How to Use Your Budget to Anticipate Risks
From the The Money Files Blog
by Elizabeth Harrin
A blog that looks at all aspects of project and program finances from budgets, estimating and accounting to getting a pay rise and managing contracts.
Written by Elizabeth Harrin from RebelsGuideToPM.com.
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Date
I’ve been going back over my notes from the PMI Global Congress EMEA which was in London earlier this year and I realised I hadn’t written anything about Olivier Lazar’s presentation on budgeting and risk. I wasn’t sure what to expect but he raised some good points about ensuring your project budget accurately reflected potential issues and gave tips on how to do that.
He talked about the project budget structure as one that acted as an early warning system, integrating cost, scope and risk.
“Everything starts with an estimate,” he said. “An estimate is a risk.”
The truth about estimating
Estimating, Olivier explained:
- Takes account of risk
- Refers to the true project scope
- Recognises uncertainty where it exists and not where it doesn’t
- Separates contingencies from the general reserve
- Defines contingency and reserves at the appropriate rate
- Identifies and counters bias
- Must be achievable.
“You fail it you have to react,” he said. “Project management is an activity of anticipation.”
Having said that, you can’t anticipate events in the future – unless your crystal ball works better than mine – but you can put mechanisms in place to maximise the opportunity to anticipate and avoid the wilful blindness that was discussed in other presentations during the conference.
Use your plan as a baseline
We all know that what you plan isn’t going to happen exactly as you had scheduled. Olivier said that we should consider the project plan as a baseline, not a map; a speedometer, not the GPS.
Usually, he went on, projects go over time and over budget because risk has not been adequately taken into account.
Therefore it’s important to plan the risk response as early as you can, because this helps you work out the cost. Risk response budgets can then be included in your budget, lowering the likelihood that you’ll go over your planned spending.
He recommended grouping risks together then identifying common response strategies, with a minimum of 3% contingency. You’ll want to increase the contingency reserves in these situations:
- High ambiguity
- Innovation
- Research and development
- Technical uncertainty
These circumstances reduce your ability to accurately identify the risk and so push the contingency up. Where you have low levels of uncertainty and ambiguity you can thoroughly identify risks (for example, in projects where you’ve done the same thing before) and thus be able to reduce the contingency reserves accordingly.
When you have identified risks (or threats) that have a high probability of occurrence, Oliver suggested integrating these fully into the project plan and identifying the opposite opportunity – the one that you could enhance or exploit.
Monitoring as you go
If 30% of your budget at completion has been used and yet 80% of your risk response budget is used up then you have a problem.
These figures show that a lot of things you thought were uncertain have actually happened – no one expects every single risk to really happen on their project because they are only risks, not certainties. If you merge your budget at completion, contingency reserves and risk budget together you might not be able to identify this situation as early. You’ll lose control and you can’t know what is happening because risk and contingency, Olivier explained, are not the same thing. Your risk and contingency budgets do not inflate your project budget (or reduce it, for that matter). They only give you more control.
If you are in this position then you need to act quickly to get your project back on track.
Review the scope statement and – while acting quickly – also take the time to react and review. Currently you are within budget so you may not have some of the triggers that you would expect, but consider this tracking your early warning sign.
Olivier concluded by saying that additional control lets you “move from panic and chaos to project management” and reiterated the idea of project management plan as the overall map for y our journey, not the step-by-step walking guide.
Have you split out risk and contingency budgets on your projects? I’d like to know what you think of this practice, so let me know in the comments.
Posted on: September 04, 2015 09:54 AM |
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Comments (7)
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Suhail Iqbal
Suhail Iqbal PMIATP CIPM FAAPM MPM MQM CLC CPRM SCT AEC SDC SMC SPOC PRINCE2 MCT| PM Training School
Rawalpindi, Punjab, Pakistan
I know Olivier Lazar and would love to see him speak again. He has raised some very interesting points and I appreciate as he is able to see risk in every action we take in project, like estimating. Looking forward to attend one of his presentations again.
arlene trimble
Assistant IT Director| Local Government
Alamo, Ca, United States
fosco frongia
Senior project manager| ENTE PATRIMONIALE CHIESA GESU' CRISTO SUG
Fino Mornasco, Como, Italy
The risk is intimately correlated with the correct info and data we have. Or, in other terms, the risk is strongly linked to the lack of information.
Theoretically if we have all correct info and data needed for the project we won’t have any risk… if we analyze, understand and use them properly.
Naturally we never can reach this level, which is the perfection, for this reason we need to implement a process focused in acquiring the most necessary information which we should elaborate for a correct application in the project.
According with the words by Oliver we have to consider that every action - and evolution in the project – is not risk free so this process should be applied throughout the course of the project (particularly in the planning and monitoring) and, relying on new acquired knowledge, we must be disposed to make adaptions and improvements in our “baby”.
Thanks, everyone. I don't think we'll ever reach perfection! That's why risk management is so important, because you can't possibly predict the future.
NAGESH RAMAMURTHY
Principal Consultant| Aadhya Consulting
Bangalore., Karnataka, India
Well thought and articulated by Olivier. I very well connect with that "30% of your budget at completion has been used and yet 80% of your risk response budget is used up" example. I have heard this having been indicated to me earlier. Of many issues, 2 of them I had anticipated and suggested were, "either there has been great amount of scope creep with no push back or risks & their responses have not being planned appropriately". Both ways, there were talent issues.
I´m agree with you Elizabeth, but if your estimation for your risk is bad (remember that is a probability¡¡¡)?, why you are going to lose money?
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