In my last article about project financial management, I wrote about contingency funds. Tolerance is different from contingency.
Let’s quickly recap the difference between contingency and tolerance: A contingency fund is money set aside at the start of a project to be used in case of need, for example, to offset unforeseen increases in costs.
A budget tolerance is a range within which you can spend without having to report back to your sponsor or ask for more money. It’s usually a small amount represented as a percentage. Tolerance is either calculated as a straight percentage of the core budget estimate or as a percentage of the core estimate plus the contingency fund. As you should assume the contingency will be spent, it’s better to agree a tolerance based on the latter.
Confusing?
It’s not really. If you use time tolerances on your project schedule, you will find that budget tolerances work in exactly the same way. Here’s an example.
If you have a budget of £80,000 with a tolerance of 10% and you complete the project for £85,000 you have still delivered within the parameters set by your sponsor. Ten per cent of £80k is £8k so you can bring the project in between £72k and £88k without going back to discuss the over or under spend with your sponsor.
A budget tolerance of 10% means you can deliver the project 10% over (or under) cost without having to get special permission to do so.
You might wonder why minus tolerances are important. If you can deliver the project for less money, surely that’s a good thing, right? Generally, yes it is. But it also means that your estimates and budget tracking were not very good. If your budget is £80k and you only spend £20k someone will start asking questions. And with good reason. It’s important to manage cash flow efficiently. Especially for small companies, having money tied up in projects is not a great use of their cash. It could be spent on other projects or other initiatives within the company.
So tying money up in project budgets that could be put to better use elsewhere is not good business practice and will cause significant issues in small organizations. If you believe your budget will not be spent within the tolerance levels, study why, double check and then raise a formal change to make your sponsor aware of the issue and adjust the budget according to your new calculations.
The main point of having tolerance is a way of minimising effort for the project stakeholders as you will not be bothering them with frequent change requests for tiny budget increases. Agree an appropriate tolerance and write it into the project documents. What is appropriate will depend on the size of the project, the size of the organization and its maturity with regard to projects.
The tolerance will not be ‘used’ until the end of the project but it will help you monitor performance and track how you are doing compared to your initial estimates. As soon as the project looks like it will fail to deliver inside the tolerances, you know you have a problem to address. Tolerances can be used like early warning systems: they give you a little bit of leeway but enable you to quickly tell how far you are from your targets if the project begins to stray off course.
The way to get tolerance set on your project is to agree it with your sponsor, and the easiest time to do this is during the project initiation phase.