What is Cost Overrun?
Cost overrun, also known as budget overrun, is the scenario when the cost of a project or business tends to increase than what was it budgeted for and can be due to the increase of cost due to improper budgeting or underestimation of the actual cost on account of some unforeseen scenarios which was not accounted for during the process of budgeting.
- Cost overrun is generally prevalent in infrastructure, building, and IT projects, which sees a lot of unexpected costs during its phase of project completion.
- They are primarily on account of three factors like political reasons, psychological reasons, and technical reasons.
- Primarily it is due to lack of financing, lack of coordination, unplanned cost, or project delays.
- It is always uncertain, and budgetingBudgetingBudgeting is a method used by businesses to make precise projections of revenues and expenditure for a future specific period of time while taking into account various internal and external factors prevailing at that time. for the same is not possible. It is deemed to happen when certain phases of a project or business tend to cross the actual budgeted cost.
- The measurement of cost overrun is different for different industries or companies.
Types of Cost Overrun
#1 – Estimates
Cost regarding the business may be underestimated due to factors like personal bias and complicated procedures involved in the completion of the task. We can use the reference class forecasting methodology to enhance the chances of deriving more accurate estimates. The problem is that the best of forecasts may prove wrong to calculate the perfect estimate, and thus keeping a contingency as a part of the budget is always a good practice to face adverse scenarios in the future.
#2 – Risk
Risk can be any scenario for which we cannot assign a probability. They cannot be predicted earlier and, at times, are not within the control of the business like natural calamity, which may delay the completion of a project or vendor performance, which may eventually hurt the business. A proper risk management plan may help the business mitigate the risk to some extent, but risk stands to be the primary type that is faced by every business or project.
#3 – Scope Creek
Scope creek is defined as occasions when unaccounted activities crop up in the project or business, which was not included in the budget or the actual cost. It can happen when the management goes on adding features to the project as and when it is evolved or required or in the cases when the project team gets too creative and begins the inclusion of undocumented activities. Project management and controls are primarily designed in such a way to prevent such scenarios by the constant reassessment of the budget.
#4 – Cost Escalation
Cost escalation is more related to economic factorsEconomic FactorsEconomic factors are external, environmental factors that influence business performance, such as interest rates, inflation, unemployment, and economic growth, among others. like inflation, which may include the rise in the price of a particular item over a period that was not accounted for in the initial budget.
How to Avoid Cost Overrun?
- Traditional techniques involve the application of project management tools like PRINCE, though results are not guaranteed.
- In the present-day scenario, more modern tools and applications like Agile are taking over traditional techniques to help businesses deal with a cost overrun.
- Business as a unit should plan proactively and include several scenarios which can lead to such overrun.
- The monthly or quarterly forecast is a must for taking into consideration the changes in the actuals as compared to budget and plan accordingly.
- The business should pay a lot of attention during the project planning stages, as this serves as the base.
- The vendor’s capability to perform and deliver needs to be thoroughly checked at the time of vendor hire.
- The business should make practice using modern scheduling tools and charts for better control of the cost.
- The project manager requires to monitor and control the project continually.
- Stakeholders of the project or the business should always be kept informed about the changing scenarios, so they are on the same page, and in this way, the business can utilize their knowledge.
- Fighting with scope creek is a must, and businesses must see they stay within the scope that was initially planned.
- Cost which is unplanned: Unforeseen scenarios may bring about a couple of activities that were not initially taken into the plan or budget. It can be due to technical, political, or psychological reasons.
- Communication Breakdown: A misunderstanding between two departments or people involved can bring about unnecessary costs.
- Change in Project Scope: The event, which leads to scope creek, is one of the prime reasons. Scope creek is defined as occasions when unaccounted activities crop up in the project or business, which was not included in the budget or the actual cost.
- Underestimation of Project Complexity: Certain phases of a project or business are so complex that proper budgeting of it is, at times, a tough job. This is more likely involved with large, expensive projects.
- Inadequate Financing: Financing serves as the backbone of every business or project. The capital shortage may eventually lead to cost overrun, where the project or the business may face a crunch in funding their common activities.
- Lack of Leadership Experience: A relatively inexperienced management or inefficient management may lead to improper planning of the project and inaccurate project budgeting. Thus over time, the project may fall victim to wrong budgeting and fall into a case of cost overrun.
- Absence of Contingency Plan: Business also suffers when there is no backup planning or a contingency plan for unavoidable scenarios. A backup plan is a must, especially for large scale projects as some deviations from the usual budgeted cost may cost millions.
- Project Delays: Delays in the project completion from its usual planned completion eventually gives rise to cost overrun as those activities which extend beyond the completion deadline were not accounted for in the budget.
Prevention of Cost Overrun
#1 – Proper Planning
Planning serves as the very base of every project or business, and the best way to prevent cost overrun is to plan it before the project gets executed. The more accurate the estimates are, the more are the chances that the project will stick to its budget.
#2 – Knowledge of Vendors
Vendors must be thoroughly assessed before they are hired. Full knowledge about their capabilities and experience in the field should be obtained by the project and business to avoid worst-case scenarios. Proper due diligence is needed before the relationship with the vendor is cemented.
#3 – Avoid Scope Creek
A lot of undue activities should find no place in the project, and business or project should stay in the original scope of the project with minimum deviation to the plan.
#4 – Use of Project Planning Tool
To monitor and control the project, the use of modern tools like the Gantt excel chart or project tracking template should be implemented so that the project manager is aware of every stage of the project and the chances of cost overrun.
This is an unavoidable scenario that is faced by every business or project, but how to minimize it or mitigate it depends a lot on the management or the project manager. A proactive approach can help the business to reduce the chances of cost overrun with proper planning and a thorough analysis of the estimates.
This article has been a guide to What is Cost Overrun & Meaning. Here we discuss the types of cost overrun, characteristic, and how to avoid along with causes and prevention. You can learn more about from the following articles –