How to Create a Project Budget – An Ultimate Guide

The basis of any successful project is a well-thought-out budget. The project budget is your financial plan; it outlines the expected costs associated with taking a project from concept to completion. It’s not just about the numbers–it’s about setting a clear path for resource allocation and financial planning.

What is a project budget?

There are multiple interpretations of the definition of Project Budget. At Birdview PSA, we use the following description:Project Budget is the amount that the final Project Cost should not exceed.

In other words, Project Budget is a Planned (Budgeted) Project Cost.

Naturally, once a Project Manager sets a target for their Project Budget, this target should be compared to the EAC Project Cost. As a Project Manager, you want to make sure that your project stays under or on budget: Project Budget – EAC Project Cost should be equal or greater than zero. This difference is usually referred to as Budget / Cost Variance.

Budget vs. сost variance in project management

Cost variance involves checking how well your project is sticking to its budget. It looks at the difference between the budget planned before starting the project and the actual amount spent

If your Cost Variance is negative, it means that you will be over your allocated budget when the project is completed. You need to mitigate this risk as soon as possible or prepare for a tough talk with the project stakeholders.

How to calculate project budget?

Sometimes you are given a fixed project budget that you have to work with. If that is the case, congratulations, your job just got easier (spoiler alert: it did not).

More often, especially with billable projects, you need to calculate your project budget (internal planned cost) to prepare a quote for your customer. Here are the four steps we recommend following:

Create your work breakdown structure (WBS) (i.e. the list of tasks needed to complete the project).
Work with your team to estimate the time required to complete each task. Estimated time multiplied by the internal rates of team members assigned to each task will give you the estimated labor cost, an essential aspect of budget management in project management.
Add all planned expenses.
Some tasks might have a fixed cost, for example, if they are to be completed by vendors or contractors. If you do not want to record these tasks as planned expenses, you can add a separate budget for each such task (activity).
At this point, you got all the estimated costs of a project; this is what you think your project will cost you. However, it is always good to add some additional contingency padding to cover some unexpected risks.

The summary of the Labor Cost + Planned Expenses + Activities Budgets + Contingency Project Budget padding will give you the Total Project Budget or the way it is called in Birdview PSA: Total Project Budgeted Cost. This comprehensive approach to budget management in project management ensures that all financial aspects of the project are considered and managed effectively.

Project budget management: use cases and examples

Now that we have covered the breakdown of project finances, we will review a few different project billing scenarios and see which financial metrics would be useful in each case.

1. Managing the budget for an internal project

Scenario: You need to organize a company retreat.

Financial needs:

Prepare a budget for the retreat.
Monitor costs as the preparation goes on.

Initial Setup:

Create a detailed project plan (WBS)
Specify estimated hours for the tasks, where internal labor costs are expected (for example, Marketing department acting as a profit center and charging internally for its work on the retreat signage)
Add planned expenses for each task in the plan that has any costs associated with it (for example, accommodation booking, catering, canoe rental, etc.)
Set aside an additional budget for unexpected expenses and force majeure.
Combine estimated labor cost (24 hours * $50/hr = $1,200), additional contingency project budget ($4,500), and all planned expenses ($18,600).
Your total project budgeted cost comes to $24,300.

Metrics to track:

As the project progresses, compare the Actual Project Cost and Estimate at Completion (EAC) Project Cost with Project Budget to make sure you‘re staying on track.

2. Managing a flat fee project

Scenario: The Customer Success team needs to implement and deploy a software platform for a customer. Implementation will be sold as a fixed cost contract. This project will only involve labor costs, with no expenses to occur.

Financial needs:

Determine the value of the contract using a 30% profit margin requirement.
Make sure certain high-risk activities do not exceed their budgets.
Monitor overall internal labor costs.
Bill customer and track payments according to the agreed schedule.
Calculate project profitability.

