The importance of contingency and its weightage in project budgeting

• July 02, 2024
• Yesmindz Team

The importance of contingency and its weightage in project budgeting

An opening statement on Contingency

Contingency, in some cases is a contentious issue and people many times hold diverse opinion on contingency. In my experience, I have found experienced project developers conveniently agree or disagree on contingency & quantum of contingency. The opinions are far diverse like,

• 1. We implemented almost identical project last year and are considering cost as per our experience. Then why there should there be contingency?
• 2. Our project capex calculation is fairly detailed with all backups. There is no need for contingency.
• 3. The current budget is only an estimation and in case it increases, we will fund it from our pocket.
• 4. The lender wants 5% contingency, so we have to consider it. Maybe we will reduce cost from other heads and park it under contingency.
• 5. The lender wants to park entire contingency as fixed deposit with them. So, we have to reduce contingency in the project.
• 6. The need for contingency will appear at the end of the project execution. We have time and will arrange additional fund at that time.



As a reader, I am hopeful that you will definitely agree with me on the fact that none of the above logics can be completely true. I have examples in each of the above cases, where non-consideration or lower consideration of contingency have affected the project at the end.

Understanding contingency

We can take example from our everyday life.

We allocate a specific budget for our leisure travel plan and at the time of actual travel, we find it increased by 30% or more. Reason, we spent on one exotic carnival experience to make travel memorable, upgraded to a resort on the sea front at a higher cost and our baggage weight doubled up due to the purchases we made.

We budgeted a specific amount for a family function and it increases due to increase in the charges of the venue. We land up paying more.

Now as it happens in our personal life, the same way it happens in any project. To put it in perspective, Contingency in a project budget refers to funds allocated to address unexpected costs increase during project implementation. This is a financial buffer that helps us completing the project smoothly despite unforeseen expenses. This allocation helps mitigating the risks related to project delays, scope change etc.

Effective contingency planning is essential for project managers to maintain control over the budget and deliver successful project outcomes.

Methods of contingency calculation

The quantum of contingency in a project must be calculated based on the following,

Risk Assessment: Identify and evaluate the potential risks that could impact the project. These risks may include,

Risks related to the status of land and registration. In case of projects, where the land requirement is high the land price may go up considerably when the land acquisition starts.

Status of engineering. In case the project engineering activities are in preliminary stage, there are chances of change in the configuration.

Soil condition like, rocky soil of soft soil etc.

Status of receipt of quotations and issuance of supply contracts.

Proportion of imported v.s., domestic component in the project.

Historical Trend:

Trying to explore the cost escalation of similar projects in the past in the same region, may help understanding the probable impacts in advance. This helps in taking mitigation measures also.

Expert Judgment:

Experts are those, who has prior experience in similar assessment. Consult with experienced project managers and industry experts to estimate the potential impact of identified risks.

Calculation of Contingency:

Percentage of Project Cost: A common method is to allocate contingency is assigning certain percentage of the total project cost. This percentage can vary from 5% to 20% of of the project based on risk.

Percentage of Project Cost: Three-Point Estimate: Calculate the contingency using optimistic, pessimistic, and most likely cost estimates for each task/ cost head. The formula for the three-point estimate is: Contingency = (O + 4M + P) / 6

Where,

‘O’ stands for Optimistic Estimate,

‘M’ stands for Most Likely Estimate and

‘P’ stands for Pessimistic Estimate

Conclusion:

It is important to accept that the need for contingency in any project can never be overruled. Hence, there is the need for assignment of contingency at the beginning of the project concept and review it periodically over the period of implementation.

By combining the above stated methods, project managers can develop a comprehensive and reliable contingency budget that adequately covers potential risks and uncertainties.