When estimating the costs for a project, it is preferred that the people responsible for individual tasks be responsible for estimating their costs. This has the benefit of producing a more accurate cost estimate and garnering commitment from the responsible parties. Unfortunately, there are times when a project’s budget is determined without input from the responsible parties. When the overall project budget has been set, it is up to the project manager to see that each work package in the work breakdown structure receives an adequate budget (Gido & Clements, 2009).
There are two primary methods for determining the total budgeted cost for individual work packages. The bottom-up, or cost aggregation, budgeting method estimates the costs of individual activities and summarizes them into work packages to which they are associated. The perception of this method is that it generates more accurate results since each scheduled activity is accounted for. Scheduled activities that are small or simplistic have a better chance of producing accurate budgeting results (Project Management Institute, 2004). Although Kim and Park (2006) were talking about government budgeting, their observation that the bottom-up budgeting process encourages over-estimation is accurate. In a situation where the overall budget for a project has already been determined, the bottom-up budgeting method is likely to quickly fill the budget if other constraints are not put into place.
The top-down budgeting method assigns a total budgeted cost to each work package based on the scope of the work package in relation to the entire project (Gido & Clements, 2009). This method of budgeting became popular with many governments in the late 1990s. Governments find this method particularly attractive because it allows financial managers to assign overall budgets to various departments without the risk of going over budget. Once each department accepts the overall budget, it is up to the management of that department to determine how to most efficiently use its allocation (Kim & Park, 2006). Similarly, the top-down approach to project budgeting has the same advantage. Since each work package is assigned a portion of the total budget, it is the responsibility of the project team members to complete the scheduled activities for that work package within the defined budget. It is imperative that some sort of reserve analysis be done to provide an operating cushion in the event a cost overrun (PMI, 2004). Since the top-down approach tends to be less accurate than the bottom-up approach, this budget reserve is vital.
As the project progresses, it is the responsibility of the project manager to monitor spending and perform the cost control function. Typically, the project manager will maintain an ongoing analysis of the costs of the project. At any point in time, the project manager should be able to determine whether the cost is running above or below budget. Measurements such as cost variance and cost performance index give the project manager an understanding of how the project is performing. Cost variance is the difference, expressed in currency, between value of work performed and the actual cost. If the cost variance is negative, the project is costing more than it is producing. The project manager should take steps to increase work performance or reduce spending. Similarly, the cost performance index is the earned value of the work performed divided by the actual cost. If this number is less than 1.0, the project is overrunning its budget (PMI, 2004). Regardless of methodology, the project manager must monitor costs as the project develops to ensure that corrective actions are taken if necessary.
Finally, it is worthwhile to understand the difference between estimating and budgeting. Cost estimating is the first step in the budgeting process. It involves determining the costs associated with the project and can be performed at a level of the work breakdown structure. Budgeting, on the other hand, involves the distribution of funds between the various work packages. Budgeting happens after the cost estimates are produced.
Gido, J., & Clements, J. P. (2009). Successful project management (4th ed.). Mason, OH: South-Western.
Kim, J. & Park, C. (2006). Top-down Budgeting as a Tool for Central Resource Management. OECD Journal on Budgeting, 6(1), 87-125. Retrieved March 23, 2009, from Business Source Premier database.
Project Management Institute. (2004). A guide to the Project Management Body of Knowledge (3rd ed.). Newton Square, PA: Project Management Institute.