Before approving the budget, it is necessary to include additional costs that may arise due to any unforeseen circumstances. Unforeseen expenses are additional funds that provide the ability to perform various tasks that may cost more than planned or even be unplanned. For example, unforeseen costs will arise if the costs were estimated too low, if the delivery costs exceed the expected ones, and if the task takes longer.
Also, unforeseen expenses mean expenses that are not directly related to the production and sale of goods, including penalties, fines, penalties for violation of transportation rules, failure to fulfill delivery obligations, production of low-quality goods, compensation for losses incurred by consumers of low-quality products, untimely payment for supplies and so on.
Contingency calculation methods
Creating a reserve of financial resources to cover unforeseen costs is a way of dealing with risks, which involves assessing the relationship between the potential risk affecting the final cost of the project and the amount of expenses that are necessary to overcome possible failures in the implementation of the project. The main problem in the process of creating a reserve is the correct assessment of the potential consequences of risks.
Contingencies can be calculated in several ways. For example, one of the methods is to assume that the costs that were included in the enterprise budget are the most likely. Then, a mechanical method for calculating unforeseen costs for each of the tasks is used. For this, a simple formula is used: 1 - (optimal costs / maximum costs) x optimal costs. The adjusted amount of unforeseen expenses is obtained taking into account the estimated costs and the most probable costs. This value is equal to the difference between optimal costs and maximum costs in the worst case scenario.
The big difference between optimal costs and maximum costs in the worst case scenario entails the highest unforeseen expenses. On the contrary, if the difference between these values is insignificant, then the unforeseen costs will be less.
The main problem when using this calculation method is that it depends on the use of the optimal cost estimate. In fact, the use of this estimate is appropriate only when it was based on the most probable, close to optimal or optimal variant.
Project managers often use the worst-case indicators when they believe that the tasks assigned are associated with high risks. Then unforeseen expenses should be calculated by other methods.
An alternative method of calculation, by which you can estimate other costs, including unforeseen, is to add a reserve of 10 percent in excess of the budget amount required for the implementation of the project.
After the implementation of the project, for which a reserve has been allocated, you can compare the actual and planned distribution of costs. Based on the data you can identify trends in the use of the allocated amount. The unused part can again be returned to the reserve for the implementation of another project. It is important to note that all sections of the use of the reserve must be registered, as well as periodically prepare reports on them along with other information on the cost of the project.