Management Reserve (MR)

What is the Difference Between Budget and Funds?

By / / , , , , , , ,
, , , , , , ,

Quick Summary

  • A budget is a project management metric used to plan and measure performance, while funds are real dollars recorded in the accounting system and spent to perform the work.
  • Earned Value Management distinguishes planned values (e.g., BCWS, BCWP, BAC) from actual costs and estimates (e.g., ACWP, ETC, EAC) to provide insight into project performance and funding needs.
  • Contract funding profiles influence how budgets are time-phased, and regular EAC analysis is essential to forecast total funding requirements and avoid breaching funding limits. 

While working with numerous clients over the years, H&A earned value consultants frequently observe people using the term “money.” Typically, they mean “funds” when they really mean “budget.” People often confuse the terms, even though they have been used within the project management community long before the advent of earned value management practices. 

The intention of this blog is to highlight the difference between “budget” and “funds” and promote a common understanding of the terms. Using the correct term helps to eliminate confusion and improve communication between project team members, management, and the customer. 

Examples of Budget and Funds Confusion

Here are a couple of common statements H&A earned value consultants have heard many times:

  • I am requesting management reserve (MR) to fund my overrun.
  • I underran my budget, so I am going to return funds to MR.

Why are these inaccurate statements? The people making them have confused the terms or may think that “budget” and “funds” mean the same thing. 

Explaining the Difference Between Budget and Funds

The simple definition is that “budget” is a project management metric, a planned value. It cannot be used as funds (i.e., money) to buy something tangible, such as a cup of coffee. “Funds” are real dollars. The purpose for budget is to measure project performance so that as funds are expended (the actual costs) to perform the authorized work, any difference, more or less than what was planned, can alert management.

The table below summarizes the differences between the two terms.

Budget Funds
Cannot be spent Money – real dollars being spent or forecasted to be spent. Funding represents the customer’s ability and commitment to pay. 
A number on a piece of paper, in a spreadsheet or database – it is a project management metric Actual costs recorded in the accounting system of record used for financial reporting
Budgeted Cost for Work Scheduled (BCWS)

  • Time phased budget for required resources to accomplish tasks scheduled in the integrated master schedule (IMS)
  • Forms the performance measurement baseline(PMB)
 Estimate to Complete (ETC)

  • Funding required to complete the remaining work, exclusive of prime contractor fee
  • ETC plus ACWP results in the Estimate at Completion (EAC)
Budgeted Cost for Work Performed (BCWP)

  • The budget value for completed work
 Actual Cost of Work Performed (ACWP)

  • The costs incurred and recorded to accomplish the work performed
Budget at Completion (BAC)

  • Budget representing all authorized scope of work (SOW)
  • Cannot change without a change to the SOW with appropriate approval
 Estimate at Completion (EAC)

  • Funding number representing all the money (at the cost level – does not include fee) that will be spent
  • Can change without a commensurate change in the SOW

An Overview of Budget Terms

It is often helpful to review the basis for determining and distributing a project’s total budget used for planning and measuring project performance, as illustrated in Figure 1. Note: this is a simplified discussion to highlight the budget terms and does not include nuances such as an Over Target Baseline (OTB) situation. 

Figure 1: Budget Distribution and Terms Illustrated

The budgeting process begins with the Contract Target Price (CTP). This is the total negotiated contract value. It includes the negotiated contract cost (NCC) plus the contractor’s planned (target) profit or fee. The Contract Budget Base (CBB) is the starting point for a contractor’s internal budgeting process outlined below. 

