Every so often I’m asked questions about handling project finances. Here is another batch of Q&A. If your question isn’t answered here, drop me a line and I’ll try to include it next time.
Today we are focusing on tolerance.
You've recommended ranges for budgets as well as tolerances - can you recommend whether to combine these or keep them separate?
Estimates are better if they are ranges. You might estimate your budget to be £90-110k, for example. This will become a narrower and narrower estimate as the project progresses. But when you are discussing budgets at the business case stage, a range is a more appropriate response to uncertainty.
Tolerance is the amount by which the project can be delivered over (or under) budget without anyone being concerned. It’s usually a small amount represented as a percentage. If your tolerance is a percentage, you will express it as something like +/-5% i.e. you can be up to 5% under budget or up to 5% over budget and still be delivering the project appropriately.
I would not combine tolerance and budget estimates. Set your budget. Then agree a tolerance level with your project sponsor. Apply the tolerance to the budget. You will end up with a statement like:
“The budget for Project Banana will be £90-110k with a tolerance of +/-5%.”
Is tolerance the difference between total cost and contingency?
No. Don’t think of tolerance as ‘real money’. It is simply a parameter in which you operate. It’s the same as saying, “I’ll aim to be at the cinema to meet you at 7pm but the trains aren’t running to the timetable because of engineering works so I could be there anytime between 6.45pm and 7.10pm. That should still give us plenty of time to get tickets and sit down for the film.”
Total cost is the amount (in range form if your sponsor will let you) your project will cost. Contingency is a pot of money put aside in case of unforeseen developments. It is not part of your overall budget and with any luck you won’t have to draw on it. It is for managing project risk.
What is the normal level of tolerance as a percent?
That’s a difficult question! It depends on the project. A project that has many elements that have been done before, an experienced team who have put together comprehensive and accurate estimates, with low levels of innovation and without the risk of new technology could easily have very low or no tolerance. This is because you’ll already know enough to ensure that you won’t need the ‘safety blanket’ of tolerance in delivery as you’ll be pretty sure that you will hit the estimates straight on.
The ‘right’ answer is whatever your sponsor says is appropriate. For organizational politics reasons, or financial constraints, the answer might be zero. Talk to your sponsor about what tolerances they consider acceptable for the budget.
If you are pushing me for an answer I would say +/-5%. That gives you a window of 10%. If you are swinging outside of that window you will either be tying up money that you don’t really need for the project that could be better spent elsewhere, or you’ll need to go back and ask for more money as your project costs have risen.
Is it customary to add % of budget as ‘miscellaneous etc’ to the project budget and is this the tolerance you are talking about?
Yes, it is customary to add a budget line for unforeseen items. But no, it isn’t tolerance. This is your contingency fund.
Is it any different for PRINCE2?
No. PRINCE2 doesn't specify any particular way to manage project finances. You can read more about project tolerances in PRINCE2 here.
Last year I gave a webinar on managing project budgets, which also included the answers to many questions. You can see the whole presentation online here, via a recording of the webinar. I’ll have some more Q&A for you soon! Got any questions? Leave me a comment and I’ll answer them in a future post.