Project Budgeting Process – What Is It? And How Does It Work?

Every organization takes projects to achieve its objectives both financial and non-financial. For-profit organizations take projects to make profits; not-for-profit organizations take projects to create value.

Estimating and assessing the total costs and revenue attached to a project is the starting point for any project. A project budget can be defined as:

“Estimation of total project costs in every process, task and milestone till completion”.

Budget allocation for a project also depends on the nature and need of the project. For example, a revenue-generating project will need a reliable cost of capital rate to analyze the profitability of the project.

The cost estimations may also take several approaches to the total project budgeting process. Financial resources are a key component of any project, a realistic and well-planned budget can be the final difference between a profitable and failed project.

The project budgeting process can take several approaches; a step by step generalized approach can be listed as:

  1. Pre-planning: The first step in project budgeting should start with identifying the tasks, activities, and milestones for the project. The break-down of the project can help in detail cost estimations and resources in full.
  2. Cost estimation: project activities and resources should be assigned estimated costs. These estimates can take several approaches, which we’ll discuss in detail below.
  3. Contingency planning: a fair share of the total budget should be allocated to contingency resources to avoid mishaps during the project completion. It also helps to meet any shortcomings in the pre-planning stage.
  4. Real-time management: this step involves real-time costs and expense management during the project activities. During this step, project cash flows also start, so this step gives project managers an idea of their pre-planned cost estimates too.
  5. Variances: during the project activities there can be positive or adverse budget variances. Operational variances can occur due to several reasons such as idle labor hours, machine inefficiencies, etc.
  6. Reconciliation: although, the final costs of the projects can be aggregated at the end of the project completion, however, reconciliation of costs can take place during the project.
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The traditional project budgeting process requires all activity and milestone costs estimated before the project commencement.

Modern project budgeting with a more flexible approach such as activity-based budgeting adopts a flexible approach that continues the reconciliation during the project.

The most critical factor in project budgeting is the cost estimations of activities and resources. Resource estimates will depend on the nature of the project, and will include:

  • Human resources such as skilled and non-skilled labor
  • Machinery and equipment to complete the project
  • Raw material, transportation, packaging, marketing, and sales.
  • Contingency resources to avoid risks
  • Project-specific costs such as project insurance

Cost estimation is the most critical and often difficult task in the project budgeting process. A project manager can take several approaches to estimate project costs.

Activity-Based Approach:

In this approach, each project activity is identified separately and allocated the best-estimated cost. The total project cost then comprises the sum of all activity costs.

Any additional activities occurring during the projects cannot be predicted with this approach, however, can be managed with contingency planning.

Bottom-Up Approach:

From the operational level to the top-level each activity and resource is assigned a cost. This approach is the most detailed and time-consuming yet effective in project budgeting.

Parametric approach:

Projects are often based on set parameters, such as the launch of a new product. Project costs can be allocated on these set parameter basis to estimate the full project budget.

Analogous Approach:

If the project is new and no historic data is available, one way of cost estimation is to compare the project with similar other projects.

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Standardized and updated activity-based project is often difficult to identify; however, this approach can offer a simple starting point.

Project budgeting offers management control and a performance measurement tool. The Project budgeting process has several advantages:

  • It offers the most critical planning tool for the project i.e. the financial planning
  • It offers management planning and performance controls
  • Cost estimation and resource allocation helps in project profitability analysis
  • Project budgeting can help in prioritizing different projects if the financial resources are scarce
  • The budgeting process helps to identify critical resources e.g. in an activity-based budgeting approach each activity is allocated costs separately

Pre-planned project budgeting offers great valuable insights to the management, however, there are some limitations attached with project budgeting:

  • Project budgeting is performed way ahead of the real-time commencement which may make the estimates obsolete
  • Project managers may feel a lack of motivation if the budget targets are set too high
  • It is inevitable to see variances in budgets, without careful contingency planning project budgets cannot achieve targets
  • Lack of comparable or historic data may make the project budget estimates unrealistic and difficult to implement

The Project budgeting process starts with the pre-feasibility study of the project. Careful and realistic cost estimations can lead to a well-defined project budget. A flexible and responsive approach towards the project during the activities can reduce the variance gaps.