How Cost Contingency is Calculated?

By Shohreh Ghorbani, M.Eng., PMP - Director, Project Control Academy

Imagine that you are asked to estimate the total cost of a project. You have measured the quantities and estimated the cost and price of each resource required for executing the scope of the project. After all the hard work that you have put into developing the cost estimate, you are asked how confident you are in the estimate? What is the probability of achieving this cost at the end of the project? Have you considered risks and uncertainties on the project?

What would be your answer?

Well, to account for cost uncertainty and to guarantee that the budget is not exceeded at a certain confidence level, a reserve fund needs to be added to your base cost estimate. This reserve amount, known as the contingency, is an estimated amount added to the project base estimate to cover the known-unknown risks in the project and to prevent cost overrun.

But how the Cost Contingency Reserve, the cost of known-unknown risks, is estimated?

How to Calculate the Cost Contingency Amount?

There are several different ways to quantify the uncertainties and measure the contingency reserve in a cost estimate. In fact, in the past two decades, many practitioners and researchers have come up with different methods of calculating cost contingency. These methods range from simply applying a predetermined percentage of total project cost to considering complex mathematical and statistical methods.

In this post, I am not going to cover all contingency calculation methods out there. My focus is only on the most common methods for calculating contingency.

The calculation of cost contingency is either based on “deterministic methods” or “probabilistic methods”.

Deterministic Methods

In practice, the deterministic methods are the simplest and most common methods for establishing the cost contingency reserve fund. The term “deterministic” implies that the cost contingency is determined as a single point estimate, typically as a percentage of the base cost estimate.

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Tags: Financieelmanagement
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