Management reserves and contingency reserves: what’s the difference?

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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 (6)

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An eye-opener ... I have never looked at Contingency Reserves for a "specific risk" as against the overall project risk. Thanks for the clarification!

Thanks, Conrad! Glad it's useful.

Congratulations! Simple, sweet and clear as a whistle.

Thanks, Serafin! Glad you found it useful.

Excellent article with clear understanding of this two concepts...

Excellent article with clear understanding of this two concepts...

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