The Importance of Having A Contingency Plan

By Rob Jafek | Boomerang Capital

Contingency reserves are for everyone. A contingency reserve in budgeting for a building project refers to an additional allocation of funds designed to address unexpected costs and uncertainties. This reserve serves a critical purpose: to keep the project on track and enhance the likelihood of successful completion. If you are not very experienced, you should use a contingency reserve to accommodate your unknown unknowns. And if you are experienced, while you know what many of those unknowns are, you won’t know which specific ones will show up on this project - but you know they will come - so you should also be using a contingency reserve.

A few of the ‘knowns’ an experienced investor is familiar with include design changes, permitting expenses, unforeseen site conditions, weather delays, and fluctuations in material prices. In such situations, options for addressing budget shortfalls are limited and can lead to difficult decisions, such as cutting costs elsewhere or seeking additional financing. While these approaches can compromise project integrity and success, you can effectively mitigate these risks by establishing a contingency reserve from the outset.

Moreover, having a contingency reserve minimizes the potential for delays. Insufficient funds can halt a project, so setting aside resources for unforeseen issues helps maintain momentum.

Determining the appropriate amount for a contingency reserve involves several factors, including the complexity of the project, your level of experience, and the likelihood of unexpected variances. More complex projects typically warrant a larger reserve, as does a lack of experience. If certain expenses are highly probable, they should be included in the budget rather than classified as contingency. Avoid the temptation to oversimplify; accurately categorize likely events within your budget.

Once the groundwork for your budget is laid, calculating the contingency reserve is straightforward. While it can be beneficial to analyze specific line items for potential variance, a common approach is to apply a percentage—typically ranging from 5% to 20% of the overall budget, with 10% being standard. If your contingency reserve exceeds 20%, consider refining your budget details or reassessing potential variances.

If you are confident in your project management skills and experience, it remains prudent to establish a contingency reserve. This reserve can be returned to stakeholders at the project's conclusion, enhancing your overall financial return without the complications of seeking additional funds mid-project.

Bottom line, the contingency reserve is an essential element of effective project budgeting, ensuring that building projects are completed on time and within budget despite inherent uncertainties and they can help ease the stress around successfully completing your project.