Project Contingency: The Ultimate Guide
Do you have contingency in your projects?
In Eliyahu Godratt’s book Critical Chain, he calls it “safety“, but whatever name you use, most projects have an element of budget provision put aside in case of emergency.
Your new project was approved for funding. That in itself is a huge step. But before you start the celebration, there are some details to check first. What exactly got approved? What are the budget constraints that come with it? Is it enough? Does the funding include contingency?
If you’re wondering what budget contingency is, then you’ve come to the right place. This article will explain project contingency, how to calculate it and how to manage it within the scope of your projects.
What is Project Contingency?
It’s not practical to document the infinite number of things that could go ‘wrong’ on a project.
You never know when Murphy’s law will kick in on your project: “Anything that can go wrong will go wrong”.
That’s where project contingency comes in. Think of it as the promise of additional resources (typically time and/or money) allocated in a project to address possible risks and uncertainties.
Project contingency is the additional resource put aside to address potential risk and uncertainty in a project.
There are two types of contingency typically used on projects:
- Budget Contingency: An additional amount of funds added to the base cost estimate of a project to cover estimation uncertainties and risks
- Schedule Contingency: Additional time allocated within a project schedule to account for uncertainties and risks that may impact the project timeline.
The contingency amount varies based on the project’s size, type, risks involved, and the level of estimating effort. It can range from less than 5% for low-risk projects to over 20% for high-risk projects. The amount of each of these should be documented in a project contingency plan.
Why is Contingency Important?
Contingency is crucial in project management as it provides a safety net for dealing with uncertainties and risks that may arise during the project lifecycle. It ensures that projects can be completed successfully despite unforeseen challenges.
The amount of contingency used in a project is based on the risk exposure and estimate uncertainty facing the project.
Estimate Uncertainty and Risk Exposure (Source: Contingency – are you covered?)
Contingency is important for:
Covering uncertainty and risk exposure in projects
Providing more realistic business cases and cash flow
Guarding a project from potentially harmful trade-offs in schedule, scope, and functionality
Improving transparency and building trust in schedule and cost estimations
How to Calculate Contingency
The basic process of calculating contingency is:
After you come up with the budget estimation, calculate estimate uncertainty.
Determine the level of risk/uncertainty in the project.
Based on the level of risk involved, decide how much money to set aside within the overall project costs to cover this risk exposure.
Ring-fence that amount until it is needed.
As shown in the figure, the total estimated project cost at completion includes the base cost estimate and contingency.
The base cost estimate is the expected cost of the known scope and contingency the amount of funds set aside to cover risk exposure and estimate uncertainty.
Components of Total Project Cost, and Contingency (Source: Contingency – are you covered?)
Contingency Management Process
Let’s take a closer look at the contingency management process.
Contingency Management Process (Source: Contingency – are you covered?)
Step 1: Determine Estimate Uncertainty
Estimate uncertainty refers to the degree of confidence in the accuracy of the project estimates. Estimate uncertainty is used to:
Cover uncertainties that are inherent in the estimating process
Account for minor errors and omissions that occur when the estimate is put together
Note: Estimate contingency is not intended to cover major changes in scope.
How to determine estimate uncertainty:
Historical Data: Use historical data from previous projects to compare and validate the current estimates. This includes labor, materials, and equipment costs.
Vendor Quotes: Incorporate quotes from vendors for materials and services. These quotes provide a more accurate basis for the estimates.
Advanced Statistical Techniques (e.g., Monte Carlo analysis): Monte Carlo analysis software calculates the cumulative probability of achieving the project at or below the budgeted cost. The level of confidence given can be used to estimate uncertainty.
According to the Association for the Advancement of Cost Engineering (AACE), there are five classes of estimates.
The most accurate estimate is a Class 1 estimate, and the least accurate is Class 5.
Five Classes of Estimates (Source: AACE International Recommended Practice)
Based on historical data of similar projects, you can determine the estimate class and apply an appropriate contingency percentage.
Example: For a $10 million system upgrade project, if the project team is confident it is a Class 3 estimate (based on historical data), the base cost estimate will range from $9 million to $12 million.
