September 19

What is the Management Reserve for Project Budgets?

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Have you ever had a budget crisis due to the lack of a management reserve? Unforeseen work comes knocking at your door. You look at your budget, but you don’t have the funds to handle this work.

What is the Management Reserve for Project Budgets?
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There is a better way to handle the unexpected. You can — assuming that your organization supports the concept of reserves — create a management reserve when estimating the cost of your project. Let’s dig a little deeper.

Why Reserves are Needed

During the course of a project, you and your project team identify risks which are referred to as known unknown risks. These risks are known — that is, they’ve been identified, but we don’t know the amount of rework that will be required if the risks occur.

We handle the known unknown risks by creating a contingency reserve using estimating techniques such as the Expected Monetary Value (EMV) Method. The contingency reserve is added to the project budget and is part of the cost baseline.

Cost Baseline = Cost Estimate + Contingency Reserve

Furthermore, project managers encounter unknown unknown risks. These risks have not been identified and we certainly don’t know the cost when these risks occur.  Here’s where the management reserve comes into play.

What is a Management Reserve?

The management reserve is the amount of the project budget reserved for unforeseen work that is within the scope of the project. The project manager adds the management reserve to the cost baseline resulting in the total project budget.

Project Budget = Cost Baseline + Management Reserve

Who Controls the Management Reserve?

The project manager does not have control of the management reserve. That’s why it’s called the “management” reserve. It’s controlled by management, most typically the project sponsor or senior management. The project manager cannot access or adjust the management reserve without approval from the sponsor.

How Do You Derive the Management Reserve?

A common method for deriving the management reserve is to add 5-10% of the cost baseline. The higher the uncertainty, the higher the percentage. Assuming the cost baseline is $100,000 and a 5% management reserve, the project manager would add $5,000 (i.e., $100,000 x 5%) to the $100,000 resulting in a total project budget of $105,000.

Putting It All Together

Cost Estimate: $93,000

Contingency Reserve: $7,000

Management Reserve: $5,000

Cost Baseline = Cost Estimate + Contigency Reserve

Cost Baseline = $93,000 + $7,000

Project Budget = Cost Baseline + Management Reserve

Project Budget = $100,000 + $5,000

When Should You Adjust the Management Reserve?

The Project Management Body of Knowledge (PMBOK) says that reserves may be used, reduced, or eliminated over time. Not everyone agrees with reducing unused reserves. Project managers should determine with the project sponsor whether management reserves will be reduced or eliminated during the project, how this will occur, and when. Include this information in your Cost Management Plan.

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