Budget Component Definition
Contract Budget Base (CBB)   Represents the financial authorization of the contract and is based on the negotiated contract cost (i.e., price less fee). The CBB is always equal to the negotiated cost for definitized work and the estimated cost for all authorized unpriced work (AUW), also known as Undefinitized Contact Action (UCA). The CBB equals the sum of distributed budgets, undistributed budget, and management reserve (MR). It also equals the sum of the performance measurement baseline (PMB) and MR.
Management Reserve (MR)   Amount of contract budget set aside to handle realized risks and emerging in-scope effort. This effort is in scope to the contract, but out of the scope of distributed and undistributed budget. 
Performance Measurement Baseline (PMB)  The PMB is the sum of all distributed direct and indirect budgets against which contract performance is measured. The PMB is the sum of the distributed budgets and undistributed budget. The PMB plus MR is equal to the CBB. 
Undistributed Budget (UB)  Budget for authorized work scope that has not yet been identified to a specific WBS element and/or responsible organization at or below the lowest level of reporting to the customer. 
Distributed Budgets   Distributed budgets may be comprised of summary level planning package (SLPP) and control account budgets.
Summary Level Planning Package (SLPP) Budgets  Budget may be set aside in SLPPs at the lowest WBS element until the future work effort can be defined in more detail. SLPPs have a high-level scope of work and are scheduled in the IMS with time-phased budgets. They are converted to one or more control accounts with subordinate work packages and planning packages as soon as possible. 
Control Account Budgets   Control accounts have a defined scope of work, scheduled start and finish dates, and time-phased budget that reflects the work decomposed to the work package or planning package level. The sum of the time-phased work package and planning package budgets equals the total control account budget. 
Work Package/Planning Package Budgets   Work packages and planning packages have a defined scope of work, scheduled start and finish date, and time-phased budget based on the parent control account. This lowest level of budget includes the element of cost detail (labor, material, subcontract, and other direct costs) and value detail (hours, units/quantities, direct costs, and indirect costs). 

Notes about Management Reserve

Remember that MR is a budget, is not a financial reserve (i.e., a source of funds). It is not time-phased and is not included in the PMB because there is no related work scope, although it is a part of the CBB. MR budget cannot be used to eliminate cost variances, cover cost overruns, or recover underruns. There is only one MR set aside for a project and the value is never negative.

MR is decreased to provide budget for realized risks or unplanned activities within the contract scope of work. It may be increased whenever the work scope is decreased along with the allocated budget (a contract modification). Customer authorized contract changes, including AUW, should be incorporated into the CBB and PMB as soon as possible; this may include MR budget set aside for added work scope. Only contract changes authorized by the customer’s designated contracting officer may change the CBB value. 

For more discussion on MR, see this blog: Management Reserve Best Practice Tips. Also see this article: The Difference Between Undistributed Budget and Management Reserve. 

Additional note. The MR budget belongs to the contractor’s program manager, not the government customer. MR is not a cost reserve (contingency) for the government customer and may neither be eliminated from contract prices by the customer during subsequent negotiations nor used to absorb the cost of contract changes. For the government customer, contingency is the cost reserve they own, typically associated with a Program Risk-Adjusted Budget (PRB). It is held outside of the project scope, schedule, and budget already provided to the contractor. Reserves held above the program permit senior government management to balance resources within portfolios and among programs. The government customer’s cost reserve could be used to modify the contract to include additional work scope (increases the contractor’s CBB) or provide the funds needed to cover a contract cost overrun. 

Budget, Estimates, and Funding Profiles

Contract funding also influences how the PMB budget is allocated and time-phased. The budget distributions are a result of the project planning process (scope of work definition, detailed schedule development, initial cost estimates), MR set aside (risk and opportunity planning), and the funding profile. This is an iterative process to develop the baseline schedule and time-phased budget plan. The budget distributed to the control accounts and any SLPPs is compared to the total PMB/UB value. As needed, adjustments to activities, sequence of work, or resource assignments are made to ensure the overall budget plan reflects the budget limit for the PMB and the contract’s funding profile. For a real-world example of this, see this blog, Understanding the ALAP Scheduling Option in Practical Terms, where a front-loaded schedule was exceeding the funding cap, and how a H&A scheduling consultant helped resolve the issue.  

Preparing an EAC every reporting cycle provides an accurate projection of cost at contract completion for internal and external management. It also represents the estimate of total funds required for the contract. The most likely EAC should be within the funding constraints for the contract. Any amounts expended in excess of the contract funding limit puts the contractor at risk. The contractor must notify the customer when their EAC analysis determines there is a potential to breach a funding constraint to address any contract funding issues as quickly as possible. 

Figure 2 illustrates a funding profile along with the range of project EACs. In this figure, the most likely EAC is within the contract funding limit.

