Cost contingency is an amount that is included in a budget to represent uncertainty. Projects and operational functions commonly run into unexpected expenses. This is so common that unexpected costs can be expected. As such, including a cost contingency in a budget is a standard practice in many industries. The following are commonly considered factors when calculating a cost contingency.
Minor CostsEstimates may include major tasks and costs but not consider minor costs and incidental expenses that typically occur. These may be included in cost contingency.
EstimatesCost contingency typically reflects the confidence you have in estimates. If you have used a robust method such as reference class forecasting to develop estimates you may be able to keep cost contingency low. Alternatively, if estimates are based on the opinion of experts who may be new to certain elements of your project, a higher contingency may be warranted.
RisksOne of the primary uses of contingency budget is to handle risks that occur and become issues. As such, risks that you have identified in the context of a project can be useful for considering the size of cost contingency. This being said, it is common to exclude the costs of major risks from cost contingency. Some risks might be reasonably be expected to be handled within budget. Others, such as a major failure might reasonably require reevaluation of your budget.
Cost Escalation & Exchange RatesPlanning for cost escalation and exchange rate fluctuations belongs with risk management as these risks can be transferred, avoided and mitigated. Minor fluctuations in prices and exchange rates might be reasonably expected to be covered by cost contingency.
This is the complete list of articles we have written about financial management.
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