Regardless of its size, every project involves costs. As an unlimited amount of money is unlikely an option, planning a budget is one step you must always take.
Without it, the greatest project idea becomes only a dream that never comes true.
In this article, we will cover project management budgeting and identify the components of a project budget.
Moreover, we will explain why budgeting is important and describe 6 types of project management budgeting methods.
Additionally, we will guide you through creating a project budget.
Last but not least, we will provide a project budget example by using project management software.
Let’s get started.
Table of Contents
What is project management budgeting?
Simply put, project budgeting refers to estimating how much it will cost to complete activities during each project phase combined.
A project budget helps set cost expectations and is critical in getting approval from project stakeholders.
Having a budget ensures funds are available when we need them throughout the project.
Obviously, you should determine the budget before the project starts.
Identifying how spending will be distributed across project activities enables better tracking and control of project costs.
However, a project budget is a dynamic document. It should be constantly monitored, reviewed, and updated during the project.
💡 Plaky Pro Tip
For more info on project accounting as a whole, which includes not just budgeting, but also cost accounting, financing, cash flow management, and Earned Value Management, read this guide:
What are the components of a project budget?
Depending on your project type, a project budget may include the following expenses:
- Labor costs — such as wages and salaries, benefits, payroll taxes,
- Material procurement costs — such as equipment, services, and supplies from external providers,
- Operating expenses — operating costs for every project phase,
- Transportation costs — if the project requires traveling or transport of materials,
- Research and consultants expenses — any studies or expert opinion you may need, such as legal advice,
- Contingency reserves — additional money for cost uncertainty such as rework, and
- Any other cost the nature of your project requires.
These costs fall into two categories:
- Fixed costs, and
- Variable costs.
As the name suggests, fixed costs are set for the project and don’t change over time.
An example of a fixed cost can be rent payment or monthly wages of full-time employees working on a project.
Suppose a pharmaceutical company has to pay $500,000 monthly for a production facility. This price remains the same during the rent period regardless of production capacity or the project the company is currently working on.
Variable costs change over time and are directly associated with the business activity.
For instance, a construction company will have to pay more for construction workers’ wages over a six-month construction project than a three-month one.
Some of the most common types of variable costs include:
- Utility expenses, and
- Raw materials.
Why is budgeting in project management important?
“Beware of little expenses; a small leak will sink a great ship.”— Benjamin Franklin
Why is that the case?
Some of the most common challenges in project management include poor estimating and lack of resources.
The ugly truth is — your project is predestined to fail if you don’t secure sufficient resources.
There are several reasons why budgeting in project management is important:
- It enables better decision-making,
- It lets you keep costs under control,
- It secures project funding, and
- It enables better future planning.
Benefit #1: Better decision-making
Project budgeting enables better decision-making during the project, as the finances you have at your disposal are predetermined.
Therefore, deciding how much money to dedicate to smaller steps within the project becomes easier.
Benefit #2: Keeping costs under control
A well-planned budget becomes the foundation for project cost control.
Setting an accurate budget helps your organization keep expenses under control via effective planning and resource allocation.
Benefit #3: Securing project funding
Setting the budget provides information on how much money we need for a project and describes when we need it.
So, budgets provide economic justification for projects. Before any project gets approval, stakeholders always want to know how much it will cost.
Benefit #4: Better future planning
Well-determined project budgets may help provide estimates for creating the budgets for similar future projects.
Some budget estimating methods — such as analogous estimating — consider similar previous projects in setting the budgets for the current ones.
Types of project management budgeting methods
Companies deal with various projects, operating methods, and available resources.
Therefore, no universal budgeting method applies to all projects in all industries.
There are several project management budgeting approaches you can use to estimate project costs, including:
- Analogous estimating,
- Parametric estimating,
- Top-down method,
- Bottom-up method,
- Three-point estimate, and
- Activity-based budgeting.
Let’s explain what each type entails.
Budgeting method #1: Analogous estimating
Analogous estimating is a method of providing an estimate of a budget based on analyzing the available data of an already completed project with a similar scope to the current one.
If we can establish general similarities with previous projects, it is possible to make reasonable assumptions about the cost, effort, and other things required to deliver the new one.
In simple words, analogous estimating takes the budget data and best practices from past projects to predict the costs of the current project.
