Cost Overrun:

When cost underestimation results in an unexpected increased cost of a project, the cost increase is termed as 'Cost Overrun' or 'Budget Overrun'.

 'Cost escalation' is different from cost overrun as cost escalation is used to express anticipated cost growth due to inflation or such other factors.

Cost Overrun is a common phenomenon, especially in infra-structure projects, buildings, technology and other projects of similar nature.

There are a number of examples in almost every country, where cost overrun had taken place. Quite a few projects had cost overrun many times their projected budgets.

Commonly three types of explanations exist for cost overrun. These are –

• Technical
• Psychological
• Political economics.

Technical Reason: Due to imperfect forecasting techniques, data inadequacy, etc.

Psychological Reason: The budget forecasters are optimistically biased, thus accounting for cost overrun.

Political-economics Reason: When there is a strategy misrepresentation of scope and/or budgets, this could lead to cost overrun.

The above causes or reasons are a kind of risk in budgeting. Therefore, a project should always provide for “cost contingency” fuds to cover the risk or cost overrun.

Improper or poor “risk analysis” and contingency estimation account for cost overrun of many projects.

The one main reason for cost overrun was poorly defined scope when the project budget was fixed.

But with new technologies, it is possible to establish the likely `cost overrun` by rating the scope of the project even for complex projects.

Cost overrun is typically calculated either as a 1) percentage, and/or 2) ratio.

Percentage: Actual cost minus budgeted cost in percent of budgeted cost.

Ratio: Actual cost divided by budgeted cost.

If the budget cost for a project is $200 millions and the actual cost is $300 millions, then the cost overrun is expressed as 50%, or by the ratio 1.5.

“Reference Class Forecasting” method has been developed to reduce or eliminate cost overrun.