What it means
A project differs from ordinary operations in that it is temporary and produces something specific, such as a new warehouse, a system migration or a product launch. That temporary nature is what creates the financial risk: budgets are set from estimates made when the least is known, and the money is committed long before anyone can verify the estimate.
The core financial tools are a baseline budget, a phased spend profile and a contingency allowance. The baseline is what the project was approved to cost, the phasing shows when the cash goes out, and the contingency is an explicit sum set aside for known unknowns rather than a hidden cushion inside each line.
Progress is tracked by comparing what has been spent with what has been achieved, not just with what was planned. This is the logic behind earned value, which values completed work at budget rates and compares it against actual cost, giving an early warning that raw spend against budget cannot provide.
Accounting treatment depends on what the project creates. Costs that build a long lived asset are usually capitalised and depreciated over its life, while costs of reorganising a process or training staff are expensed as incurred, and the split has a direct effect on reported profit.
The most common failure is scope drift rather than poor cost control. Each individual addition looks small and reasonable, but a series of them can add a fifth to the budget without any single decision ever being made to spend more.
In practice
Real-world examples.
Example
A manufacturer running a $4,000,000 plant upgrade reports monthly on spend, earned value and forecast outturn. A cost performance index of 0.92 in month three prompts a redesign of the installation sequence long before the overrun becomes unavoidable.
Example
A bank capitalises $2,600,000 of a core system replacement as an intangible asset while expensing $700,000 of staff training and change management. The chief financial officer explains at the results meeting why cash spent on the project exceeds the cost shown in the profit and loss account.
Example
A charity delivering a grant funded building project must report spend against each funder's phasing schedule. Its project manager keeps a separate contingency line of $150,000 so that variations can be approved without renegotiating the grant.
Think of it
“Project management is organizing and controlling work to deliver specific results on time and budget.
Formula
Calculation
Cost performance index = earned value / actual cost, where earned value = budget x percentage of work completed
Estimate at completion = total budget / cost performance index
A retailer approves a store fit out with a budget of $800,000. At the review point the work is assessed as 50% complete, so earned value = $800,000 x 0.50 = $400,000, while actual cost to date is $500,000.
The cost performance index is $400,000 / $500,000 = 0.80, meaning the project is getting 80 cents of value for every dollar spent. Projecting that rate forward, the estimate at completion is $800,000 / 0.80 = $1,000,000, an overrun of $1,000,000 - $800,000 = $200,000. If the plan said the work should have been 60% complete by now, planned value is $800,000 x 0.60 = $480,000 and the schedule performance index is $400,000 / $480,000 = 0.83, so the project is running late as well as over cost.Case study
Seen in the real world.
The following is an illustrative, fictional example. Ravensfield Logistics, an invented parcel firm, approved a $3,000,000 depot automation project with a twelve month timeline. Monthly reporting consisted of a single figure, cash spent to date against cash budgeted to date, and for eight months the two lines tracked each other closely.
In month nine the fictional project sponsor asked how much of the work was actually finished and learned it was closer to 55% than the 75% implied by the spend. Recalculating on an earned value basis gave a cost performance index of $1,650,000 / $2,250,000 = 0.73 and a forecast outturn of about $4,100,000, well beyond the approved budget.
Ravensfield paused the project, cut two scope items that had been added informally during the year and renegotiated the installation contract. The revised outturn came in at $3,400,000, and in this illustrative story the board's main change afterwards was to require a physical progress assessment alongside every spend report.
Watch out
Common mistakes.
- Judging a project by spend against budget alone, which tells you nothing about how much of the work has actually been completed.
- Hiding contingency inside individual cost lines instead of holding it as a visible, separately controlled sum.
- Approving small scope additions one at a time without recosting the whole project, so the budget is exceeded by accumulation rather than by decision.
Questions
People also ask.
Should project costs be capitalised or expensed?
Costs that create a long lived asset are generally capitalised, while training, reorganisation and general overhead are expensed as they arise.
How much contingency is sensible?
It depends on how novel the work is, though allowances of roughly 5% to 15% of the baseline budget are common for reasonably well understood projects.
What is the single most useful early warning sign?
A gap between the percentage of budget spent and the percentage of work genuinely completed, which is exactly what the cost performance index measures.
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