Contingency reserves and management reserves are two important concepts in project management that every project manager needs to understand. Both help you manage risks and uncertainties in projects, but they serve different purposes.
In this post, we’ll compare contingency reserves vs management reserves looking at their definitions, calculations, and when each type should be used. We’ll look at real examples of calculating and using contingency and management reserves for project budgets.
By the end, you’ll have a solid understanding of these two key project management tools so you can confidently apply them to risk planning in your own projects.
Whether you’re preparing for the PMP exam or just want to boost your project management skills, you’ll find this guide on reserves invaluable.
Difference Between Contingency Reserves and Management Reserves
Bottomline Upfront: The key distinction is that contingency reserves mitigate identified risks that were outlined during project risk planning and are included in the project baselines, while management reserves are kept as part of the budget to address unidentified risks and uncertainties that could emerge during project execution but are not included in the baselines.
What is a Reserve in Project Management?
A reserve is an amount of time or money allocated in the project management plan to mitigate risks and uncertainties. They provide a buffer against potential issues like delays or cost overruns.
Types of Reserves in Project Management
According to the PMBOK guide, there are two main types of reserves used in project management:
- Contingency Reserves: Used to manage known risks that have been identified and analyzed
- Management Reserves: Used to manage unknown risks that have not been identified
Contingency reserves are included in the cost and schedule baselines, while management reserves are not. However, both contingency and management reserves are included in the total project budget.
What are Contingency Reserves in Project Management?
Contingency reserves are provisions included in the project budget to account for identified risks that have active response strategies.
As defined in the PMBOK guide, contingency reserves provide a backup plan to address potential issues from known unknowns. They give the project manager a dedicated pool of time or money to execute the risk response if an identified risk event occurs.
Contingency reserves are quantitative, and calculated based on analysis of the project’s known risks and uncertainties. Common techniques for estimating contingency reserves include decision tree analysis, simulation, and expected monetary value (EMV) calculations.
Since contingency reserves relate to defined risks, they are included in the cost and schedule baselines for tracking performance and the project manager controls these reserves to execute contingency plans as needed.
Importance of Contingency Reserves in Project Management
Contingency reserves play a critical role in controlling project risks and meeting objectives. Here are some of the key benefits:
Mitigate Known Risks
Contingency reserves allow you to proactively address identified risks that occur. Having backup plans and funds improves your ability to respond quickly and minimize impacts.
Absorb Unplanned Changes
Even with careful planning, unforeseen events can happen. Contingency reserves give you a buffer to absorb unexpected changes without immediately disrupting budgets or schedules.
Improve Cost and Schedule Accuracy
By accounting for known risks in the project baseline, contingency reserves help provide more realistic cost and schedule estimates as your forecasts will be based on quantitative risk analysis.
Enable Better Decision-Making
With clearly defined reserves linked to specific risks, you and your team can make better-informed decisions about risk responses and tradeoffs.
Demonstrate Effective Risk Management
Establishing appropriate contingency reserves shows your stakeholders you are actively managing uncertainties and have prepared contingency plans.
How to Calculate Contingency Reserves in Project Management
There are a few recommended techniques to quantify appropriate contingency reserves. These include:
Percentage of Total Cost
A simple approach is to set the contingency reserve as a percentage such as 3-10% of the total estimated project costs. The specific percentage should be based on the overall risk level assessed for the project.
For example, projects with new technology or high complexity may warrant reserves at the higher end of the range.
Expected Monetary Value
The expected monetary value (EMV) method involves calculating the reserve as the sum of all identified risks’ probability of occurring multiplied by the impact cost if they do occur.
This provides a statistical forecast of the expected cost impacts from the known risks. Subject matter experts review the risk register to estimate the likelihood and cost impact of each identified risk. You can read more on how to use EMV here.
Monte Carlo Simulation
Monte Carlo simulation runs multiple iterations of the project cost or schedule estimates, using defined probability distributions for each identified risk’s likelihood and impact.
This generates data to determine the size of the contingency reserve needed to achieve a desired confidence level, such as 70-80% certainty of adhering to the estimate. You can read more on Monte Carlo Analysis here.
Decision Tree Analysis
A decision tree diagrams out risk event probabilities and costs to quantitatively calculate expected values for each branch or decision path. This allows a comparison of options to select the optimum approach.
Decision trees incorporate the concepts of EMV across multiple potential scenarios.
Expert Judgment
Leveraging historical data and soliciting input from subject matter experts can also provide valuable perspectives on appropriately sizing reserves, especially for unique or unprecedented projects.
The goal is to estimate a contingency reserve sufficient to reasonably cover likely impacts from identified risks while optimizing the use of contingency funds.
