Contingency Cost in Construction.
To carry out a project, one has to be very careful in the analysis of risk management.
Risks exist and happen in each project.
Types of project risks
The risks are grouped as follows:
Identified risk
Even if the magnitude of the impact is not exactly known.
In such cases, the impact of the risks is mitigated by the contingency reserve (CR)
Unidentified risk
Such risks shall be addressed by the management reserve (MR)
As we can see, the contingency reserve and the management reserve are not the same.
The contingency reserve covers identified risks and forms part of the cost base, while the management reserve covers unidentified risks and is part of the budget.
Contingency Calculation in Construction Projects
The amount of money, or time, can be estimated in a number of ways, and often only considers negative risks.
Calculations should take into account the likelihood of risks occurring, the financial magnitude of their impacts, and the cost of alternatives.
Project leaders and their teams analyze and define the cash or time reserves to be taken into account to cover these eventualities.
The contingency reserve is included in the cost baseline, i.e. Base cost = project cost estimate + contingency reserve
How to Calculate Contingency Cost?
Typically, we add a contingency reserve to a budget where there is some statistical certainty that unpredictable individual costs will be incurred.
The amount of funds or time intervals allotted for each contingency is a value that balances the accepted risk.
On the case of a project, the need for a contingency reserve is based, for example, on the probability of occurrence and the impact of one or more of the following events:
Work is being done in an area of volatile weather conditions
The bidder shall cover contingencies when the project is affected by the probability of occurrence and impact of:
Extreme temperatures.
Prolonged heavy rainfall.
Possible flooding.
Frequent winds, etc.
Potential labor conflicts
In some regions, trade unions are highly radicalized and this situation increases the possibility of strikes and changes in labor regulations.
The project will operate in a country with poor economic stability
Some nations have very unstable economic and political situations.
This causes, for example, changes in the market resulting from frequent and unanticipated increases in prices and interest rates.
The Bidder must protect itself from this situation by considering the likelihood of occurrence and the impact of this event.
Tight timelines to carry out a project and high penalties for non-compliance
If the project to be quoted is:
A short delivery period and severe penalties in case of non-compliance.
The tenderer shall protect himself against possible losses.
The designs are not entirely defined in the tender documents
This condition creates uncertainty and, as a result, the need to cover this eventuality.
Long-term projects
In the case of long-term projects to be implemented in inflationary countries, the client regulates the amount of certifications with a polynomial adjustment formula for cost changes.
The above formula must be analyzed by bidders and, where necessary, protected for cost increases not contemplated in the formula.
In conclusion, this part describes what needs to be assessed to quantify contingency reserves.
The Management Reserve
The management reserve is the reserve added to the overall project by senior management to cover unidentified or uncertain events.
These risks are not identified as part of the risk management process.
The management reserve is not included in the cost baseline, i.e.:
The project budget = the cost baseline + the management reserve.
The reserve is maintained until the end of the project.
Example
The supplier of a basic material for the project closes unexpectedly due to economic problems and it is necessary to look for another supplier of that material that meets the requirements of the Technical Specifications of the Bid.
In this case, the project manager must report the even to senior management to use the Management Reserve to solve this unforeseen event.
See the following article for instructions on calculating the profit margin for a construction project.
Contingency Cost in Construction – Calculate Man Hours