Course Name: project Management

Course No. FIN: 423

Chapter note
Prepared by SM Nahidul Islam
Dept. of Finance & Banking
Islamic University, Kushtia.
Chapter Project Budgeting and Risk Management
Questions at a glance:
1. Define budgeting & state the types of budgeting. What is the most important task for top
management to do in bottom up budgeting?
2. What are the differences between Top-Down Budgeting and Bottom-Up Budgeting?
3. In preparing a budget, what indirect costs should be considered?
4. Describe the tracking signal & what are the errors estimated in tracking signal?
5. How to improve the process of cost estimation?
6. What are the consequences of budget cut?
7. What are the differences among cost category budgeting, activity budgets and Program
Budgets?
8. Describe the learning curve
9. What do you mean by risk management? State the process of risk management.
10. Describe the golden rules of project risk management

SM Nahidul Islam
Dept. of Finance & Banking (2nd batch)

1. Define budgeting & state the types of budgeting. What is the most important task for
top management to do in bottom up budgeting?
Answer: Budgeting is the process of forecasting what resources the project will require. Generally it uses
historical costs if available. In IT projects, availability of detailed historical costs are limited. Budgeting
must consider the timing of the costs. Budgeting can be divided into the following two types
a. Top-Down Budgeting: This is the technique of developing a budget by comparing this project to past
ones using the judgment and experience of top and middle management. Advantages of top-down
budgeting include:
1. Management can develop aggregated budgets that are reasonably accurate if they are based on
comparable projects.
2. It promotes upper-level commitment
3. Overall budget costs can be estimated quite accurately, though individual elements might be in
substantial error.
Disadvantages: The main disadvantages of top-down budgeting are that:
1. Significant errors may be made for low-level tasks,
2. A lower level of budget acceptance is likely due to limited participation, and
3. It provides little training opportunities in budgeting for junior managers.
b. Bottom-Up Budgeting: This is the process of developing budgets by asking the people who will
perform the individual tasks for their estimates. These individual numbers are then rolled up to a
summary for presentation to management. Advantages of bottom-up budgeting include:
1. Bottom-up budgets typically result in more accurate estimates.
2. The resource requirements needed to complete tasks within work packages will be more accurate
than when other budgeting techniques are used.
3. Active participation of the stakeholders will tend to increase the acceptance and support for the
budget.
4. Bottom-up budgeting can help train managers to understand important dimensions of project success.
5. If the estimates are unbiased, the sum of their errors will tend to cancel out.
Disadvantages: The main disadvantage of bottom-up budgeting is the risk of overlooking tasks.
Senior management should check to ensure that all major cost elements have been included in the bottom-up
budget.

2. What are the differences between Top-Down Budgeting and Bottom-Up Budgeting?
Answer: The differences between top-down and bottom-up budgeting are given below:
Points of
distinctions
Definition

Top-Down Budgeting

Bottom-Up Budgeting

Top-down budgeting is the technique of

developing a budget by comparing this
project to past ones using the judgment
and experience of top and middle
management.

Bottom-Up Budgeting is the process of

developing budgets by asking the people who
will perform the individual tasks for their
estimates.

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Nature
Advantage
Consuming time
and cost
Motivation
Employee
participation
Long term
vision
Feeling of
employees
Existence

It is inflexible.
It promotes upper-level commitment
It takes less time and lower cost to
prepare.
Lack of motivation
Lack of employee participation.

SM Nahidul Islam
Dept. of Finance & Banking (2nd batch)
It is flexible.
It promotes lower-level commitment
It is time consuming and costly.
High level of team motivation
Employee can participate in this budgeting.

It has a long term vision.

Lack of long term vision.

Employees feel their input not valued.

Employees feel valued.

Top-down budgeting is common.

True bottom-up budgets are rare.

3. In preparing a budget, what indirect costs should be considered?

Answer: An indirect cost is a cost that cannot be directly traced back to the production of an output. For
accounting purposes, two rules of thumb are often used when classifying a cost as direct or indirect. In order
to fall into the direct cost category, the cost must be physically observable and it must be economically
feasible to track the cost during production of each output. If this is not true, then the cost will usually be
captured in bulk as an indirect cost and allocated back to the units of output that were created during a fixed
period of time. Examples of indirect costs that a project manager should consider include:
1.
2.
3.
4.
5.