Reserve levels should be revisited throughout the project as new information becomes available and estimates are refined.
What are Management Reserves in Project Management?
Management reserves provide a budget to address unidentified risks and uncertainties.
As defined in the PMBOK guide, management reserves are held outside the performance measurement baseline to cover events that were not anticipated in planning. They are used for “unknown unknowns” rather than specific identified risks.
Since management reserves are for unplanned changes, they are not estimated quantitatively. The amount of management reserve is set based on organizational process policies, historical data, and overall project complexity.
Typically the project manager does not control management reserves. They must submit change requests and obtain executive approval to use management reserves. Access is more stringent since these reserves cover unforeseen events.
Importance of Management Reserves in Project Management
Management reserves provide critical benefits for managing project uncertainties:
Mitigate Unidentified Risks
Management reserves give the team a budget to address surprising events not covered by contingency reserves. This improves agility when risks emerge.
Enable Strategic Changes
Rather than scope changes, management reserves allow pivots to project strategy that optimize business value after work begins.
Account for Inherent Error
Project plans never perfectly predict the future. Thus management reserves account for inherent estimating errors and omissions in planning.
Demonstrate Risk Appetite
The funded management reserve amount indicates organizational readiness to absorb unplanned needs and reflects risk appetite.
Smooth Progress
Management reserves prevent small surprises from forcing immediate replanning or escalation for more funds which maintains momentum.
How to Calculate Management Reserves
Unlike contingency reserves, management reserves are not derived from quantitative risk analysis. Some techniques to estimate appropriate management reserve amounts include:
Percentage of Total Budget
A common approach is to set management reserves as a fixed percentage such as 5-10% of the total budget. The exact percentage depends on factors like project size, duration, experience, and technology familiarity.
Parametric Estimating
Using historical data, organizations can develop parametric models to predict management reserve needs based on project parameters like team size or contract value.
Expert Judgment
Subject matter experts familiar with the project scope and technology can provide input on likely unidentified risks to determine adequate reserves, often as a budget range.
Qualitative Analysis
The risk identification process, even without quantitative analysis, uncovers many insights to gauge unknowns and required buffers.
Organizational Policies
Management reserves are often set by predefined organizational formulas based on data from past projects. These policies typically balance risk tolerance and cost.
The goal is to determine a management reserve that allows reasonable flexibility without tying up excess funds or indicating a bias for risk-taking. Calculating management reserves is an art – the process may be subjective but should leverage data and experience.
Contingency Reserves vs Management Reserves: Feature Comparison
Though they serve complementary purposes, contingency reserves and management reserves have distinct characteristics:
- Risk Coverage: Contingency reserves mitigate identified risks from the risk register while management reserves address unidentified risks and general uncertainties.
- Estimation Approach: Contingency reserves are quantitatively calculated based on defined risks. Management reserves on the other hand use fixed formulas or expert judgment.
- Inclusion in Baselines: Contingency reserves are part of the cost and schedule baselines while management reserves are excluded from the baselines.
- Project Manager Control: Project managers can directly utilize contingency reserves. In contrast, management approval is required to use management reserves.
- Flexibility in Usage: Contingency reserves apply to prespecified risks from planning while management reserves have flexible usage for unplanned events.
- Risk Attitude: Contingency reserves indicate cautious mitigation of known uncertainties while management reserves represent a willingness to take on unknowns.
- Financial Accounting: Contingency reserves are expenses linked to deliverables while management reserves are discretionary holdings.
- Enterprise Oversight: Overall, contingency reserves are project-focused while management reserves facilitate executive direction.
When to Use Contingency Reserves vs Management Reserves in Project Management
Contingency reserves and management reserves are suited for different situations:
When to Use Contingency Reserves in Project Management
Contingency reserves should be utilized when:
- An identified risk event from the risk register occurs
- The risk mitigation response is enacted as planned
- Impacts emerge within the known risks’ projected range
Tapping contingency reserves indicates the risk management plan is working as expected. Reserve usage is linked to a specific risk response.
Contingency reserves may also be proactively applied based on leading indicators that a particular risk is imminent. Again, this aligns with predetermined responses.
When to Use Management Reserves in Project Management
Management reserves are appropriate when:
- An unforeseen issue emerges that was not identified previously
- A planned response proves inadequate, requiring an alternative solution
- Opportunities arise for new initiatives or scope changes
Management reserves provide flexibility to deal with the unexpected. Since unknowns can’t be defined in advance, management reserve decisions are reactive rather than prescripted.
Contingency Reserves vs Management Reserves Examples
For further clarity, let’s look at examples of both project management reserves.
