Planning Project Budget Reserves

business cost management risk management technical Feb 27, 2022
Planning Project Budget Reserves

To start reserve planning requires a completed risk analysis  (for details on how to complete a risk analysis, see our publication, Risk Assessment Framework: Successfully Navigating Uncertainty) . First, estimate the financial impact for each risk, then compute the estimated monetary value (EMV). The EMV is the product of the likelihood and the impact in dollars or your local currency.

While it may have some shortcomings, one of the simplest ways to compute budget contingency reserves is:

 

where:

CR = Contingency Reserve

EMV = Estimated Monetary Value

n = Number of Risks

Also, consider that risks can have both positive and negative consequences. This means that some EMV values should be negative, and some positive.

Be sure to look at both the hard dollar impact (actual costs) and any soft dollar impact (costs challenging to estimate, such as those generated by goodwill or change in reputation). Perhaps a large amount of money is not at stake. Still, the credibility as an organization is at risk, potentially reducing sales by a large but challenging amount to estimate. So while they are not directly added to the reserve, list them in support of the reserve.

It may not be unusual for some organizations to assign a fixed percentage (typically 5-15%) of the initiative budget for contingency reserves. However, good initiative managers will perform the actual computations and review them to avoid surprises later.

The management reserve is not a part of the budget. Instead, it is the amount that management is willing to set aside for the unidentified risks. The estimate is usually determined by a top-down technique such as a rule of thumb or simply what the budget will allow. 

Let us know in the comments if you have any questions or alternative methods.

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