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:
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 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). A large amount of money may not be at stake. Still, an organization’s credibility is at risk, potentially reducing sales by a large but challenging amount. So while they are not directly added to the reserve, list them in support of the reserve.
It may be common for some organizations to assign a fixed percentage (typically 5-15%) of the budget for contingency reserves. However, good project 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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