The Importance of a Detailed and Effective Budget

For most people, preparing both the schedule and budget can be intimidating. Both require knowledge and experience regarding what we are estimating, but the uncertainty can run high in both cases, especially in the budget. In many cases, our clients review the budget in the context of a competitive bid to win their work. Therefore, we want to prepare a competitive and attractive budget, but not so much so that we run the risk of going over budget and, thereby, losing money. Estimating costs becomes easier as we gain experience, and we can look at previous projects and their budgets. In other words, when we can look at a project or activity and discern the associated cost based on experience and lessons learned. The latter is crucial in estimating costs.

The Importance of a Detailed and Effective Budget

For those of us who may not have too much experience estimating costs, then I recommend using the following options:

  • Outsource the budget to a firm that has the expertise to do so. Both estimating and some project management consultants have the expertise to take your scope of services, as well as schedule, plans, documentation, etc., and provide a professional estimate.
  • Depending on your industry, there are manuals and other online sources that provide both time and cost for various activities and materials. For example, in the construction industry, there is a comprehensive database called RS Means (rsmeans.com) where you can look up the cost per cubic yard of concrete, as well as the time and workers required to place it at the construction site; something such as “2 laborers @ 2 hours each per cubic yard. Additionally, the database includes the hourly rate for the laborers with an adjustment for your area. In other words, construction work costs will be lower in Mississippi than in New York.
  • Consult your network contacts, as well as any vendors or consultants you normally use and request a review of your estimates as a second check on the costs you have calculated. If you are participating in a competitive bid and are concerned regarding confidentiality, you can always redact your estimate and/or ask for unit prices. For example, you can ask an IT professional approximately how many hours it takes to prepare a certain web-based application; you can ask an architect friend how many hours and associated costs are required to prepare design plans for a square meter of construction. You can then take that data and extrapolate and/or apply it to your project.

Also, there are methods to mitigate the risks that are inherent in estimating. For example:

  • Always include your assumptions, exceptions, and constraints in preparing your budget. In actuality, always include this in every contract, scope of services, and whenever you prepare an agreement between yourself and another party. In preparing a budget, the following sample writing will help clarify what and how you have estimated the budget.
    • Assumption: “the client understands that this budget is a professional estimate of probable cost. The consultant is not responsible for fluctuations of material costs during the project lifecycle.” In other words, if you are working on a construction project, and the price of steel skyrockets, the consultant is not accountable for knowing this at the time he/she prepared the budget.
    • Exceptions: “the budget does not include costs of public agency permits and reviews.” In other words, if you need to have a product approved by the Food and Drug Administration (FDA,) the client will pay for their review and associated costs.
    • Constraints: “the budget is based on 2020 U.S. dollars and will be adjusted to the current exchange rate whenever this surpasses +/- 5%.” This is especially necessary when working internationally, and there is a possibility of exchange fluctuations.
  • Reserves: it depends on the contract and/or type of client, but most customers understand that there may be cost variations throughout the life of the project; whether it occurs due to increases in construction costs, as noted above, or because they themselves may require an upgrade or other change to the product or service you are providing. Therefore, it is beneficial to include reserves in the budget, which come in two types:
    • Contingency Reserve: in this type of reserve, the project manager has control over the funds and may also include the risk manager in the decision-making. These funds can be sued for “known uncertainty,” such as cost variations in materials to be used, inflation rates, and known risks. The latter is very important since it provides for funds as a risk response should the risk materialize, and these funds must be weighted per their level of uncertainty. For example, if there is a risk of a vendor going on strike, which will cost $10,000, and the probability of this occurring is 40%, then the risk we are currently projecting is worth $4,000 ($10,000 x 40%.) Of course, if the risk does occur, it will cost $10,000, but we have to adjust the cost per its probability since it is uncertain. The contingency reserve usually runs anywhere from 3% to 10% of the budget total, depending on the level of uncertainty and/or corporate and industry guidelines.
    • Management Reserve: this reserve is for “unknown uncertainties” and run somewhere between 5% and 10%. The term “unknown uncertainty” can apply, for example, if we and/or our client is working in a foreign country for the first time and all parties are not 100% familiar with government red tape, labor behavior and performance, etc. Therefore, you will want to have a separate reserve to address some unexpected costs.

In general, estimating, as the word implies, is not a precise science. Therefore, there is almost always a risk of error when exercising this activity. To that end, our best approach is to mitigate the risk through a clear definition of the work done, such as in the assumptions, constraints, and exceptions noted above, and by including the reserve funds. In all these cases, clear and honest communication between both parties (buyer and seller) is crucial to avoid misunderstandings in the future. So, document document document everything!

The Importance of a Detailed and Effective Budget

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