What is cost overrun and how to prevent it? In project planning, everything depends on accuracy. Considering that about 28% of projects fail due to incorrect cost estimates, it’s clear that your project plan deserves time and attention.
Inaccurate forecasts of costs, resources, benefits, and estimated duration can introduce project risks that affect your organization’s profitability and growth opportunities. For example, after spending nearly two years researching and developing Project AirPower — a wireless charging mat — Apple canceled the much-hyped project.
Lack of proper cost management, inefficient project design, and insufficient use of resources can lead to increased budget or even cancellation of projects. Let’s take a deeper look at cost overruns, the causes of project delays, and how to successfully complete projects while managing cost overruns.
What is cost overrun?
A cost overrun is an unexpected change in the project budget that results in an increase in the total project cost. This can happen for three main reasons:
- Economic factors that occur due to inaccuracy in the budget or scope of the project
- Technical reasons, including incorrect estimates or incorrect data collection
- Psychological causes, including the presence of scope creep or any reduction in project commitment levels
How to calculate cost overrun?
You can use this formula to quickly determine the additional costs of your project:
Here is an example:
$10,000 (actual costs) – $9,000 (budgeted amount) = 1,000
$1,000 / $9,000 (budget amount) = 0.11
0.1111 x 100 = 11.11% over budget
How to detect cost overruns
As all project managers know, projects rarely go according to plan. However, the best practice is to do everything you can to keep project costs within budget. That means spotting potential cost overruns before they become an untamable beast.
If you start a project without a detailed budget plan, this is the first warning sign that you will face cost overruns. Without an outline, you run the risk of unexpected costs and have no metrics to track the project’s actual costs.
Once you’re involved in the project, having an effective budget outline makes it easy to recognize excessive costs. For example, if you projected to spend $35,000 in the first month of a 6-month project, but found that your actual costs were $45,000, this is an early sign that you may run into cost overruns later on.
What are the signs of cost overruns?
Teams need to make sure they have a clear view of project progress to spot any signs of cost overruns as soon as they occur. Here are some ways to quickly spot potential cost overruns:
- Lack of detailed project budget plan
- Lack of contingency plan, which leads to unexpected costs getting out of control
- Failure to use tools to track project costs
- Imperfect use of resources
- Not tying costs to specific tasks or creating a work breakdown structure
- Failure to review similar past projects and historical data
- Not documenting project deliverables, leading to unexplained scope creep
Common reasons for cost overruns in projects
For projects to be successful, it is important to avoid cost overruns. Even with all the checks and balances in place, you can still go over budget.
Before we can understand how to control cost overruns, let’s take a closer look at the common causes of cost overruns in projects.
Incorrect project estimates
28% of projects fail due to wrong estimation. Inaccuracy in estimates can result from both underestimation and overestimation of costs.
Both are equally harmful and result from intentional or unintentional forecasting biases.
To ensure positive project outcomes, estimates must be data-driven and accurate.
Range creep
With a dynamic business environment and frequently changing business needs, scope creep is often unavoidable.
45% of projects experience scope creep, which is one of the most common cost overruns in project management. Using a comprehensive and accurate project tracking system can help monitor completed and pending tasks to control scope creep.
Lack of risk management
Every project manager creates plans in the hope that they will go as intended. Unfortunately, nothing is that simple.
Unforeseen internal or external factors can cause unexpected project delays or lead to cost overruns. Having a risk and change management strategy in place can help your team avoid any financial losses.
Communication gaps in teams
29% of projects fail due to unclear communication. Not having a simple line of communication between project managers and stakeholders can lead to avoidable delays.
Such delays can cause wasted effort, misdirection of resources, lost time, and costly project management.
Conclusion
Cost overrun occurs when the actual cost of a project exceeds the planned cost. This can happen for many reasons but is usually caused by incorrect estimates during the planning stages, delays, or changes in scope.
Check Also:
What is project budgeting and how is it done?
Definition of operating cost (OpEx) and capital cost (CapEx)
