Agile

What is cost overrun, and how can you prevent it?

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Wouldn’t it be fantastic if every project ran to schedule, under budget, and met stakeholders' expectations every time? While projects go awry all the time, good project managers are prepared to manage any eventualities — and great project managers put the work in ahead of time to mitigate risks before the project has even begun.

One issue every project manager will run into in their career is cost overrun. Let’s discuss what cost overrun is, why it happens, and how you can be a great project manager and prevent it from disrupting your projects.

What does cost overrun mean?

Cost overrun occurs when the actual cost of a project exceeds the project’s planned cost. This can happen for many reasons but is usually due to the creation of inaccurate estimations in the planning stages, delays, or changes to scope.

How do you calculate cost overrun?

You can use this formula to quickly determine your project overspend:

Here’s an example:

$10,000 (actual expenses) - $9,000 (budgeted amount) = 1,000
1,000 / $9,000 (budgeted amount) = 0.11
0.1111 x 100 = 11.11% over budget

How to identify cost overrun

As all project managers know, projects rarely go to plan. Even so, it’s still best practice to do everything you can to keep the project costs within budget. That means identifying potential cost overrun before it becomes an untameable beast.

If you’re beginning a project without a detailed budget outline to guide you, that’s the first warning sign that you’ll likely face cost overrun. Without an outline, you risk unexpected costs and will have no benchmark against which to track the project’s actual spending.

Once you’re in the throes of the project, having an effective budget outline will make it easy to identify when costs are overrunning. For example, if you anticipated spending $35k within the first month of a 6-month project, but you can see your actual costs are $45k, that’s an early indication that you may face cost overrun later.

What causes cost overrun?

There are several causes of cost overrun. Let’s look at some of the most common in more detail.

Poor project estimates

The first step to running a successful project is nailing the planning stage. That includes producing accurate time and spend estimates.

When budgeting for a project, guesswork isn’t good enough. Any proposed costs should be based on data, including sense-checked quotes from third parties and spending from similar past projects. Finger-in-the-air budgets will never be accurate and significantly increase your chances of facing cost overrun later down the road, whether because you’ve underestimated the cost or time needed for a key component or have missed something entirely.

Scope creep

34% of projects across industries are affected by scope creep. While in an ideal world, we’d only ever have to deliver what we were initially tasked with, in reality, projects need to be flexible. That can mean facilitating additional deliverables or needing to rework the entire project due to changes to the brief.

No risk management

Mistakes happen. Changes are required. People get sick, suppliers shut down, and software breaks. It’s impossible to plan for all eventualities but not taking risk into account during planning can mean expected delays, which ultimately lead to cost overrun. We wrote about managing project risk with a risk register here.

Ineffective communication and collaboration

Project delays tend to have a financial impact, and delays are often caused by poor communication. Breakdowns in communication can occur both within the team, such as when tasks aren’t effectively delegated or briefed, and if project managers don’t keep in frequent contact with stakeholders.

How can cost overrun be prevented?

Over a third of projects across all industries aren’t completed within budget. How can you avoid your projects experiencing the same fate?

Effective project planning

To ensure your project comes in under budget, set yourself up for success with effective project planning. This includes creating a solid project budget, which should cover everything you’ll need to complete your project, from salaries to research costs, travel expenses to contingency reserves.

In addition to creating your budget, it’s best practice to complete a risk assessment, project plan, and time estimates as required for your sprint planning.

Work with trusted third parties

Working with third parties is a necessity for many projects; whether you require a supplier to source materials on your behalf or outsource tasks you can’t complete in-house to a freelancer, it's important you’re confident in who you lean on for support.

Developing strong relationships with your vendors can mean they understand your business as well as you do, helping produce accurate and fair estimates. Communication is also likely to be easier than with a supplier with whom you’re still establishing your relationship.

However, there are benefits to trying new solutions or developing relationships with fresh talent. If you’re working with a third party for the first time, it pays to ensure they’re trustworthy. Do due diligence by sense checking quotes, running background checks, reviewing similar projects they’ve completed, and ensuring they have the capacity and ability to do what you need to the standard you require.

Nip scope creep in the bud

Scope creep is often due to poor planning that fails to take into account all eventualities or additional requests from end-users and stakeholders.

Not all scope creep is bad, but it can impact costs. The best way to prevent the project’s scope from creeping in the first place is to consider all eventualities during planning. When new requests are received, make sure to review how necessary these are as well as whether you have the budget and resources to allocate to them.

As dictated by the project management triangle, if the scope increases, the budget must too. It’s simply not possible to deliver more work, or different work, without either the budget flexing to cover the additional costs or the quality of the work suffering.

Utilize a project management tool & track project progress

A 2020 report by PMI showed that 32% of executive leaders considered choosing the right technologies to invest in as important to achieving success in the future.

Investing in the right project management tools helps you quickly and effectively track project progress and will highlight potential cost overrun before it becomes an issue. Project management tools can also support resourcing, finance reconciliation, and task delegation.

Champion clear communication

Always keep channels of communication open. This is especially important for remote teams or for when you’re working with several external parties or stakeholders.

Clear communication can be supported by project management tools. When all communication is tracked in one tool, including at a task level, it saves you the hassle of digging out conversations from old emails or instant messaging chains. Plus, it makes all project information accessible to the whole team. This level of transparency is key to preventing cost overrun.

How to limit the damage when cost overrun occurs

Despite your best efforts, you may still experience cost overrun. Don’t panic; here’s how to limit the damage.

Uncover the cause

Mistakes happen. What’s important is that we take accountability and show that we’re able to apply learnings in the future. Completing a retrospective review of the project can help identify the events that caused the project to overspend or why delays happened.

The cause of cost overrun can be as significant as massive oversight during planning or something as unavoidable as illness in the team. Completing a review that involves the whole project team will help you come to the right conclusion and encourage transparency between team members.

Manage stakeholders

If you need additional budget to complete the project, you need to be honest with stakeholders about what happened. While that doesn’t necessarily mean laying out every little occurrence that led to cost overrun, it does involve outlining the key reasons and what your plan is for recovering the project.

Engage with your team

After cost overrun, the whole team needs to pull together to complete the project. Take the time to work with your team to show them the revised plan, so they understand what needs to be done and what support they’ll get along the way. In these situations, it’s key that everyone is singing to the same tune, so prioritize communication.

Return to basics and best practices

If all else fails, return to basics. Working with best practices can include revisiting your scope and objectives, reconsidering who is responsible for managing risk, or introducing more rigorous quality assurance processes.

Keep on budget (and on track) with Forecast

Forecast is the project and resource management solution that helps project managers globally deliver their projects on time, to high standards, and within budget.

Having the right information to hand can go a long way to minimizing delays and allowing you to make informed decisions quickly. Forecast offers basic features, including task planning and time tracking, as well as AI-informed admin automation and Advanced Analytics that give you oversight of all your project data in one place.

Try Forecast out for yourself by signing up for a free trial below.

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