Risk management is the process of identifying and
proactively responding to project risks. Generally (but not always) you will
look for ways to eliminate risks or to minimize the impact of a risk if it
occurs.

However, what if you’re unsuccessful in preventing some
risks? In that case, the risk will actually occur and cause some type of
problem for your project. If the risk occurs, there may be some monetary impact
on your project.

A risk contingency budget can be established to prepare in
advance for the possibility that some risks will not be managed successfully.
The risk contingency budget will contain funds that can be tapped so that your
project doesn’t go over budget.

The question is–how do you know how much money to place
into the risk contingency budget account? You can use Expected Monetary Value
(EVM) as a technique to quantify the risk into budget terms.

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We will need two numbers for each risk:

P–probability
that the risk will occur.

I–the
impact to the project if the risk occurs. (This can be broken down
further into the cost impact and the schedule impact, but let’s just consider a
cost contingency budget for now.)

If you use this technique for all of your risks, you can ask
for a risk contingency budget to cover the impact to your project if one or
more of the risks occur. For example, let’s say that you have identified six risks
to your project, as follows:

Risk

P (Risk Probability)

I (Cost Impact)

Risk Contingency

A

.8

$10,000

$8,000

B

.3

$30,000

$9,000

C

.5

$8,000

$4,000

D

.10

$40,000

$4,000

E

.3

$20,000

$6,000

F

.25

$10,000

$2,500

Total

 

$118,000

$33,500

Based on the identification of these six risks, the
potential impact to your project is $118,000. However, you can’t ask for that
level of risk contingency budget. The only reason you would need that much
money is if every risk occurred. Remember that the objective of risk management
is to make sure that the risks do not impact your project. Therefore, you would
expect that you will be able to successfully manage most, if not all, of these
risks. The risk contingency budget should reflect the potential impact of the
risk as well as the likelihood that the risk will occur. This is reflected in
the last column.

Notice the total contingency request for this project is
$33,500, which could be added to your budget as risk contingency. If risk C and
F actually occurred, you would be able to tap the contingency budget for
relief. However, you see that if risk D actually occurred, the risk contingency
budget still might not be enough to protect you from the impact. Risk D only
has a 10% chance of occurring, so the project team must really focus on this
risk to make sure that it is managed successfully. Even if it cannot be totally
managed, hopefully its impact on the project will be lessoned through proactive
risk management.

The risk contingency budget works well when there are a
number of risks involved. The more risks the team identifies, the more the
overall budget risk is spread out between the risks. The EVM technique provides
a formula for determining the right amount of budget to apply to the risk
contingency budget.