Budgeting in Project Management: Methods, and How to Estimate a Project Budget?

Budgeting is the foundation projects are built upon, budgets are the limiting factor because the amount of finance that is available for a project will then determine how that project is created, how many resources both human and capital are employed, and how that project is executed.

A project cannot begin before a detailed budget is created because the budget gives a sort of blueprint to the project leader to decide the course and direction of the project.

What is a Project Budget

A project budget is the sum of money that has been allocated or sanctioned for any particular project that spans over a specific period. As stated above, the budget is a limiting factor for any budget, a budget defines how much can be spent in order to achieve the desired target of the project.

The purpose of a project budget is therefore to keep the costs within the predefined limits of the budget in order to meet the expected goals.

The project manager needs to make sure that the budget is followed and maintained, it has been seen that project managers at times get distracted and focus more on completing the projects on time instead of focusing on meeting the deadline while remaining within the budgetary limits.

Importance of project budgeting

  • Budgeting is an essential part of getting a project approved and secure project funding.
  • Well-planned budgets become the foundation for project cost control.
  • Project budgets have direct relation with the financial viability of an organization.

Project budget management is therefore a key skill that project managers need to be equipped with. It consists of steps that are designed to help the project manager manage the project effectively because if a project has got a well-defined budget as stated above then the scope, objectives, and goals of the project will also be well defined and clear for the project manager.

Some of the steps in creating a simple project budget are as follows.

  • Budget estimate: This step requires creating a budget using the income and expenditure data available from all the cost centers or departments. Costs that are not available will have to be estimated using forecasting techniques discussed below. 
  • Milestones, tasks, phase: To make the project budget as simple as possible it is important to break it down into separate tasks, milestones, or phases as applicable. Breaking down the project into manageable milestones helps prioritize and focus on the most important task, thereby increasing the chances of remaining within the budgeted limits. 
  • Add the estimates: Once the cost estimation is done and the project divided into tasks or phases, all of the estimates relating to different tasks and phases should be summed up to arrive at the final figure for the budget.
  • Add contingency expenditure: At the time of estimating the budget, the complete scope of the project isn’t usually clear, and therefore it is better to allocate some amount for contingency expenditure. It is a norm to keep this figure at least 10% of the total budget.
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How to estimate a project budget?

A number of forecasting techniques can be used to estimate a budget. Some of the techniques have been briefly discussed below.

Bottom-up estimation

The bottom-up estimation is the most commonly used method for creating project budgets. It simply requires summing up all of the costs allocated to the different activities in the project.

The sum of all the costs is the total project cost. Bottom-up estimation is particularly useful when every minute aspect of the project is known.

Since this technique accounts for every bit and aspect of the project, it takes a considerable amount of time to draw up a budget using the bottom-up estimation.

It is important to understand that budgeting is a continuous process, budgets grow and need to be updated as the project continues, and usually, as the project moves into its later stages and becomes more defined and the goals become clearer, the budget too becomes much more detailed.

Therefore there is a need to continually adjust the budget as the scope becomes clearer.

Top-down estimation

As the name suggests, this approach is the exact opposite of the first technique. The top-down estimation approach takes the sum total or the final budgeted figure and then breaks it up and allocates it to all the different activities, tasks, and phases of the project.

Top down approach is useful at the consideration stage where there is a need to decide whether the project should be accepted or not, while keeping the budget as a limiting factor.

The drawback of this approach is that it leaves very little room for any change, the budget is very much set in stone with this approach, every project experiences an increase in scope and planned tasks as it proceeds and the top-down approach discourages frequent changes to the plan and revisions in the budget.

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It is therefore ideal for projects of recurring nature where the nature and scope of the project are fully understood. 

Analogous estimation

This approach is suitable for experienced project managers who have a good idea of what the nature and scope of a project is and can therefore quickly draw up a budget based on similar past experiences.

An experienced project manager can use past data and experience to estimate the cost of a similar project, for instance, if a project manager has worked on a project to construct a mile-long bridge, then estimating a budget for a two-mile-long bridge under similar conditions won’t be too difficult. 

The drawback of this technique is that it is only useful for projects for which a precedent exists, new and unique projects cannot effectively use this approach, similarly inexperienced project managers may find it difficult to apply this technique.

Furthermore, analogous estimation is not a very accurate technique because it relies on drawing parallels between similar projects and there are many aspects of costs that change over a period due to inflation, wage rise, etc.

Parametric estimation

This can be considered as an improvement upon the analogous approach. The parametric approach focuses on gathering data points from similar projects and then applying them on the project at hand.

For instance, a project manager can use the material cost and labor cost from an ongoing project, training cost estimates from a past project, and capital expenditure estimates from yet another project with similar outlay and activities.

The objective of parametric estimation is to make the analogous estimation technique more accurate with the inclusion of data sets that suit the current project from many different projects, in order to increase the overall relevance of costs.

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It uses statistics, historical records and variables to create a budget quickly compared to a bottom up approach but similar in accuracy.

The drawback is that finding similar and relevant data sets may be difficult and time-consuming in and of itself and this technique too only applies to projects for which similar projects already exist. 

Three-point estimation

The three-point approach is a scenario-based approach that includes the best, worst, and most likely scenarios and takes their weighted average. This approach minimizes the risk of exceeding the budget and therefore allows project managers to deliver the project within the budgeted estimates. Perhaps the only drawback of this approach is that it is a time-consuming approach.

Budgeting in project management, therefore, can be considered as a key activity that gives the project its direction, a good project budget can not only help complete the project efficiently but it can also make things much easier for the project manager, thereby allowing them to focus on other core activities of the project.