding for the project is not available when it is needed. There is a natural tension between the financial people in an organization, who do not want to pay for the use of money that is just sitting in a checking account, and the project manager, who wants to be sure that there is enough money available to pay for project expenses. The financial people prefer to keep the company’s money working in other investments until the last moment before transferring it to the project account. The contractors and vendors have similar concerns, and they want to get paid as soon as possible so they can put the money to work in their own organizations. The project manager would like to have as much cash available as possible to use if activities exceed budget expectations.