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The Budget Defines the Constraints
A robust project budget enables you to make key decisions regarding the constraints with which you need to complete the project. For example, the project budget will help you determine the items that should be included--the scope--and which items should be removed. Alternatively, if the key constraint is to complete a project before a specified date, then the project budget will help you determine the degree of schedule crashing permitted so that you can deliver the project on time.
The project budget is created after the Estimate Costs process. The cost estimates from that process are directly fed into the creation of the project budget. According to PMBOK, the project budget is part of the Determine Budget process. There are several techniques used to determine the project budget:
- Cost Aggregation
- Reserve Analysis
- Historical Data
- Funding Limit Reconciliation
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Cost aggregation requires you to aggregate costs from an activity level to the work package level. This is because costs are measured, managed and controlled at the work package level during the project life-cycle. The final sum of the cost estimates are applied to the cost baseline (a tool project managers use to monitor and control project expenditures).
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To protect the project from cost overruns, most projects have a buffer. This buffer is called a Contingency or Management Reserve. The degree of protection provided is proportional to the risk foreseen in the project and the norms within your organization. The buffer is part of the project budget, but not the cost baseline. No amount of buffer can protect the project if you don't follow the golden rules of managing risks.
Read Protect Your Project Against Cost Overruns for more information on Reserve Analysis.
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Historical data from a closed project can be used to determine the estimates for the new project. For example, if your organization has developed a block of apartments, you could use the same estimates for the development of another block of apartments. This is similar to analogous (parametric) estimation and is dependent on the similarities between the two projects.
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Funding Limit Reconciliation
Many organizations have limited funding for projects, which affects the project cash flow. The funding may be based on a fiscal year or a quarter. Either way, your project budget must adhere to the constraints imposed by the funding limit.
For example, suppose you have outsourced a part of a project and the vendor delivers and invoices you in the first quarter. However, the invoice and consequent payment was planned for in the second quarter. In this case, as a Project Manager, you wouldn’t have the funds to pay the vendor in the first quarter.
You will use funding limit reconciliation to avoid large variations in the expenditure of project funds. Funding Limit Reconciliation may lead to revisions in the schedule and resource allocation. Therefore, the project budget directly impacts not only the cost, but also the schedule and scope of work that will be completed.
Best Practice: Instead of committing to a budget for the entire project, commit to the budget for each release. In addition, watch out for scope creep during project execution. Otherwise, you will surely run out of funds.