How is Cost Contingency Calculated? Cabbage for Sage Blog

Contingency: the estimated amount added to the project base estimate to cover project risks. Having cost contingencies helps prevent cost overrun issues, which can be disastrous to a project.

But how do you estimate project contingency correctly?

While it can be tempting to add a flat percentage to the project cost in hopes that it will cover unforeseen situations, this approach isn’t the most effective – there are too many variables to consider. For example, similar projects run numerous times by an experienced project manager will require a smaller contingency than a new project with unknown elements.

Follow the steps below to calculate a more meaningful contingency – one that takes into consideration the potential risks and focuses on the costliest issues.

SEPARATE YOUR CONTINGENCIES

To accurately calculate a contingency, specify exactly what the amount will cover. Contingencies are typically used to cover potential project risks, such as unmet objectives, rather than changes in scope. Changes to project scope require a recalculation of both the baseline budget and the contingency.

Including a second contingency amount (or program contingency) can cover risks that weren’t initially identified but become obvious later in the project.

IDENTIFY AND DETERMINE POTENTIAL RISKS

Risk planning should be a major part of your project contingency, which is why flat percentages generally don’t work. The easiest way to do this is to multiply the probability percentage by your estimated cost impact, providing a risk contingency for each line item. For example, a risk probability of 20% multiplied by a cost impact of $40,000 equals a risk contingency of $8,000.

CALCULATE YOUR CONTINGENC

If you perform the risk contingency calculation above for every identified project risk and then add them together, you’ll have a strong contingency calculation. (Consider the flat percentage you would have chosen. Is the calculated contingency more or less than the flat percentage? How would that affect your project?)

GET SPONSOR SIGNOFF

Whatever you calculate your contingency to be, you’ll need approval from your project sponsor to set the funds aside. (It’s often easier to keep the contingency separate from the baseline budget, but make sure it’s accurately presented during project sign off.)

Depending on the length of the project, it may be helpful to re-evaluate the contingency, as the balance between the contingency and uncertainties in the forecasted costs to complete remaining work may change as the project progresses.

If the goal is to maintain a steady level of risk, you might also consider revising the plan of work to uncover additional savings and release some of the contingency so there’s a reduction in risk. Contingency funds released from projects can be used to balance a portfolio of projects, support additional company requirements, or even taken as profit.

For more information about contingencies and calculating them, contact us today.