Together with time and scope, a project budget is the bread and butter of every project.
Underestimate it and you end up with insufficient resources, not to mention a stalled project. Overestimate it and you risk getting no approval. In fact, according to PMI, 38% of project failures are due to inaccurate cost estimates.
Don’t worry, though. Creating a project budget is more science than art. The tools you need - cost types, budgeting methods, and the budgeting process - lie ahead of you.
A project budget sums up all the costs of individual activities, tasks, and milestones needed to successfully deliver a project. This includes labor and material costs, but also contingency reserves to accommodate for unforeseen risks.
The project budget is not static, though. The output usually consists of a cost baseline, which helps you compare the actual spending with the original project budget and revise it when changes occur.
As a project manager, the project budget is your best ally when it comes to:
But most importantly, a project budget will build up your project allocation muscle. Is one expensive project better off than two cheaper ones? Then it might have a higher impact. Decisions like these allow you to prioritize strategically and better lobby your projects.
Now off to the costs that go into creating a project budget.
Every project incurs costs. The gist is to capture all the existing costs, especially the hidden ones, that can impact your project budget.
Here are five project cost categories you can use to get an accurate cost breakdown.
People, equipment, and material costs. These are what the project management body recognizes as standard resources. They represent a good starting point but remember to include variable and operational costs too.
Direct vs. indirect costs. Direct costs are closely tied to the actual project. You have to buy them to get the project going. Examples include equipment, licenses for say project management software, and so on. On the other hand, indirect costs are overhead costs that are tied to the project indirectly. Examples include office rental, heating, lighting, and janitorial services, to name a few.
Fixed vs. variable costs. Fixed costs remain constant over the entire project, like utilities. Variable costs, though, change with the length of a project, either on an hourly, piece, or user basis. Examples include salaries, training, legal advice, and consulting fees.
Operational costs. Some equipment might require a specific type of “fuel” to function. Copy machines run on ink cartridges, office spaces on electricity, you get it. When tying the budget, make sure to account for all hidden equipment and machine operational costs.
Sunk costs. Perhaps the most sneaky of them all, sunk costs are those that have already been spent. They are considered “spilled milk” as the famous sunk-fallacy goes. In other words, unrecoverable and should not be considered when making project decisions. For example, if you’ve invested $1 million in a project and want to spend $500k to complete it, you should probably stop as the investment is not worth it.
The list above is, under no circumstances, an exhaustive one. So tread carefully and choose the combination of categories that uncover most of your project costs. If you're new to project cost management, check our guide here.
Capturing project costs is just half of the equation. You also need to estimate them as accurately as you can. A job that becomes harder with the size and complexity of a project.
Even though a universally accepted project budget template doesn’t exist, there are several ways to estimate a project budget.
The bottom-up method first determines the individual cost of activities within a project, then sums them up to create the final project budget. This begs the expertise of the actual project members working on those activities, as they are in a better position to estimate them.
👍 PROS: Detailed task breakdown.
👎 CONS: Time-consuming to identify the smallest task units.
The top-down method is the opposite of the bottom-up approach. It starts with the project cost first, then divides a portion of it to individual activities. This is a standard method for flat rate projects, where project managers use historical data to determine the project budget.
👍 PROS: Less time-consuming.
👎 CONS: Less accurate as the project scope and plan are not yet defined.
NOTE: So far, we’ve covered project budgeting methods. The following are task budgeting methods and ultimately build into the first two. Use them when you can’t accurately estimate a task’s cost with enough confidence.
As the name suggests, the analogous method estimates the cost of a project by analyzing data (project scope, budget, duration, etc.) from similar past projects. Here, you’re dealing with a gross-value estimate that must be adjusted for risks and known differences, as rarely two projects are the same.
👍 PROS: Less time-consuming and less costly.
👎 CONS: Not so accurate, should be used with other budgeting methods.
Unlike the analogous method, the parametric estimation technique uses unit rates (hourly rate, square meters, etc.) and parameters from similar projects or industry standards to calculate the project budget. The unit rates are then multiplied by the number of units. For example, if a masoner is laying tile floors for $100/square meter, you can use this rate or an industry-accepted one to estimate the project budget.
👍 PROS: More accurate.
👎 CONS: Depends largely on a unit rate’s price, quality, and availability.
The three-point method uses the most optimistic (O), the most pessimistic (P), and the most likely (M) cost estimates in a weighted formula - (O + 4M + P)/6 - to determine the budget closest to reality. The method is perhaps the most accurate and will help you avoid project cost overruns by identifying and taking into account known risks.
