Preparing The Project Budget

Preparing The Project Budget

Of the big three conventional measures of project successbud get, schedule and functionality the budget is, in many ways, the most important. It is the budget that determines whether or not a project is worth while the cost side of the cost-benefit analysis. It is also frequently the most sensitive aspect of project progress. Dollars are, after all, the universal corporate standard of measure.

It follows, then, that the budget should receive a degree of attention at least equal to that given to the schedule.

A project budget consists of four kinds of cost items: staff charges, expenses, capital costs, and general office overhead. If the client will make periodic payments, the budget may also include a cash flow analysis. Exhibit 4.23 gives the budget for part of the sample project.

Except for general office overhead, all cost items are contained within the WBS. Staff charges are the charge rates for team members multiplied by the time spent on each activity. They are derived from work, distributed, and overhead activities. Expenses and capital costs have their own WBS items and normally include travel and living, materials and supplies, and acquisition costs.

General corporate overhead may or may not be part of the budget, get, depending upon company policy. If it is included in the budget, it is usually calculated using a formula based on a percentage of staff charges.

Assembling the budget, therefore, should involve little more than adding up some numbers from the WBS and, where required, adding in the general corporate overhead. In other words, the budget should be automatically generated from the WBS and presented in a report that can be produced by project management software. Of course, as anyone who has ever presented a budget can attest, it's not that simple.

The problem is that just as the client had an expectation of the schedule, management has an expectation of the budget. (A note on terminology: I will assume that the schedule is the primary concern of the client, whereas the budget is the primary concern of management. Obviously this is not always true, but I need to differentiate between groups with a different focus, and this terminology is as good as any. Management may, of course, refer to the management of the systems organization executing the project or to a separate group within the client organization.)

When the budget is presented, it is usually met with the objection that it is too high and that it must be reduced. The estimators are required to "go back to the table," "sharpen their pencils," and produce the kind of numbers management expected.

As you will probably have observed, cutting the budget is akin to aligning the schedule, and the comments that applied in that section apply here. Just as you had to resist the pressure to arbitrarily cut estimates to meet the schedule, you must show the same resolve with regard to the budget. Assuming that you have an honest estimate, it is your responsibility not to yield to the pressures to change it.

Nevertheless, there are means to cut each of the components of the budget: staff charges, expenses, capital costs, and even general corporate overhead.

Staff Charges

Staff charges are hours times rates. While "sharpening your pencil" implies reducing hours, staff charges can also be lowered by cutting rates.

While rates in many companies are sacrosanct, they are also arbitrary. They may be tied to salaries, job classifications, seniority, or other factors, but they are always the product of company policy. Hours, on the other hand, arise from the work to be done. If the choice is between changing hours and changing rates, change rates first.

Not all companies will allow you to change rates, but where the option exists, a slight reduction in rates can have a marked effect on the budget.

Another approach to reducing rates is to base them on lowercost people. If Mary, a senior analyst, has to do work that could be done by a more junior person because no junior people are available, it is reasonable to object that the rate should be that of a junior person and not Mary's because the project should not have to bear the higher cost imposed by external factors.

At times, you may actually be able to use lower-cost people. If Fred costs $50 an hour and Joan $30, and Joan takes three weeks to do what Fred can do in two, it is less expensive to use Joan (of course, the schedule will be affected). In any case, charging at the rate of the lowest-cost people is one way to cut a budget.

Expenses

Expenses are the extraordinary costs of the project, such as travel or special supplies. They do not include everyday items such as stationery or photocopier charges because life is too short to spend it accounting for pieces of paper or photocopy toner. These items should be covered under general office overhead.

Expenses such as travel can be reduced if you insist that the project pay only for expenses that are necessary to get the job done. If the project requires that you or members of your team travel, those expenses are legitimate charges against the budget. However, if management or sales staff travel in order to cement relationships or develop new business, their expenses should be covered by their own departments.

Consulting services and training can be major expense items that can sometimes be trimmed by finding lower-cost alternatives. Some of these services may even be available in-house, and the rates will be far lower than outside organizations will charge.

Other expenses tend to be trivial compared to the overall budget. Do not waste time trying to trim something that would not have a significant effect if it were eliminated entirely.

Capital Costs

If capital items such as hardware are to be acquired and then turned over to the client after the project, the costs will be handled either as a flow-through or as a profit item. In either case, such capital costs should not affect the budget, since the client will pay for the items, whatever they cost.

However, if you need to purchase equipment for the project, such as workstations for the project team, the budget is affected. There are two approaches for acquiring such items: purchase and amortization.

With purchase, the project buys the equipment outright and turns it over to the systems organization after the project. With amortization, the systems organization buys the equipment and charges the project for its use based on some payment schedule.

If you need to acquire equipment, calculate the lowest cost to the project. For example, if you need ten $4,000 workstations, it will cost you $40,000 to buy them (plus taxes and maintenance contracts; do not forget them). If the company buys the workstations and agrees to amortize them over three years, your one-year project should be charged just over $13,000, a savings of about $27,000.

An old and honorable approach to reducing capital costs is negotiating the best price. Many companies have standard suppliers and do not bother to challenge their prices, but if you can find another vendor who is prepared to offer suitable equipment for less, you can insist that the lower-cost equipment be purchased or that the project be charged the lower amount and not be penalized by the company's poor purchasing procedures.

General Corporate Overhead

General corporate overhead is normally applied as a standard formula, not subject to change or negotiation. However, you may be able to argue that some of the expenses or even capital items in the budget should be financed from other company funds rather than  having to be paid for by the project. For example, if the company has a policy of continuously upgrading equipment (and, more important, a fund to do so), you may propose that the policy be applied to your project's workstations, which the company will own when the project ends. If the company has a research and development fund and your project uses new technology, you may request that training and familiarization be covered by the fund.

Contingency

Just as there is contingency in the schedule, so there must be in the budget. The schedule contingency, stated in workdays, implies a budget contingency of the number of workdays times a rate. The rate should be the average rate for the project, which is calculated as the total staff charges divided by the total staff hours (or days).

However, the budget should also include a contingency for other costs. Some emergency travel may be required. Another workstation may be needed. Consulting services may be required. More training may be needed. All of these should be allowed for by the contingency.

Like schedule contingency, budget contingency should be overt rather than hidden in the various expense and cost items.

Cash Flow Analysis

Many systems development organizations, particularly those with external clients, want projects to be self-financing. In other words, at any point in the project, the cash in must always equal or exceed the cash out.

On projects run by such companies, progress payments based on milestone deliverables are usually required from the client. If you are asked to set up the payment amounts and the milestones, use a spreadsheet showing the accumulated expenses by month, the milestone payments, and the surplus. You are attempting to build a schedule of milestone payments that will ensure that the cash received to date always exceeds the costs to date. Since you have no flexibility with regard to the coststhey are consequences of the planyou will have to adjust milestone payments so that they are frequent enough and large enough to cover the ongoing costs.

Complete self-financing is not always possible. It depends on the company's ability to negotiate payments from the client. The cash flow analysis will tell the company where additional financing will be required.