Define project risk and contingency reserves
Differentiate between schedule and cost estimation to project risk
Evaluate how risk management affects project outcomes
Determine how cost estimates impacts project risks
Purpose: To understand how contingency reserves can impact the risk evaluation and cost estimation.
Determine how to evaluate a company�s contingency reserves
Recommend strategies on how companies need to apply risk techniques in order to have contingency
reserves.
Project Risk and Contingency Reserves
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Project Risk and Contingency Reserves
Project risk is the uncertain event or condition that, if it happens, results in a
negative or positive impact on the project objectives. Project risk is also the possibility that a
project will fail to meet its objectives and goals. Contingency reserves refer principally to the
amount of quantity of money or any other financial resource that should be allocated at and
above the formerly selected estimate amounts in order to mitigate the risks of overrun to a
suitable level for organizations which are financially responsible (Heagney, 2016). Also,
contingency reserves can mean the particular time quantity in human hours that should be
allocated beyond and above the formerly evaluated quantity of hours needed so that any overtime
or unanticipated work hours can be adequately compensated for. Generally, both contingency
reserves and project risks concerning time and finance are established at the initial stages of a
project (Heagney, 2016).
Schedule and Cost Estimation
A project schedule is used to show how long it will take to complete the project or
any other part of it as well as provide the basis for preparing resource and cost plans. A project
schedule is used to break down the tasks or activities of a project and assign durations and both
start and end time to ensure that project managers execute the project on time as well as ensure
accurate costing and resource commitment. Thus, project schedule provides the guidelines for
establishing a Gantt chart and flowchart used within the risk analysis of a project. Cost
estimation is the prediction of costs or prices of resources required by the scope of the project as
well as addressing risks and uncertainties. Cost estimation of a project provides inputs for
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budging, cost analysis, planning and project schedule and cost control processes (Kendrick,
2015).
Risk Management and Project Outcomes
Risk management in a project is the process of identifying, quantifying and
managing risks. Project management significantly affects the outcome of projects. For instance,
projects using new technology may face the prospect of technological failure in delivering the
expected outcomes, while highly complex projects tackle the challenges of accurately estimating
costs and time (Kendrick, 2015). Project managers try to identify and manage all risks associated
with a particular project in order to prevent project failure. Besides, risk management helps
project managers to factor in contingencies such as time and finance that will assist outline what
might happen during project execution and be prepared for future eventualities. Besides, known
risks allow project managers to include additional tasks within the project schedule to mitigate
them. Therefore, risk management is crucial because it helps achieve improved project benefits
and projects’ outcomes (Heagney, 2016). This is because it assists project managers to achieve
the success of the project with fewer obstacles as well as allows cost, time and resource savings.
Thus, it affects the outcomes of a project significantly.
Moreover, risk management helps to improve organizational reputation and
ensures that the organization is well prepared to tackle any trouble that affects the project
outcome. Hence, effective risk management increases the trustworthiness of the anticipated
benefits and project outcomes. Risk management can impact project outcomes, both negatively
and positively as it helps in dealing with uncertainty on a project. This is because risks can rise
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or underestimate costs, employee turnover, cause client dissatisfaction, delayed or inaccurate
material delivery, and technological disappointments.
Cost Estimates Impacts Project Risks
Cost estimates have significant impacts on project risks. Project managers rely on
project estimates to manage all expected risks. Risk management is the method of optimizing all
the consequences and probability of optimistic risk events or opportunities and mitigating all the
consequences and probability of pessimistic events to the objectives of the project (Pritchard &
PMP, 2014). Cost estimates impact project risks both favorably and unfavorably during the
derivation of a total project cost. Project cost estimates determine the level of risk analysis
regarding project location, size, and types of work involved. Cost estimates also determine the
policy of a project or cost risk and how detailed risk analysis can be performed. Cost estimates
establish the risk components to be used, levels or thresholds of risk tolerance to be used as well
as visibility and reporting requirements. Thus, cost estimates provide the opportunity to identify
risks that might affect the project and document their characteristics (Pritchard & PMP, 2014).
Cost Estimation and Contingency Reserves
As a project manager, it is vital to comprehend how contingency reserve impacts
all components of cost estimation and project outcomes. Project managers should set up an
effective method of cost estimation in order for stakeholders to continue supporting the
organization (Hammad, Abbasi & Ryan, 2016).
Evaluation of Contingency Reserves
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Contingency reserves are not random reserves, but well-estimated reserves based
on various risk management tools and techniques. Project managers control contingency reserves
of organizations. This is because contingency reserves are used to mitigate the risks that occur
during project execution. Various techniques are used to evaluate and calculated the contingency
reserve. Therefore, a project manager can calculate the contingency reserve using different
techniques which include decision tree analysis, Monte Carlo Simulation, expected monetary
value and a percentage of the project’s cost (Hammad, Abbasi & Ryan, 2016). Project managers
of small and medium-sized organizations use a percentage of the project’s cost to manage small
projects. This percentage helps to save resources and money and is usually between 3% and 10%
of the total cost depending on the perceived risks of the projects. Expected monetary value is a
geometric tool for quantifying risk and assists in evaluating the contingency reserves. Expected
monetary is applied in a medium to a high-cost project to establish the contingency reserve in
order to ensure that the project failure is completely minimized. Expected monetary value is
evaluated using the probability and impact of each event.
The decision tree analysis is a quantitative technique used to evaluate the project
risk and helps in selecting the best alternative from many available options. Decision tree
analysis helps to in determining numerous choices and the possibility of each happening and
their impacts. It also assists in evaluating the anticipated monetary value for every event in order
to choose the best choice. Monte Carlo simulation is used to give a variety of probable outcomes
and the probabilities for choices of actions. Therefore, these techniques help to get valuable
information in order to make an informed decision for allocating funds and resources to the
contingency reserve (Hammad, Abbasi & Ryan, 2016).
Recommended Strategies for Contingency Reserves
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The contingency reserve is vital in managing known risks as well as residual
risks. Project managers must be trained expertly because all backup plans use the contingency
reserve and identifying risks. Therefore, managers must evaluate contingency reserves properly
in order to manage identified risks and estimate figures that will ensure the complete execution
of a project. Project managers should have the authority over the contingency reserve and are
used as part of the performance measurement baseline. Thus, project managers must plan
effectively about risk identification and management and monetary identification. Besides,
project managers must carry out both qualitative and quantitative risk analysis as well as
communicate the risk to stakeholders and funders of the project. Also, project management must
incorporate technology aspect in order to ensure proper risk identification and mitigation as well
as monitoring and controlling all risks associated with the project.
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References
Hammad, M. W., Abbasi, A., & Ryan, M. J. (2016). Allocation and management of cost
contingency in projects. Journal of Management in Engineering, 32(6), 04016014.
Heagney, J. (2016). Fundamentals of project management. Amacom.
Kendrick, T. (2015). Identifying and managing project risk: essential tools for failure-proofing
your project. Amacom.
Pritchard, C. L., & PMP, P. R. (2014). Risk management: concepts and guidance. Auerbach
Publications.