Figure 2: Management Level EACs with Funding Profile

Reinforcing a Commitment to EVMS Excellence

A common theme of the H&A blogs and articles is helping clients to achieve and maintain a commitment to a high level of excellence in all EVMS process areas. An important part of this is continuous EVM training and project scheduling training, whether for beginners or advanced practitioners. This includes targeted training when clients identify an area where project personnel could use a refresher, more hands-on training, or mentoring. Examples include basic and advanced EVMS workshops, Completing Variance Analysis Reports, Developing an ETC and EAC, as well as short, targeted courses on topics such as Budget versus Funds. Give us a call today at (714) 685-1730 to get started.

What is the Difference Between Budget and Funds? Read Post »

Management Reserve Best Practice Tips

By / / , , , , , ,
, , , , , ,

A recurring theme H&A earned value consultants find themselves discussing with clients is emphasizing that management reserve (MR) is a very precious budget set aside that must be protected and used appropriately. Unfortunately, MR is often used inappropriately, and quickly depleted in the early stages of a project.

What happens when MR is consumed for other uses than what it was intended? There is no budget available for appropriate uses of MR such as for emerging work, rework, redesign, or make/buy adjustments within the scope of the contract when it is needed in the latter stages of a project. When that happens, a project manager is forced to create a “home” for actual costs for these activities. This results in other inadvisable actions such as:

  • Zero budget work packages which are also known as estimate to complete (ETC) only work packages.
  • De earning the budgeted cost for work performed (BCWP) and opening completed work packages to accept charges.
  • Culling budgets from future unopened work packages, and if they exist, planning packages, summary level planning packages (SLPP), and undistributed budget (UB).

These actions will call into question the integrity of the EVMS and EVM data. The customer conducting EVMS surveillance will also be quick to point out this deficiency in the EVMS implementation and raise the issue to ensure it has management’s attention to correct. The inappropriate use of MR has created a cascade of problems that could have been avoided. In some instances, project personnel were simply not following the rules for the use of MR found in the contractor’s EVM System Description. That’s an easier problem to resolve than other root causes.

The Role of Risk and Opportunity Management in Establishing MR

What H&A earned value consultants often uncover as the root cause of inappropriate uses of MR was that a robust risk and opportunity (R&O) management process would have made a difference in establishing a quantified set aside for MR to handle realized risks. Proactively identifying and managing risks improves project performance. The expectation of specific risks occurring leads to risk handling plans that lower the likelihood and impact of risks. It also provides an informed basis to establish an adequate amount of MR that reflects identified and assessed risks.

The risk assessment provides additional information that assists a project manager’s decision making process to validate a request to use MR is appropriate and has the backup data needed to justify the use of MR and the amount of MR allocated. This detail is necessary for the baseline change request (BCR) approval process as well as the Integrated Program Management Report (IPMR) Format 5 or Integrated Program Management Data and Analysis Report (IPMDAR) Performance Narrative Report (PNR). A project manager is required to identify the changes to MR during the reporting period and provide a brief explanation of the change. This explanation has the potential to pique the interest of the customer to gain a better understanding of why MR was used and the potential impact to the integrity of the EVM data.

Note: MR may increase or decrease for a variety of reasons. The primary use of MR is to handle realized risks within a control account that is within the statement of work (SOW) for the contract. All MR debits or credits should be tracked in a log for full traceability for the entire life of the project. Remember that MR can never be a negative value.

Acceptable Uses of MR

As highlighted in an H&A article titled “The Effective Use of Management Reserve,” examples of the appropriate uses of MR include:

  • Newly identified work is authorized and assigned to a control account manager (CAM). It may be that once the work begins, one or more tasks that were missed in the original planning process now need to be scheduled and resource loaded. Newly identified work could also be the result of internal replanning that required a change in approach or resource requirements.

    An example of this could be a project manager issued a work authorization to a CAM to conduct three tests to meet the requirements in the contract SOW. In the middle of the first test, it becomes clear to the CAM and project manager that a fourth test will be necessary. The project manager and CAM should be aware of this potential risk and be prepared to implement their risk handling strategy as a result of the R&O management process. The CAM can quickly prepare a BCR that the project manager can immediately approve to allocate MR budget to complete the fourth test. 
  • It is necessary to redo a task. This may include unanticipated redesign, remake, or retest. Hopefully, the project’s risk register identified the potential risks associated with the original tasks and management was prepared for the realized risk. 
  • Make/buy adjustments.  This could result in an MR debit or credit. 
  • Statement of work transfers from one organization to another. This could result in an MR debit or credit. 