Sales, general, and administrative expenses (SG&A)

Contract penalties
Contingency allowances
Waste and reduction to fair market value (defects, spoilage, and obsolescence)
Turnover costs (replacement and training of personnel)

4. Describe the tracking signal & what are the errors estimated in tracking signal?
Answer: A tracking signal is a measurement of how well a forecast is predicting actual values. As forecasts
are updated every week, month or quarter, the newly available demand data are compared to the forecast
values. The tracking signal is computed as the cumulative error divided by the mean absolute deviation.
Positive tracking signals indicate that demand is greater than forecast. Negative signals mean that demand is
less than forecast. A good tracking signalthat is one with a low cumulative errorhas about as much
positive error as it has negative error. In other words, small deviations are okay, but positive and negative
errors should balance one another so that the tracking signal centers closely around zero. Once tracking
signals are calculated, they are compared with predetermined control limits.
The following two types of errors estimated in tracking signal:
1. Random error: Random error refers to equal chance that estimates are higher or lower than true
value.
2. Bias error: A consistent tendency for forecasts to be greater or less than the actual values is called a
bias error. It is also known as systematic error. Errors caused by bias do not cancel o u t .

Islamic University, Kushtia

SM Nahidul Islam
Dept. of Finance & Banking (2nd batch)

5. How to improve the process of cost estimation?

Answer: Estimates by nature are always wrong. Its important to build contingencies into the process or to
account for uncertainty in some other way. One way to do this is to use the PERT process of developing
likely, optimistic, and pessimistic estimates. In addition, the PM must understand whether overhead cost is
part of the estimate or not. Cost estimates can be improved by the following ways
1.

Use of standard forms/templates

i. Ensures that items are not missed
ii. Standard format to review
iii. Standard way to add overhead costs
iv. Standard rates for various resources

2. Use of historical metrics

i. If available, information from previous projects
ii. Productivity rates
iii. Create new metrics ($ per requirement, component per requirement)

6. What are the consequences of budget cut?

Answer: The consequences of budget cuts are given below:
a.
b.
c.
d.
e.

Resources of organization and project budgets can be in conflict

Estimates can be inflated
Need to bring estimates in line with what company can spend, need to spend to make ROL
Estimates must be refined, padding removed
Efficiencies must be found

7. What are the differences among cost category budgeting, activity budgets and
Program Budgets?
Answer: Category-oriented is based upon historical data accumulated through a traditional, category-based,
cost accounting system. Individual expenses are classified and assigned to basic budget lines such as phone,
materials, personnel- clerical, utilities, direct labor, etc. or to production centers or processes. These expense
lines are gathered into more inclusive categories, and are reported by organizational unit.
Activity budgets consider each project individually. On the other hand, Program budgets consider
all of the activities of the organization together. These aggregate all activities (i.e. programming, project
management, etc.)

8. Describe the learning curve

Answer: A learning curve is a graphical representation of repetitive tasks that, when done on a continuous
basis, lead to a reduction in activity duration, resources and costs. Learning curve is relevant in taking
following decision:

Pricing decision based on estimation of future costs.

Workforce schedule based on future requirements.
Islamic University, Kushtia

SM Nahidul Islam
Dept. of Finance & Banking (2nd batch)

Capital requirement projections

Set-up of incentive structure

An operations manager can express the relationship between the amounts of time it takes an organization
with a learning rate percentage of r to produce the nth item as an equation:

= 1
Where,

= the time required for the nth unit of output,

1 = The time required for the initial unit of output,

n = the number of units to be produced, and
r = log decimal learning rate / log 2.
For example: Consider the information given in the aircraft manufacturing example above:
T1 = 100 minute
T2 = 80 minute
Learning rate = 80%
What would be the time required to produce the eighth part?
Here, T8 = (100)(8-0.322) = 51.2 minutes

since b= ln(0.80)/ln(2) = -0.322

0.9

0.8

Time per unit

0.7

0.6

0.5

0.4

0.3

0.2

0.1

20

40

60

80

100

Cumulative repetitions

Exhibit: Learning Curve 80 Percent Learning Rate

Islamic University, Kushtia

SM Nahidul Islam
Dept. of Finance & Banking (2nd batch)

