Forecasting financial need is one of the most important factors in project management. This first becomes an issue when the project manager plans the project budget for executive approval. Budgets continue to be important as variations from budgeting spending are a large part of the controlling phase of the project. Initial budgets remain important through the closing process group when they are reconsidered in concluding the success of the project.

Clearly budgets are important and a discussion about their key issues is justified.

Budgeting and Project Cost Issues

Projects consume resources, and organizations need to track costs. Some costs are easy to track and to allocate to projects the activities responsible for the costs. These easy-to-allocate costs are direct costs such as manufacturing labor, raw materials used in assembly, or gasoline consumed in transport. In contrast, some costs are harder to allocate. These include overhead costs such as rent, depreciation and SG&A (sales, general and administrative expense), among others.

Your organization may have specific rules about allocating overhead to projects. If so, you should follow those rules when assigning overhead to different work packages.

If you are able to create your own rules, there are two practical and defensible ways to allocate costs to work packages. The first would be activity-based costing. For example, overhead might be applied on a per-hour or per-dollar basis for each employee’s work effort. This would be a simple and practical way to allocate the administrative and managerial costs of human resources. The more dollars spent on wages or the more person-hours spent on a work package, the higher its actual allocated overhead costs.

The only way to assign overhead that is easier than activity-based costing is not to allocate it at all to any work package. This may sound ridiculous, but it is arguably the best economic way to think about the fixed costs of a project or organization. Fixed costs such as overhead cannot be recovered and are not dependent on organizational output. What’s more, fixed cost expenditures are gone forever once the project is initiated or even earlier if these costs were incurred before the project was initiated. As such, these are sunk costs and should not be the basis of decisions during the execution or controlling & monitoring project phases. Executives considering projects should think of any project-specific fixed costs only before making a go/no-go decision in approving the project. The moment the project is approved, these costs are money down the drain and have no bearing on any individual work package.

Activity-Based Costing for Work Packages

Now that we have discussed problems with assigning overhead and other fixed costs, let’s focus on budgeting variable costs to work packages. We can associate these variable costs to each work package in a series of steps:

1. List activity-based costs that would be incurred as progress is made in a work package. Activity-based costs include wages, raw materials, activity-based overhead allocation and other variable costs.
2. Estimate the unit cost of each activity in the work package. This will probably involve research such as collecting quotes from vendors or looking up wage rates of employees.
3. For each stage of work package completion, multiply the unit cost and the occurrence of that activity. Add up these products to create a total planned value for the cost of each phase of work package completion. 

The planned value of each increment of progress in a work project is incredibly valuable information. Project managers can use it to create a “time-phased budget” that relates actual spending to budgeted spending for a given level of progress. This will allow managers to compare planned spending and actual spending without being confused by delays or progress that occurred ahead of schedule. They will not be wrongly pleased by delayed projects spending little or wrongly frustrated by exceptionally fast progress resulting in rapid spending.

Since work packages follow the 100% rule, adding their budgeted costs will create a total variable cost for the project. Any unallocated fixed costs for the project can be added to the total variable costs to generate a total value for the project budget.