Inadvisable Uses of MR Commonly Allowed

Although it is often allowed in a contractor’s EVM System Description, it is inadvisable to use MR for direct and indirect rate changes in the future. Note: MR should never be used to make any rate adjustments (or any other adjustments) to historical budgeted cost for work scheduled (BCWS) or BCWP data.

A rate change is not a change to the SOW for a CAM. It is merely a change to the cost of that work. Cost variances that occur because of direct and/or indirect rate changes can easily be explained in a Variance Analysis Report (VAR). Ironically, this use of MR is typically treated as a one-way street. Contractors apply MR when the direct and/or indirect rates are going up in the future but do not return to MR when the rates are projected to go down.

When a contractor’s EVM System Description allows MR to be used for future direct and/or indirect rate changes, ideally, the likely rate changes are identified as a risk and quantified when the initial MR is established for a project. This requirement should be noted in the EVM System Description. That way the set aside for MR includes budget for corporate rate adjustments that are outside of the control of the project manager or CAM. 

Another example of a commonly allowed but inadvisable use of MR is to “true up” a purchase order that is in excess of the original budget at completion (BAC) for material, equipment, or purchased services. For example, a project manager issues a work authorization to a CAM that includes purchasing material, equipment, or services from a supplier. The CAM then reaches an agreement with a supplier with scope, schedule, and budget. If that agreement is greater or less than the BAC, MR should not be applied, nor should budget be returned to MR to make the BAC match the PO value. Assuming the scope does not change, then MR should not be used to wipe out a cost variance whether positive or negative. The cost variance can be easily explained and the EAC can be increased or decreased. This is another example where contractors are treating this as a one-way street; they apply MR when it goes up, but do not return to MR when it goes down. A contractor would not “true up” for internal work overruns/underruns so why “true-up” for material or services provided by a supplier? 

Best Practice Tips

The following is a short list of best practices H&A earned value consultants often recommend clients implement for managing MR.

  • The EVM System Description should clearly spell out what are appropriate and inappropriate uses of MR. It should also provide guidance to eliminate instances of the “one way street” debit from MR. If needed, provide supplemental procedures, decision trees, or other work instructions to help project personnel follow EVM best practices and preserve MR for handling realized risks which typically occur in latter stages of a project.
  • Ensure that the R&O management process is integrated with the EVMS and provides the necessary risk identification and assessment information for the project manager to establish a realistic MR set aside based on quantifiable information. Where applicable, ensure likely rate changes are captured as a potential risk to the project and considered when the initial MR for the project is established if they intend to use MR for rate changes in the future.
  • Conduct recurring training to reinforce the purpose for MR and the appropriate use of MR. A recommended approach is to discuss a variety of use cases with project personnel so they know how to handle various situations that may occur on a project. 

Have you noticed “creative” uses of MR that are contrary to EVM best practices? Hopefully, you identified those situations as part of your EVMS self-governance process and were able to quickly implement corrective actions before your customer pointed out the issue to you. H&A earned value consultants often assist clients with producing procedures or work instructions that clearly spell out how to use MR appropriately. We also offer a range of EVMS training to reinforce EVM best practices including the appropriate use of MR. Call us today to get started.

Management Reserve Best Practice Tips Read Post »

Who Owns Subcontractor Management Reserve (MR)?

By / / , , ,
, , ,
Who Owns Subcontractor Management Reserve?

Subcontractor, Prime Contractor… Customer?

There has long been discussion regarding who “owns” a subcontractor’s Management Reserve (MR).  Some believe that since the entire contract value was awarded by the prime contractor to the subcontractor, the MR belongs to the prime.  Unfortunately, they might have been influenced by some of their customers who believe a prime contractor’s MR belongs to the customer – even to an extreme in which the customers interject themselves in the prime contractor’s decision process in using their MR. So contractors might figure that if the customer is doing that to them, they should do the same to their subcontractors.

DCMA Cross Reference Checklist

They may try to justify this by pointing out that in the DCMA Cross Reference Checklist (CRC dated 22 March 2019) Guideline # 14 Sub-question b asks:  

“Is major subcontractor Management Reserve (MR) incorporated and traceable to the prime contractor’s EVMS?”