Initial Setup:

Create a detailed project plan (WBS). Use a template if available.
Assign employees to each task.
Specify estimated hours for all tasks (activities).
Make sure all resources involved in the project have their internal rates specified.
Add the budget for all activities that have a previous demonstrated history of potentially exceeding estimated costs.
Set aside an additional budget for unexpected expenses and force majeure.
Calculate Estimate at Completion (EAC) Project Cost:
Labor Cost ($7,000) + Additional Project Budget ($1,000) = $8,000.
Calculate Project Flat Fee based the desired 30% Profit Margin.
Project Fee = Project Cost ($8,000) + 30% = $10,400.
Setup agreed upon payment schedule, i.e., 25% prepayment, 20% when the initial platform configuration is done, 35% when the training is completed, 20% when User Acceptance Testing is completed.
Make sure your team tracks their time.

Metrics to track:

For high-risk activities, monitor and compare their Activity Actual cost with Activity Budget.
Compare Actual Project Cost, EAC Cost and Estimated to Complete (ETC) Cost with the overall Project Budget.
Record and track all received payments.
Monitor project profitability.

3. Managing the budget for Time and Materials contracts with a profit margin goal

Scenario: A time and material contract has been signed for an IT Support project. An in-house team, as well as 3rd-party contractors, will be involved. Different billing rates and fixed billing amounts need to be applied based on the type of activity performed.

Financial needs:

Set different billing rates based on the type of activity performed (hourly or fixed cost).
Add a 15% billing markup for all jobs performed by vendors and contractors.
Monitor overall internal project costs and maintain a 30% profit margin.
Monitor billable hours compared to total available hours to maintain at least 75% Utilization rate.
Bill customer monthly.

Initial Setup:

Create a detailed project plan.
Assign employees to each task.
Specify estimated hours for all tasks (activities).
Make sure all resources involved in the project have their internal rates specified.
Set Project Billing Type as “Time and Material” and choose “Activity Rate” as a billing preference.
Specify hourly billing rates for activities that should be billed based on time (both for internal team and 3rd-party contractors).
For all fixed cost activities performed by 3rd parties:
- Add them as actual non-billable expenses.
- Add them as fixed-fee activity billing costs with an extra 15% markup.
Add all labor-based payments to 3rd parties as non-billable expenses as well.
Set a 30% Profit Margin as a target to track.

Metrics to track:

Compare Actual Project Cost, EAC Cost, and Estimated to Complete (ETC) Cost with the overall Project Billing.
Record and track all time logs and expenses.
Monitor project profitability.
Compare Billable and Non-Billable Time Entries to monitor Utilization Rate.
Run monthly billing reports to charge the customer for all unbilled activities.

4. Managing the budget for Time & Material contracts with rate cards

Scenario: A time and material contract has been signed for an engineering project. Billing will be based on the role a person has in the project.

Financial needs:

Set different billing rates based on the role, skills, and seniority of each team member.
Set a target revenue of $250,000 and a target profit amount of $50,000.
Monitor overall internal project costs.
Bill customer monthly.

Initial Setup:

Create a detailed project plan.
Assign employees to each task and assign them the appropriate role in this project.
Specify estimated hours for all tasks (activities).
Make sure all resources involved in the project have their internal rates specified.
Set Project Billing Type as “Time and Material” and choose “Rate Cards” as a billing preference.
Specify Rate Cards for this project.
Set a $250,000 revenue target and a $50,000 profit target.

Metrics to track:

Compare Actual Project Cost and Actual Billing to track real-time project profit, and EAC Cost vs. EAC Billing to track expected profit.
Record and track all time logs and expenses.
Monitor project total billing (revenue) and profitability.
Run monthly billing reports to charge the customer for all unbilled activities.

FAQs:

Why is a project budget important?

A project budget provides a financial framework for the project, guiding spending and ensuring the project is completed within its financial constraints.

How often should I review my project budget?

Review your budget regularly, at least once a month, or more frequently for fast-paced or critical projects.

What do I do if my project is going over budget?

Identify the causes of the overrun, assess the impact, and explore options such as reallocating resources, adjusting project scope, or securing additional funds.

Can project management software with a budgeting module be useful?

Project management software equipped with a budgeting feature can significantly increase precision in budget forecasts, simplify monitoring, and boost the efficiency of reporting, thereby enhancing the overall management of budgets.

Project financial metrics Appendix: project finances formulas