👍 PROS: Most accurate method.
👎 CONS: None.
With a clear understanding of the available types of costs and project budgeting methods, it’s time to create the actual project budget. We’ll follow the budgeting process closely in Runn.
The best way to scope a project is to create a work breakdown structure (WBS). Hence, divide your project into task lists, tasks, and milestones to understand deliverables and inform your stakeholders about what they will get in return for their money. From here, you’re in a better position to identify the costs and resources required.
To illustrate this, we will create a time & materials project called “Landing page”. Remember that in Runn, all projects are divided into task lists. To add one, simply click and drag on the project timeline and do so for the rest of your project phases.
Next, estimate each task as optimistically as you can. Either by looking at historical data from similar projects or using one of the mentioned task budgeting methods.
In Runn, you can assign a business cost to each user. This is the salary you pay to keep your team members working. To define the business cost:
a. Go to Manage, choose People, and select a user.
b. Click on the three ellipses, then Edit.
c. Assign a different Cost to business.
What’s left is to schedule resources for each task list and mention the number of working hours.
The software then automatically calculates the overall resource cost (on a task list basis) by multiplying the hours scheduled with the cost to the business. To find out this figure:
a. Go to Manage, select Projects, and choose your project.
b. Scroll down to Phases for the cost breakdown.
c. Check the People Cost column.
Contingency reserves are emergency funds that safeguard the project against known and unknown risks. They are meant to be spent, so always include them, even if they make the project look expensive. A good margin is somewhere between 5-10%, but know that riskier projects will require more contingency.
Luckily, Runn has placeholders for different role types, each with its own cost, just in case you need an extra designer or developer during the project execution.
In terms of project accounting, don’t forget about taxes too. The majority of suppliers are sending quotes without taxes. Account for them to create a realistic, tax-inclusive budget.
Once costs, contingency, and tax are known, add up all your estimates to get the cost baseline. This is your official measurement yardstick. Use it to track your spending against the original budget and keep it in close range, as you will often reference it.
Also note that beyond this point, you can’t make any budget changes unless you’ve received special approval from your sponsors.
If you’ve followed the previous steps, the cost baseline should be automatically calculated and available under the project overview’s Project People Costs.
The final step is to get budget approval from your sponsors and stakeholders. Initially, the sum requested might be a little higher than expected, so prepare for some fund cuts. Nevertheless, your goal is to arrive at an approved budget with as fewer iterations as possible.
To better convince stakeholders of the value of your project, Runn allows you to assign a rate card to each type of resource. This is the project’s revenue. To add a rate card:
a. Go to Manage, choose Rate Cards, then New Rate Card.
b. Select Hourly rate (assuming you run a time & materials project).
c. Assign hourly rate values for each role.
The platform will then sum up all the earned value and display it under Project Revenue, right next to the Project People Costs, so you can calculate the project profitability with ease.
NOTE: In this example, we’ve used the bottom-up estimation method. If you want to use the top-down estimation method, go directly to the project’s Budget tab and enter the total scheduled hours for each resource type.
Pay in mind, though, that for the final budget, Runn will consider the rate cards (a.k.a. the actual billable hours), not the resource cost to the business.
What you’ve seen so far is a simple approach to project budgeting. In reality, though, the process begs a few observations.
Never shrink numbers to fit the budget. They might look good on paper, but when the budget is approved, the shortcomings will surface quickly. If you’re not confident enough in your budget, revise the scope instead and make sure all team members understand the project context.
Include the accuracy of each estimate. At the end of the day, estimates are just estimates: honest guesses made in the light of a percentage of known information. You might do them in a rush or not take into account unpredictable random events such as black swans, a case in which their accuracy diminishes. That’s why you must always specify their level of accuracy. As the PMBOK suggests, a project might have a rough order of magnitude (ROM) estimate between -25% to +75% in the initial phase. Later, as it progresses and more information is known, the accuracy could vary between -5% and +10%.
Now that you know the ins and outs of creating a project budget, go ahead and use your freshly acquired knowledge. Look back at a similar project and total the tasks, resources, and costs on a piece of paper. Or try a project management software like Runn to spare yourself the effort.
The last thing I want you to remember is this: a project budget is a living document. Even if you’ve got it approved, document and revise it the more information you get your hands on.
Tasked with creating a resource breakdown structure (RBS), but don't know where to start? Here's everything there's to know.