While this might sound to some as though it justifies the argument that the MR belongs to the prime, it really doesn’t.  The actual guideline 14 question is simply asking if the contractor implementing EVMS (in this case the subcontractor) simply does or does not “Identify management reserves and undistributed budget.”  Since the subcontractor is implementing their management system on their contract with the prime, the only requirement is that the subcontractor identifies a Management Reserve (MR) amount (which could be zero, by the way). If they do, then (strangely) subquestion b puts the onus on the prime contractor to reflect the subcontractor’s MR in their EVM system [i.e., strange because how would a subcontractor demonstrate to a review team that their MR is being reflected in the prime’s EVM System?]. This question would be more appropriate if the subcontractor was also the prime to a lower-tier subcontractor.

Reporting vs. Ownership

The above only addresses the reporting of a subcontractor’s MR, but what does the government documentation actually say about the “ownership” of the subcontractor’s MR?

Note: A point to remember in this entire discussion is that the Guidelines, the EVMIG, the Cross Reference Checklist (CRC), and the EVMSIG were written to apply to any contractor required to implement EVMS on a contract – whether they be a prime contractor to a government customer or a subcontractor to a prime contractor (their “customer”).

EVMSIG Chapter 3 Introduction

The EVMSIG Chapter 3 Introduction (pg. 17) says this about MR:

“An allowance is made for a portion of the CBB to be withheld outside of the PMB as Management Reserve (MR) for internal management control purposes. MR is intended to provide the contractor with a budget to manage risk within the established contract scope (Guideline 14).”

As this introductory paragraph points out, MR is established by the contractor (or the subcontractor) for their internal management control purposes to have budget to manage risk within the contract scope. There is no mention of customer involvement in the decision-making process.

Para 3.9 (Guideline 14), Intent of Guideline

A more definitive statement in the EVMSIG is: “Para 3.9 (Guideline 14), Intent of Guideline” in the second paragraph – bullets and underlines have been added for emphasis:

  • “MR belongs to the contractor Program Manager, not the Government,…” [ergo, NOT the prime in a prime/ sub relationship]
  • [It] “provides the contractor with a budget for unplanned activities within the current program scope. MR enables program management to respond to future unforeseen events within the work scope of the program by distributing budget to mitigate program risks.”
  • “To establish MR, the contractor’s program management sets aside budget based on the program’s risk management process and assessment.”
  • [MR] “is not a source of funding for additional work scope or the elimination of performance variances.”
  • “MR is not a contingency fund and may neither be eliminated from contract prices by the customer during subsequent negotiations nor used to absorb the cost of contract changes.” And finally,
  • “MR belonging to a major subcontractor must be incorporated into the prime contractor’s EVMS with traceability to the subcontractor’s reported MR.”

Subcontractor Reports

This last bullet specifically points out that the MR belongs to the subcontractor, and that it must be reflected in the prime’s EVMS as reported by the subcontractor.  Some choose to include a subcontractor’s MR in their own MR value; having it there, however, increases the risk of having the prime think they have more MR to use when, in fact, they do not.  The subcontractor’s MR is not the prime’s to use, so the prime would need a very good mechanism in place to keep the two MR amounts separated.  This needed segregation becomes more complicated if the prime has more than one subcontractor.  Regardless of where the contractor places the subcontractor MR, EVMS requires it to be traceable to the MR value the subcontractor reports.

A Contractor’s Control Mechanism

Management Reserve (MR) is something that is allowed to provide a contractor with flexibility in handling the unknowns on a contract.  It doesn’t matter if it is a prime contractor to a government customer or a lower-tier subcontractor to a higher level (or prime) contractor.  MR is a contractor’s control mechanism and should not be subjected to any level of customer involvement.  The guidelines and implementation/ interpretation documentation try to control improper uses of MR (e.g., covering performance variances, performing out of scope work, etc.), but customers – at all levels – should not interject themselves in a contractor’s decision-making process on the use of MR. Remember also, if customers involve themselves in that process, there is a risk that their perceived “direction” to the contractor could make them complicit in poor MR decisions.

Who Owns Subcontractor Management Reserve (MR)? Read Post »

Scroll to Top