As projects are usually not the same in terms of size and level of complexity, we must adjust the estimate upward or downward to account for the differences.
This method is not entirely accurate, and only companies with similar previous projects can use it.
What does this model look like in practice?
For example, it cost $100,000 to develop a website three months ago.
Now, you are in charge of developing a new website that is similar in terms of complexity, time, and scope in general.
Based on that, you can predict that expenses will be the same or slightly over the sum you spent on the previous, similar website development project.
Budgeting method #2: Parametric estimating
Parametric estimating is a method that combines historical and statistical data and uses the relationship between variables to provide accurate estimations.
We can use it to calculate the time, cost, and resources needed for the project.
It takes the cost variables and data points from specific parts of related projects and applies them to the current one.
In its simplest form, the parametric estimation includes only one parameter and a linear relationship between the parameters and the amount of cost or time.
To calculate it, we can use the parametric estimating formula:
E_parametric = (A_old / P_old) x P_curr
- E_parametric — is a parametric estimate,
- A_old — is a historic amount of cost or duration,
- P_old — is a historic value of the parameter, and
- P_curr — is a value of the parameter in the current project.
So, to apply parametric estimating, we need a historical value.
For example, we know that we spent 3 hours on a particular task in previous projects, costing $1,500.
Based on that, we need to estimate costs for a new project, considering that it will take 15 hours to finish the task.
The parameter p_old value is three hours, and the p_curr value shows how much time will be spent on the current task — assuming that the rate of $500 per hour has not changed.
A_old = $1500
P_old = 3 hours
P_curr = 15 hours
E_parametric = (A_old / P_old) x P_curr
E_parametric = ($1,500/3) x 15 = $7,500
Parametric estimating is more accurate than analogous estimation, as it uses more than one data set and the statistical relationship between historical data and variables.
Budgeting method #3: Top-down method
According to the Corporate Finance Institute, top-down budgeting “refers to a budgeting method where senior management prepares a high-level budget for the company. The company’s senior management prepares the budget based on its objectives and then passes it on to department managers for implementation.”
When determining the budget this way, management takes into consideration previous experiences and current market conditions.
When discussing projects, a top-down estimating method looks at the project budget in its entirety and then calculates individual costs for each element.
Management determines the project budget based on their knowledge and assumptions derived from historical experience.
Then, the project team works on the project and uses the allocated budget.
This approach is most suitable when there’s a fixed price for the project.
However, this estimating method has its disadvantages.
The major one is related to the fact that it is challenging to accurately forecast the budget before understanding the scope of work and before having a project plan.
Budgeting method #4: Bottom-up method
The bottom-up method estimates the cost of individual elements of a project and adds them up to get the total project cost.
These estimates are often done at the lowest Work Breakdown Structure (WBS) levels — i.e. work packages or project activities. Such estimates tend to be more accurate than those derived from top-down estimating.
The downside of bottom-up estimating is that it takes a lot of time to get into the smallest detail of the project.
In addition, it is not unusual that tasks are added throughout a project, as project requirements can change over time.
💡 Plaky Pro Tip
You can use the bottom-up method to determine your estimate at completion (EAC) — i.e., your current expectation of the final project cost — at any stage during the project. Read more about it here:
Budgeting method #5: Three-point estimate
As its name suggests, the three-point estimate uses three calculations to estimate a budget:
- The optimistic estimate — where work is finished and funds spent most efficiently,
- The pessimistic estimate — where work is completed with the budget spent least efficiently, and
- The most likely estimate — the most realistic outcome.
By using this method, a project team evaluates various perspectives and can estimate project costs more realistically.
We can apply two formulas for three-point estimating — triangular distribution and beta distribution.
The formula for calculating the triangular distribution goes as follows:
E = (o + m + p ) / 3
The formula for calculating the Beta distribution goes as follows:
E = (o + 4m + p ) / 6
- E — is an estimate,
- o — is an optimistic estimate,
- p — is a pessimistic estimate, and
- m — is the most likely estimate.
The beta distribution is a weighted average in which more weight is given to the most likely estimate. By using it, we can determine the level of certainty of this prediction.
We get the variance by the difference between the pessimistic and the optimistic forecast divided by six squared.
To sum up, three-point estimating lets you consider different perspectives and helps figure out a realistic cost estimation.