Determine Estimate Uncertainty Five Classes of Estimates (Source: AACE International Recommended Practice)
Step 2: Determine Risk Exposure
Risk exposure is determined by:
Creating an initial risk register
Quantifying risk using Expected Monetary Value (EMV)
Robust risk management requires:
Clear risk statements in “IF event, THEN consequence” format
Example: IF the Factory Acceptance Test fails during stage inspection due to unresolved technical defects, THEN the project will incur a 3-week delay to address rework and retesting.Quantifying the risk impact in terms of cost or schedule
Determining the probability of occurrence of each risk event
Calculating EMV for each risk (EMV = Probability × Impact)
Summing the EMVs (a simple method for aggregating risk)
Expected Monetary Value
Step 3: Set Desired Contingency Funding
Example: For a $10 million system upgrade project using a Class 3 estimate, the project team assumes a 10% contingency:
Estimate Contingency: We will assume 10% of $10 million as the total estimate contingency at $1 million
Risk Contingency (EMV-based): $32,500 or $0.032 million
Total Contingency Required: $1.032 million
Total Contingency Funding
Step 4: Check Adequacy of Contingency
How do you monitor contingency funds during project progress?
Too much contingency leads to sub-optimal use of project funds.
Too little contingency may require going back to the sponsor for additional funding.
Two metrics are used to track the contingency reserve:
1. Contingency to Estimate-to-Complete (ETC)
- Formula: (Contingency remaining in $) / (ETC excluding contingency)
- Rule of thumb: Greater than 3% and less than 15% is reasonable
2. Contingency to Risk Exposure (EMV)
- Formula: (Contingency remaining in $) / (EMV)
- Rule of thumb: Generally between ±25% is reasonable (range: 0.75 to 1.25)
Your status report should flag contingency adequacy when either metric exceeds these boundaries.
How to Access Contingency Funds
A good practice is to devise a process that provides traceability of contingency funds. There must be a formal process for requesting and allocating them.
That traceability ensures transparency – important for audits, stakeholder inquiries, etc.
Summary
Project contingency is a critical component of project management. It enables a realistic and transparent approach to handling uncertainties and risks. By incorporating contingency into the project budget, project managers can avoid harmful trade-offs in schedule, scope, and functionality – ultimately leading to better project outcomes.
References/Sources:
- Contingency – are you covered? (PMI Global Congress 2012 Conference Paper)
PML would like to extend a huge thank you to Siddharth for sharing his knowledge and wisdom with the PML community! Learn more about him below and reach out to connect!
About the Author
Siddharth was born and bought up in Pune. Pune, is a city in state of Maharashtra and geographically at eastern part of India. Pune is often referred to as the ”Oxford of the East” because of its educational institutions and has historically been a major cultural centre.
Siddharth holds a Mechanical Engineering degree and an MBA in Operations Management. He is also PMP and ACP certified practitioner from Project Management Institute.
Siddharth is passionate about designing, developing, and delivering impactful training programs on various project management topics. Siddharth is a firm believer that an effective facilitator bridges the gap between theory and practice. Drawing from his extensive project management experience, he highlights the relevance of complex concepts through real-life applications. He has successfully conducted numerous open house Microsoft Project Scheduling workshops. Additionally, he has facilitated personal coaching and web-based sessions on various project management topics.
With over 20 years of project management experience, he has worked across various domains, including new product development, high-end technology-driven manufacturing automation, software development for automobile embedded systems, and Oil and Gas projects. In his previous role, Siddharth had successfully implemented a Project Management Office for a $100M project portfolio and established an Enterprise Project Management framework across the organization to streamline project management processes and improve collaboration among project stakeholders. As Head of the PMO, Siddharth played a pivotal role in establishing the Enterprise Risk Management framework, enabling the company to meticulously evaluate risks associated with high-value tenders before making informed go/no-go decisions. Siddharth has managed large projects in fast-paced, complex environments involving cross-functional, multi-site, and multi-vendor teams.
He is skilled in procurement and contract management, project scheduling, and budgeting. Siddharth is proficient in using Microsoft Project for scheduling. By meticulously tracking and monitoring projects with this tool, he has saved the company millions of dollars in liquidated damages. He excels in collaboration, coordination, and multitasking.
Currently Siddharth is working as a Solopreneur. He runs a project management training and consulting firm called pmfornonpm. It stands for Project Management for Non Project Managers. He started this learning platform to help business managers:
- Learn the basics of project management skills to deliver positive results to your organization
- Get acquainted with project management vocabulary so that you will feel confident while talking to other fellow project managers
- Use project management planning tools such as Microsoft Project
- Prepare for global accreditation in project management such as PMP Consult Small and Medium scale Enterprises in Risk Management, Project Schedule development and analysis, Project specific PMO set-up etc.
For training inquiries and project management services, Siddharth can be reached by:
Email: pmfornonpm@gmail.com
Website: pmfornonpm.in
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