Contingency Reserves Example
A project has a risk of delayed equipment delivery that would add 1 month of downtime. Historical data shows the risk likelihood is 60% with a $50,000 impact.
Using expected monetary value analysis, the contingency reserve for this risk is:
Risk probability * Impact = 60% * $50,000 = $30,000
If the delivery is delayed, the $30,000 reserve will be used to pay for alternate temporary equipment rental during the 1-month lag.
Since this risk and response were defined proactively in risk planning, the project manager can directly activate this contingency without escalation. The reserve usage is recorded and tracked.
This demonstrates the purpose of contingency reserves – to fund prescripted mitigation responses for identified risks when they occur to minimize impacts.
Management Reserves Example
Now let’s examine management reserves:
Halfway through a project, new regulations are enacted that require additional unplanned design work and could delay the timeline by 2 months.
Because this risk was unidentified, no contingency reserve was allocated for it. The project manager requests use of the 10% management reserve to hire contractors to assist with rework to avoid delays.
The steering committee approves $80,000 of the total $100,000 management reserve to facilitate the changes which enables the new work to be completed on time, preventing negative schedule impacts.
Unlike the contingency reserve, the management reserve usage required escalation and was not prescripted. The flexible buffer allowed the team to implement an unforeseen response to address surprises.
This illustrates the power of management reserves to proactively manage the unexpected using discretionary funding.
Contingency Reserves vs Management Reserves: PMP Tips
If you are a candidate for the PMP exam, an understanding of when and how to leverage contingency reserves and management reserves is important.
Here are some quick exam tips to keep in mind if you encounter questions on this topic:
- Know the definitions. Contingency reserves mitigate identified risks, and management reserves address unidentified risks
- Contingency reserves are quantitatively estimated, while management reserves use fixed formulas
- Contingency reserves are part of the cost/schedule baseline, and management reserves are not
- The project manager controls contingency reserves but needs approval to use management reserves
- Use contingency reserves for risks identified in the risk register in alignment with predefined responses
- Use management reserves for unforeseen issues requiring new responses beyond the risk plan
- Compare examples that demonstrate when each type of reserve is used
- Avoid using management reserves to cover cost overruns or unapproved scope changes
Mastering contingency and management reserves shows you grasp key aspects of risk management. On the PMP exam, read questions on project reserves carefully to determine which type is being referenced.
Conclusion
Whether you’re an experienced project manager or just starting your career, truly understanding contingency and management reserves is crucial.
Both reserves empower you to optimize the management of known risks and unidentified uncertainties. Applying these reserves at the right times enables you to deliver projects on time and within budget.
Mastering contingency and management reserves demonstrates you have the strategic skillset to actively control risks.
With the knowledge from this post, you are now well-equipped to leverage reserves to successfully manage project risks and drive results.
FAQs
What Happens to Unused Management Reserve?
Any management reserve that is not ultimately utilized is released back to the organization upon project completion. Since management reserves are set aside to address unplanned changes, if the funds are not needed they are returned.
The unused management reserve balance provides positive variance and cost savings for the project.
What Can Management Reserve be Used For?
Management reserves are used to handle unforeseen work that is outside the scope of the project.
These reserves cover unexpected costs arising from risks not accounted for in the project’s risk register, effectively allowing for adjustments without affecting the approved budget baseline.
Is Management Reserve Included in Cost Baseline?
No, the management reserve is not included in the cost baseline. The cost baseline encapsulates the approved budget for the project work, excluding management reserves.
These reserves are kept separate to address unforeseen changes or risks that are outside the scope of the original project plan.
Is Contingency Reserve Part of Budget?
Yes, the contingency reserve is included in the cost baseline budget for the project. Because contingency reserves are estimated based on quantitative risk analysis of identified risks, they are incorporated into the overall project budget to cover potential impacts from those known risks.
What Happens to Unused Contingency Reserves?
Unused contingency reserves typically revert back to the project’s budget or the organization’s fund. They could also be reallocated to other projects or set aside for future uncertainties.
The exact process is determined by the organization’s policies and project management guidelines.
Who Controls the Contingency Reserve?
The project manager has direct control over the contingency reserve and can authorize its usage without escalation when a related predefined risk response needs to be performed.
Since contingency reserves mitigate identified risks, the project manager is empowered to execute contingency plans as defined in the project risk management process.
Who Controls the Management Reserve?
The project manager does not directly control the management reserve. To utilize the management reserve, the project manager must submit a change request and obtain approval from the sponsor, PMO, or other governing executives.
Access to management reserves is typically more stringent than contingency reserves since they cover unplanned changes.
