The Money Files

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A blog that looks at all aspects of project and program finances from budgets and accounting to getting a pay rise and managing contracts.

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Management reserves and contingency reserves: what’s the difference?
Categories: accounting, contingency

Picture of cashDo you have contingency on your project? In Eliyahu Goldratt’s book Critical Chain he calls it safety, but whatever name for it you use, most projects have an element of budget provision put aside in case of emergency.

Let’s start with a definition of what management reserves and contingency reserves are, taken from Michel Thiry’s book, Program Management.

Contingency reserve: “a planned amount of money or time which is added to an estimate to address a specific risk.”

Management reserve: “a planned amount of money or time which is added to an estimate to address unforeseeable situations.”

Can you see the difference?

Contingency reserves

When you work out the contingency reserve for a task or project estimate, you do so based on project risk. How do you want to respond to that risk? Most times risk responses require cash or extra time to put a plan in action. The amount of contingency allocated depends on the risk and also on the risk response.

As contingencies are linked to particular risks, if the risk passes and is not realised, the need for the contingency goes away. That means returning the cash, or taking any extra time out of the task schedule. You don’t get to keep the contingency ‘in the bank’. If you feel that you need to, it’s probably because another risk is looming on the horizon. If that is the case, you should increase the contingency related to that risk and make your plans accordingly. It is OK to change your contingency strategies as you go forward with the project – after all, as you get nearer to a particular risk event you find out more about it and have more knowledge about how you would deal with it and that is quite likely to change your response.

Management reserves

Every project could do with one of these! However, in my experience few projects have them. A management reserve is a pot of money of a size that is based on the overall uncertainty of the project. For example, if you are doing an innovative project that your company has little experience of, you would want a big pot of money (or time) as your reserve. If you are working on something relatively straightforward, perhaps something that your company has run several times before, you wouldn’t need such a large amount or in some cases any amount of management reserve at all.

Management reserves are generally calculated using that well-known finger-in-the-air method, although it would be good to think that they are scientifically worked out based on the experience of the company and historical data extrapolated from previous relevant projects both at your company and across your industry. However, it is more likely that you just guess.

Management reserves are only used in emergencies, and that is the reason (in my opinion) that many projects don’t have them. The default for projects without management reserves is to go back to the project sponsor, explain the situation and ask for more cash, or more time. If you can do that anyway, what’s the point in having a management reserve? You still have to ask permission before you dip into the reserve, so the actual process for getting your hands on the money or authority to change the delivery date is the same.

A management reserve means that at least the money is put aside for you, and you avoid the situation where the project sponsor says that there is no additional budget available for your project – in which case you’d be stuck finding a way to deliver what you needed with the available money, which would probably involve changing the timescale or compromising on quality (the classic iron triangle constraint).

You don’t give back what is left of your management reserve when the crisis has passed. The pot stays active until the end of the project, although you may find that towards the end of the project when you have more certainty about how things will unfold, you can give back some of the money or use it for something else.

Now that you know more about management and contingency reserves, do you have these on your projects?

Posted on: August 26, 2012 12:11 PM | Permalink | Comments (0)

Managing Money Q&A (Part 4): Why do projects go over budget?
Categories: accounting, budget, contingency, FAQ, forecasting, tips

CalculatorIt was a while ago now that I gave a webinar on managing money on projects, but it is taking a long time to answer all the questions that I didn’t get round to doing during the live session.  Thanks to all the fabulous participants, who asked such brilliant questions!  I am still trawling through them hoping to answer them all, and here is today’s batch of managing money Q&A.  

What is the difference between the contingency and a reserve?

Nothing.  Call it whatever you want.  The idea behind both contingency and a reserve is to have a pot of money put aside in case of unforeseen developments.  Regardless of what you call it, you can’t draw on it as a matter of course.  Accessing the contingency fund is only done with the permission of the sponsor – it’s not there for you to use as a buffer because you haven’t managed to keep the project costs on track.

If you choose the biggest number in the range of total project cost, would you then use that as the basis for applying a percentage as contingency?

What you are talking about here is presenting budget figures as a range to key stakeholders during the decision making process.  This is a great idea, and it encourages people at the early stages of a project to take into account the fact that the planning is not yet completely finished.  If you then want to apply a percentage amount as contingency – say, 10% - choose the biggest number in the range. So if your budget prediction is a range of £250k to £280k, you would work out 10% contingency as 10% of £280k, giving you £28k.  You can always hand your contingency back if you don’t need it, or reforecast it to a more accurate level later.

How we can handle project cost in a software product development company where the same resources are being used both for Development and production support and trouble shooting the issues of the live product?

Timesheets!  The project costs you must be referring to here are resource costs.  All other costs could be attributed directly to the cost of brining a new product to market, like buying a new server to host it on or marketing for new clients.  Accurately predicting and monitoring resource costs on a project are going to be hard unless you know how your teams are spending their time. Get them to do timesheets for a couple of months to get a baseline of what percent of their time is spent on support and troubleshooting.  This will give you a basis on which to forecast going forward.

On the other hand, if you aren’t worried enough now to be tracking time and working out how much effort your teams put into managing projects, why do you want to going forward?  Consider the reasons why knowing this information is important to you before going to the effort of introducing a time recording system that won’t give you all the data you need to make useful business decisions.

Would you say an initial budget has a +/- % deviation and encourage revisiting the initial estimate to reduce the deviation or wait till you expect to exceed initial budget?

Never wait until you expect to exceed the initial budget to reforecast.  Typically, project budgets are reforecasted at the same time as the rest of the company accounts are reforecasted, so once a quarter is normal, if the project is large or costly.  You can set points in the project lifecycle where it is sensible for you to revisit the costs.  For example, after the first phase, or once the development is complete could both be good examples of where it is an appropriate time to look again at your projections.  

I would say a budget has a +/-% deviation, and I think this is a good habit for sponsors to get into – they should be used to looking at ranges of numbers, and you can then revisit this estimate to reduce the deviation once more detail is known.

What are the reasons for going over budget and how can I control it early?

Where do I start?!  Here are some reasons:  poor estimating, equipment costing more than you first thought, forgetting to add in the tax (I’ve done that), not calculating formulae properly so your sums are wrong before you start (done that too), a risk materialising and not having budgeted for problem resolution, resources costing more than you thought i.e. having to pay for overtime or weekend working. The list goes on, and I’m sure you have your own suggestions of why projects go over budget.

Mainly it all comes down to poor monitoring and control.   If you have estimated accurately, keep the project on track, manage the resources effectively, and forecast estimate to complete properly, you should at least have an early warning that you are going to go over budget, and you can address this appropriately.  That could be through increasing the budget, using the contingency fund, trimming down the scope or dropping the quality of some deliverables, or through other means.

Read Part 1 here
Read Part 2 here
Read Part 3 here

You can see the whole presentation online here, via a recording of the webinar.  I’ll have some more Q&A for you soon!
 

Posted on: August 06, 2010 04:45 PM | Permalink | Comments (0)
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