What is Cost Overrun?

Characteristics

  • Cost overrun is generally prevalent in infrastructure, building, and IT projects, which see a lot of unexpected costs during the project completion phase.They are primarily because of three factors: political, psychological, and technicalIt is primarily due to a lack of financing, 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.read more 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.

You are free to use this image on you website, templates, etc., Please provide us with an attribution linkHow to Provide Attribution?Article Link to be HyperlinkedFor eg:Source: Cost Overrun (wallstreetmojo.com)

Types of Cost Overrun

#1 – Estimates

Cost regarding the business may be underestimated due to factors like personal bias and complicated procedures involved in completing 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 forecasts may prove wrong to calculate the perfect estimate. 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 the risk is the primary type 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 were 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.read more 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 applying 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 cost overruns.Businesses as a unit should plan proactively and include several scenarios leading to such overrun.The monthly or quarterly forecast is a must for considering the changes in the actuals compared to the budget and planning accordingly.The business should pay much attention during the project planning stages, as this serves as the base.The vendor’s capability to perform and deliver must be thoroughly checked at the time of vendor hire.The business should practice using modern scheduling tools and charts to control costs better.The project manager is required 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.

Causes

  • The unplanned cost: 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 incur 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 were 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 is sometimes a tough job. It 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 or inefficient management may lead to improper project planning 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 give rise to cost overruns as those activities beyond the completion deadline were not accounted for in the budget.

Prevention of Cost Overrun

#1 – Proper Planning

Planning serves as the 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. The project and business should obtain full knowledge about their capabilities and experience in the field 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 within the project’s original scope with minimum deviation from the plan.

#4 – Use of Project Planning Tool

To monitor and control the project, modern tools like the Gantt excel chartGantt Excel ChartGantt chart is a type of project manager chart that shows the start and completion time of a project, as well as the time it takes to complete each step. The representation in this chart is shown in bars on the horizontal axis.read more 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.

Conclusion

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 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, characteristics, and how to avoid along with causes and prevention. You can learn more about it from the following articles –

  • Objectives of Cost AccountingCost-Based PricingCost EstimateCost ControlBudgetary Slack