There are two primary methods of budgeting: top-down and bottom-up. In top-down budgeting, managers use their experience and past data with previous projects to estimate the overall costs and major subproject costs (Meredith, Shafer and Mantel 2017, 237). Those hierarchical figures are then passed down to lower-level managers to then breakdown those high-level estimates to their subtasks. This method is useful when there is high potential to overlook a step that may impact the budget negatively or are too small to be worth identifying since the high-level costs would include all sub-tasks. The different high-level budget categories also represent stable percentages of the total budget. While some elements may be off within the budget, overall, it can aggregate to a fairly accurate amount with minimal effort (Meredith, Shafer and Mantel 2017, 237).
Bottom-up budgeting looks at the costs of a project in the opposite way. Instead of setting up a budget for the major sections and allocating to the lower levels, a bottom-up budget calculates cost and time for each individual subtask first. Those subtask costs are then summed together to determine the higher-level budget costs. These kinds of budgets are typically more accurate but require more effort to ensure that accuracy. Missing elements in a budget can cause larger issues. It is also important to ensure there is some contingency reserve for the known-knowns, and management reserve for the unknown-unknowns (Meredith, Shafer and Mantel 2017, 238-239). Bottom-up budgeting also includes more lower-level management in the cost preparations making them more likely to be engaged with the process, less likely to have cost overruns, increased likelihood of using the most accurate data, and provides them more training for future roles (Meredith, Shafer and Mantel 2017, 239). When utilizing this more accurate but higher effort method, it is important that top management ensure that all elements of work are represented in the budget to avoid missing important pieces. Top managers should also ensure their subordinates have open and honest communication during the budget setting process. If a project life cycle curve is a stretched-S shape in terms of time to project completion, then it is best to use a superior’s cost estimates because a small reduction in budget near the end will not fully derail the project. However, in a stretched-J life cycle curve small budgetary changes in the end can have larger impacts. In this case the subordinate’s estimates should be used to avoid any major impacts to project completion.
Pitfalls in Cost Estimating
Cost estimates are a critical element for a project’s success. However, there are many pitfalls when it comes to cost estimating. One of the main issues with cost estimates is that conditions are always uncertain and require the use of assumptions. A method to helping manage assumption and uncertainty issues is to develop cost scenarios for minimum, most likely, and maximum scenarios to get a better gauge on the sensitivity of the different elements in their budget (Meredith, Shafer and Mantel 2017, 271-273). Another issue that often arises is that for projects that have routine tasks, the time it takes for the task to be repeated reduces overtime as expertise is gained. This can cause for improper allocations for time and costs. Using a learning curve calculation can help prevent issues regarding time and cost estimates for repetitive tasks (Meredith, Shafer and Mantel 2017, 251-253).
Additional issues like bad data or incomplete work breakdowns can create issues with budgeting as well. To help manage all potential cost overrun issues it is important for a PM to have a detailed plan and tracking system to determine where they are going over budget. Once it is determined where the overruns are, a PM can adjust the scope, cost, or deadlines on remaining elements within the plan to accommodate the issue. Cost estimations are based on assumptions and uncertainty, but with a detailed plan and a useful tracking system PMs can ensure they are able to resolve conflicts in the most efficient manner as problems arise.
Meredith, Jack R., Scott M. Shafer, and Samuel J. Mantel. 2017. Project Management: A Strategic Managerial Approach. 10th ed. Hoboken, NJ: John Wiley & Sons. ISBN-13: 9781119369097.