Budgeting the Project

DR. ABDUL HADI

2015
Budgets ?

Are plans for allocating organizational resources to project activities

forecasting required resources

quantities needed

when needed

and costs

Budgets help tie project to overall organizational objectives

Budgets can be used as a tool by upper management to monitor and guide

projects.

Example of Budgeting the Project

Example of Budgeting the Project

Types of budgeting

There are two common budgeting methods:

1.

Top-down Budgeting

Based on collective judgments and experiences of top and middle managers

Overall project cost estimated by estimating the costs of major tasks

A crucial factor for successfully implementing this method for estimating

budgets is the experience and judgement of those involved in producing the

overall budget estimate.

Takes less time

Promotes upper-level commitment

Involves no multilevel participation

Lower management better understands what upper management expects

Presented down the ladder

Top-Down Budgeting

Advantages

accuracy of estimating overall budget

errors in funding small tasks need not be individually identified

Disadvantages

Competition for funds among lower-level managers, try to secure adequate

funding for their operations. Unhealthy competition.

Subordinate managers often feel that they have insufficient budget allocations to
achieve the objectives

2.

Bottom-up Budgeting

Work Breakdown Structure (WBS) identifies elemental tasks

Those responsible for executing these tasks estimate resource

requirements

The resources, such as labors and materials, are converted to cost

This method of budgeting provides the following benefits:

Financial Managers have the ability to centrally review the total

project budget/s

Project Managers have the flexibility to define their project budgets

independently

Takes more time

Involves cross-section of the organisation

Presented up the ladder

Seeks participation at all levels

Encourages commitment to the plan

The resources are converted to cost

Bottom-Up Budgeting

Bottom-Up Budgeting

Advantage

more accurate in the detailed tasks

Clear flow of information

Use of detailed data available at project management level as basic source of

cost, schedule, and resource requirement information.

Participation in the process leads to ownership and acceptance

Disadvantage

Risk of overlooking tasks. Sometimes critical activities are missed and left
unbudgeted

Top management has limited influence over the budgeting process,

Individual tend to overstate their resource needs because they suspect that
higher management will probably cut all budgets by the same percentage

More persuasive managers sometimes get a disproportionate share of

resources

How to provide a budget?

Work Element Costing

Determine resource requirements and then costs for each task

fixed costs (e.g., materials)

labor time and labor rate

equipment time and equipment rate

overhead

general, sales, and administrative (GS&A)

Work Element Costing

The Impact of Budget Cuts

on Type 1 and Type 2 Project Life Cycles

The Impact of Budget Cuts

on Type 1 and Type 2 Project Life Cycles

J-type life cycle:

Reduce the level of resources a larger than proportional cut will be made in
project objective or performance
Project in Serious Disaster

S-type life cycle:

Reduce the level of resources a smaller than proportional cut will be made in
project objective or performance
Project safe

The Impact of Budget Cuts

on Type 1 and Type 2 Project Life Cycles

Impact:

The top-down budgeting is probably acceptable for S-type project

For J-type project, it is dangerous for upper management not to accept the
bottom budget estimates

Activity Versus Program Budgeting

Activity Budgeting
Budget Orientation

Program Budgeting

Activity oriented budgeting

Based on historical data accumulated through an activity-based accounting system

expenses assigned to basic budget lines

Traditional organizational budget

Program oriented budgeting

Each project is divided by task and time period

allows for aggregation across projects

Activity Budgeting

Program Budgeting

Improving Cost Estimates and Forecasts

Forms

Improving Cost
Estimation
Tracking
Signal

Learning
Curves

1. Forms
A form for gathering data on project resource needs might include:

people managers, technical and non-technical

money

materials facilities, equipment, tools, space, etc.

special services

And might identify:

person to contact

how many/much needed, when needed

whether available

A Form

2. Learning Curves

Tn T1n r
where
Tn = the time required to complete the nth unit
T1 = the time required to complete the first unit
r = log(learning rate)/log(2)

3. Tracking Signals

A tracking signal number can reveal if there is a systematic bias in cost

and other estimates and whether the bias is positive or negative

By observing their own errors a project manager can learn to make

unbiased estimates

Other Factors Influencing the Success of a Project

Changes in resource prices

estimate rate of price change individually for inputs that have

significant impact on costs

Waste and spoilage

Team member turnover costs

Using mythical man-months

Organization climate

Just bad luck

Estimate of Project Cost - Made at Project Start

Three Basic Causes for Change in Projects and Their Budgets

Errors made by cost estimator as to how to achieve tasks.
New knowledge about the nature of the performance goal or setting.
A mandate a new law or standard, etc.

Additional Topics

1. Handling Changes

Accept a negative change and take a loss on the project (least preferred)
Prepare for change ahead of time include provisions in the original contract that

allow for renegotiated price and schedule for client-ordered changes in

performance (best practice)

2. Key Elements of Risk Management

Risk management planning

Risk identification
Qualitative risk analysis
Quantitative risk analysis
Risk response planning
Risk monitoring and control

3. Failure Mode and Effect Analysis (FMEA)

List ways project might potentially fail

Evaluate severity (S) of each failure

1 represents failure with no effect and 10 represents very severe

and hazardous failure

Estimate likelihood (L) of each failure occurring

1 indicating that failure is rather remote and not likely to occur and
10 indicating that failure is almost certain to occur

Estimate ability to detect each failure (D)

1 is used when monitoring and control systems are almost certain to
detect the failure and 10 where it is virtually certain the failure will
not be detected

Calculate Risk Priority Number (RPN)

Multiply S, L and D together

Sort potential failures by their RPNs

Consider ways of reducing the risk associated with failures with high
RPNs

4. Other Approaches to Risk Management

Game theory
Assume that competitors and the environment are your enemies
Select a course of action that minimizes the maximum harm
Expected value
The value of the outcome multiplied by the probability of the
outcome occurring
Simulation