Budgeting method #6: Activity-based budgeting
According to Investopedia, activity-based budgeting “is a system that records, researches, and analyzes activities that lead to costs for a company. Every activity in an organization that incurs a cost is scrutinized for potential ways to create efficiencies. Budgets are then developed based on these results.”
The process includes the following steps:
- Identifying relevant activities,
- Determining the number of units related to each activity
- Outlining the cost per unit of activity, and
- Multiplying the result by the activity level.
Let’s explain it further through an example.
Suppose company X sells sports clothing. They expect to receive 20,000 sales orders in the upcoming year. The cost of processing every single order is $8.
Thus, the activity-based budget for the expenses relating to processing sales orders for the upcoming year is:
$20,000 x $8 = $160,000
Activity-based budgeting enables more control over the budgeting process, as revenue and expense planning happens at a precise level that provides valuable details regarding projections.
How to create a project budget?
Creating a project budget doesn’t have to be a tedious task.
To do so, one can follow these steps:
- Define project tasks and milestones,
- Determine project resources,
- Assign budget estimates,
- Add contingency funds,
- Finalize the budget, and
- Get approval.
Step #1: Define project tasks and milestones
First, create a list of tasks you have to complete during the project and determine important milestones.
Step #2: Determine project resources
Then you should identify the resources you need for a project. Make a list of everything you need to complete the project on time, including people, equipment, and all other resources.
Step #3: Assign budget estimates
With all potential project costs listed, it’s time to estimate the cost of your entire project. To do so, you can use one of the previously mentioned methods for budget estimates.
Step #4: Add contingency funds
You can’t be 100% accurate in predicting the costs at the beginning of the project. Therefore, a fund for emergencies is highly advisable. A contingency fund serves as a reserve when project costs increase.
Step #5: Finalize the budget
Collect the estimates into project management software and include all the constraints, assumptions, and a timeline.
Step #6: Get approval
Revisit your estimates and ensure the figures are accurate. To do so, check with experts and project team members if everything is correct. This way, you will be confident when presenting the budget to management and stakeholders.
Project management budgeting example
Let’s see what project budgeting looks like, on a concrete example.
You may need a lot of data, but, fortunately, your desk doesn’t have to be buried under a pile of documents — project management software is a valuable tool when developing a budget.
It helps coordinate the tasks that make up a budget, and you can have all the information you need in one place.
For the purpose of this example, we will use Plaky project management software.
Plaky is free for an unlimited number of projects and users.
Moreover, you can use it to manage all kinds of projects.
How can you use it for project budgeting?
You should start by creating a new board within your space. It represents a virtual space where you can organize your project.
To do so, navigate to the space menu at the top left corner, click +Add, and select New Board.
Then, you should adjust the newly created board to suit your needs.
You can then:
- Add a board description,
- Add item groups and items,
- Add columns — i.e. the building units of items that help you define the content on the board.
After doing that, you should specify the cost categories you expect within your project and contingency reserve.
We list the following cost categories:
- Operating expenses,
- Material procurement,
- Transportation, and
- Contingency reserve.
Then, you can assign people responsible for managing these expenses and add statuses and tags to provide more details.
In Plaky, everything is customizable. You can create the statuses you need and choose the colors you prefer for each of them.
You can also create custom tags and select the colors of your choice for them.
After doing so, you can add information about the money spent and the money remaining for each cost category — and determine contingency reserve.
The final version of your project budget may look like this:
Then, you can invite stakeholders to oversee your project budget.
They can be involved in a project as:
- Active members,
- Subscribers to a task,
- Viewers, or
It’s well known that time is money. By sharing a board with stakeholders and management, you can save everyone’s time — as there will be no need for exchanging lots of emails on status updates.
Moreover, project management software is accessible from everywhere — even distributed teams can work on projects and share information easily.
Keep your budgeting accurate with Plaky
You may have the most original project idea — but without securing sufficient funds, that idea will never come to realization.
So, accurate budgeting is essential for any project’s success.
You can use several budgeting methods to determine the project costs and set a realistic budget.
We explained the 6 most frequently used ones, and you can choose the one that is most appropriate for your project.
To save everyone’s time on status updates, use project management software — and enjoy having all critical information in one place. Even better, protect your budget with a project management software you can get for free — try Plaky today.