6 Steps to Create a Project Budget

No matter the industry or project in question, project budgeting is vital. Being able to accurately anticipate project expenses and properly allocate funds across various project tasks is what enables businesses to keep their bottom line intact and their stakeholders happy.

The last thing any project management professional wants is to find themselves in a situation where the cost of their current project is either unknown or completely out of control, or they’re left scrambling trying to secure funds for team members to complete their work.

Project budgeting should begin during the development of the project plan. If done well, the initial cost estimates should end up close to the final actual costs.

This article will show how to create an accurate budget that incorporates various expense categories for a holistic estimate of a project’s eventual cost.

What is a project budget?

A project budget is the estimated cost of completing a project. It’s an overall view of what will need to be invested monetarily to complete every phase of a project. However, it’s not a one-and-done deal. The project budget will evolve as project requirements change. The project budget also keeps stakeholders informed of what’s needed and when.

More complex projects are often more challenging when it comes to budget management, and you may find it helpful to create a work breakdown structure (WBS) to identify important deliverables, develop an appropriate project schedule, and perform initial cost estimation.

Project costs to consider in your project budget

Here are some cost categories typically assessed when creating a project budget:

• Labor costs. This includes the hourly and project-based pay for any workers who are part of the project team.

• Material costs. If the project requires manufacturing items or creating physical deliverables, you’ll need to add the costs of all associated materials. Even projects consisting primarily of knowledge work can incur material costs associated with needed software or IT infrastructure.

• Overhead. This category refers primarily to indirect costs such as those related to running the company and those that might apply across multiple projects. This can include things like office space, cloud services, and electricity.

• Professional services. Any work outsourced to other professionals such as legal filings or cybersecurity reviews fall under this category.

• Contingency reserves. When creating your project budget, you will first determine a baseline for the total cost. However, initial budget estimates almost never match final expenditures. Often there are costs that could not have been anticipated ahead of time. You can budget for the unexpected by allocating funds in a contingency reserve for the project.

6 steps to create an accurate project budget

Creating a project budget should be done with the greatest possible accuracy. Accuracy is important because the project budget isn’t self-containing. It affects other parts of the project, such as the project schedule. If the project budget is inaccurate, then your team might not be able to complete deliverables on time. An accurate project budget also accounts for expected and unexpected costs, preventing cost overruns.

The following steps serve as a guideline and are applicable to most project budgeting scenarios.

1. Review cost data from past projects

One of the best places to begin when creating a project budget is to look over previous projects and historical data. Try to identify similar projects or projects that contain similar tasks.

Look at what the initial budget estimates were for those projects and the final project expenditures. Actual final cost data from similar projects is extremely valuable because it will include expenses that weren’t foreseen. Insights obtained from this data will allow you to make better budget estimates on all similar future projects. Keep this data handy as you move through the next steps of budget creation.

If you don’t have access to historical data, or this particular project doesn’t have any similar predecessors, you may be left starting from scratch. Be sure to keep detailed records of your calculations and include notes about actual final costs so the project can serve as a reference for future endeavors once it is complete. ‍

2. Break your project down into smaller increments

By breaking down your project into its component parts, you can better identify the costs associated with each. Creating a WBS is one approach but there are many others, as well. Many project managers find that good project management software can help with this process.

Suppose, for example, the project in question involves the development of a new software application. In breaking this project down, you’ll need to identify which team members will be needed, what tools and technology must be provisioned in the development process, whether any training is required, whether you will need to consult experts or make use of managed cloud services, what the testing and deployment processes entail, and so on.

For each project increment you identify, make note of work hours required, cost constraints, task dependencies, and any other relevant details. If applicable, make note of historical data for similar increments from other projects, as well.‍

3. Estimate costs associated with each milestone

After breaking down your project into increments and compiling notes about what is required for each, it’s time to begin estimating costs for every project milestone.

Start by identifying the major project milestones and then aligning each project increment with the milestone it supports. Use historical data to generate cost estimates if you have it. If you don’t have any historical data, consult project stakeholders or knowledgeable team members for help determining pricing.

When possible, estimate project costs for both the best and worst case scenarios so you have a range of values to work with. You may record the average estimate for each milestone, but knowing the range of possible costs will help you set a contingency budget later on. ‍

4. Estimate overall costs for the project

When breaking a project up into component parts and estimating the cost of each, you may be overlooking costs associated with the project as a whole. This might include things like overhead, hiring costs, and so on. Consult with project team members and make an effort to identify all other project-based expenses and attempt to pin down accurate estimates of each.

You may find it helpful to use a budget template during this process. Such templates can easily be found online or may be included in your project management software of choice.

5. Combine your component estimates into a budget total

Once you’ve done the heavy lifting of dissecting your project into its component parts, estimating the cost of each piece, collating these estimates by milestone, and assessing whether there are any additional project-wide expenses, you can compile all of your numbers into a total budget estimate.

Compare your estimate to past projects of similar size and scope. If there are major discrepancies in your estimate and the final cost of similar past projects, take some time to try to reconcile the differences.

Because every project is different, how confident you feel about the accuracy of your estimate may vary. It’s worth making notes about possible sources of error, including whether you feel certain values might be under or over-estimated and by approximately how much. This will keep you prepared for budget changes as the project progresses and ensure that you run a successful project.‍

6. Leave room for contingencies and unseen risks

Errors in your initial budget estimate can be accounted for by including room for contingencies and unanticipated expenses. Use your notes about your budget calculations to inform how much additional funding you should set aside for this project in order to be relatively confident you will have everything you need.

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FAQ

Creating an accurate project budget is essential for the success of any project. This section answers some common questions about project budgeting, ensuring you understand key concepts and techniques that will help you manage costs effectively.

What is the project scope, and why is it important for budgeting?

The project scope outlines all the work required to complete a project. It’s critical for budgeting because it defines the boundaries and deliverables of the project. When you have a clear project scope, you can better estimate the cost of a project, ensuring that you allocate resources accurately and avoid budget overruns.

What is bottom-up estimating in project budgeting?

Bottom-up estimating is a detailed estimation technique that involves breaking down a project into smaller components. Each part is estimated individually, and the total project budget is built from these smaller estimates. This method provides a high level of accuracy, making it ideal for complex projects where precise cost management is needed.

‍How does top-down estimation differ from bottom-up estimation?

Top-down estimation starts with an overall project budget estimate and breaks it down into smaller components, while bottom-up estimating begins with detailed estimates for individual tasks that are then rolled up into the total project cost. Top-down estimation is quicker but may be less accurate than bottom-up estimating, which provides a more detailed and precise budget.

How does analogous estimation help in project cost planning?

Analogous estimation uses the costs of past similar projects to estimate the cost of a new project. This technique is especially useful in the early stages of a project when detailed information is not yet available. It’s a quick way to forecast the budget but may lack the precision of other techniques like bottom-up estimating.

What is parametric estimation, and when should it be used?

Parametric estimation is a technique that uses statistical data and project variables to estimate costs. For example, it might calculate costs based on the number of units produced or hours worked. This technique is best for projects with repetitive tasks or historical data that can be applied to the current project for accurate forecasting.

How does three-point estimating improve budget accuracy?

Three-point estimating involves using three cost estimates—optimistic, pessimistic, and most likely—to calculate a more accurate project cost. This method helps project managers account for uncertainty by considering different potential outcomes, leading to better risk management and more reliable budgeting.

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