9. What do you mean by risk management? State the process of risk management.
Answer: Risk management is the process of identifying things that can go wrong. It consists of the
followings 1. Risk Identification: This step is brainstorming. Reviewing the lists of possible risk sources as well as
the project teams experiences and knowledge, all potential risks are identified. All the potential sources
of risk in a Project are given below:
a. Technology
b. Project Organization
c. Senior Management
d. Client
e. Skills/character of project team members
f. Outside factors (laws, etc)
Scenario analysis is common method for identifying. Interview all project members.
2. Risk Management-Analysis: This step is state various outcomes and probabilities. For this
purpose, the following statistical methods can be used a. Decision tables
b. Monte Carlo simulation etc.
These methods, while good, are generally beyond the bounds of use in normal projects. Most use is to assign
an estimate of the probability of an event occurring (high, medium, low)
3. Risk Management-Response / Mitigation: Based on the probabilities and impact of the negative event
occurring, must determine which risks to plan for and how.
a. High impact and high probability- first priority
b. High impact and low probability- next priority
Risk response plans are contingency plans that will be executed if things go bad.

10. Describe the golden rules of project risk management

Answer: The golden rules of project risk management are given below:
1. Make Risk Management Part of Your Project: The first rule is essential to the success of project risk
management. You should embed Risk Management into your project. Many people believe that; there is
no need to formalize Risk Management and they are blindly confident that no Risks will occur. You
cannot mitigate a risk if you do not plan to do so.
2. Identify Risks Early in Your Project: The first step in project risk management is to identify the risks
that are present in your project. This requires an open mindset that focuses on future scenarios that may
occur. Two main sources exist to identify risks, people and paper. People are your team members that
each brings along their personal experiences and expertise. Paper is a different story. Projects tend to
generate a significant number of (electronic) documents that contain project risks.
3. Communicate About Risks: Communicating about risks is a two way street. Listen to team members,
sponsors and stakeholders when they talk about issues. Include risk communication in team meeting,
project meetings and stakeholder meetings.
4. Consider Both Threats and Opportunities Project risks have a negative connotation that they are
the bad guys that can harm your project. However, modern risk approaches also focus on positive risks,
Islamic University, Kushtia
6

SM Nahidul Islam
Dept. of Finance & Banking (2nd batch)
the project opportunities. These are the uncertain events that are beneficial to your project and
organization. These good guys make your project faster, better and more profitable.
5. Clarify Ownership Issues: After developing a list of risks, clarify who is responsible for managing
that risk and assign a risk owner for each risk. Risk owner is responsible for optimizing this risk for the
project. In this regarded, Monitor the risk, Communicate changes in the risk, and Develop strategies for
mitigating the risk.
6. Prioritize Risks: All risks are not created equal. Focus on risks that will have the largest impact on your
project. Develop a method of prioritizing risks that works for you.
7. Analyze Risks: Take some time to have a closer look at individual risks. Dont jump to conclusions.
Consider risks at multiple levels such as Individual and the Entire Project. The information you gather in
a risk analysis will provide insights into your project and the necessary input to find effective responses
to these risks
8. Plan and Implement Risk Responses: Implementing a risk response is the activity that actually adds
value to your project. You prevent a threat occurring or minimize negative effects. Execution is key here.
The other rules have helped you to map, prioritize and understand risks. This will help you to make a
sound risk response plan that focuses on the big wins.
9. Register Project Risks: Maintain a Risk Register or Risk log. A good Risk Register/Log contains; Risk
Descriptions, Clarifies ownership of risks, enables you to do some level of analysis, Document actions
taken to mitigate, avoid or ignore a given risk, Document critical dates and /or actions that will
necessitate action.
10. Track Risks and Associated Tasks: Update the Risk Register regularly. Document Tasks implemented
to mitigate or avoid a risk. Document risks that are no longer relevant. Document new risks that arise
during your project.

Islamic University, Kushtia