Juggling resources is no easy task, but Dan Lowry discusses how having capital reserves is important for operations and also mitigates risk.
Written by Dan Lowry
EDITOR’S NOTE: This article originally appeared on LearningFM’s blog.
Understanding contingency and management reserves is important. In the last post, I discussed types of costs and the methods for estimating them. The next step is to compile all cost estimates and add contingency reserves to create the cost baseline. This baseline is used during the execution phase of a project to measure, supervise, and control actual costs of the project. The only thing the baseline does not contain is management reserves. The cost baseline plus management reserves make up the total project budget. We will discuss what these reserves are and when to use them.
These funds are set aside as an allowance to mitigate risk. They are amounts determined by either a percentage of the cost estimate or an actual number calculated through some form of quantitative analysis (i.e., you identify a risk and calculate what it would cost if the risk occurred and include that amount in your contingency reserves).
Contingency reserves are included when there is a known risk. This means that the likelihood of a negative impact to the project has been forecasted and accepted. An example of this is identifying rock in a given area that must be excavated, but not knowing how much will be encountered. The PM’s cost estimate would include all known costs associated with the excavation plus a contingency to mitigate the risk of encountering additional rock formations, causing increased time and labor.
These funds are set aside to mitigate unidentified risk. They are controlled by management and can be used as they see fit. Because management reserves are for unknown risks and out of the control of the PM, they are not included in the cost baseline. Once again, the total project budget consists of all cost estimates, contingency reserves, and management reserves. However, the cost baseline the PM uses to supervise and control the project budget does not include management reserves.
Understanding how to mitigate risks through budgeting is an important tool. You will come to rely heavily on these two reserves in order to effectively manage your project and adhere to the cost baseline.
I’m interested to know what your experience has been with risk and reserve planning. Please email me at email@example.com.
If you’d like to learn more about types of contracts from Dan, check out this article.
ABOUT DAN LOWRY
Dan Lowry is a published author and the Director of Facilities at Southern Hills Country Club. In addition to his civilian work, Dan has served in the Oklahoma Army National Guard as a Major for over fifteen years, utilizing his facilities and operations expertise as an engineer. With an MBA in finance, he’s a certified Project Management Professional® through the Project Management Institute® and maintains his credentials as a Facility Management Professional through the IFMA. Dan currently shares his insights on both his LearningFM site as well as his podcast.