Powerful project financials
Project financial management goes well beyond simply planning, capturing, and managing costs on individual projects. It must also address the customer’s need to maintain a balance between the project investment and the expected benefits or returns associated with that project, the potential impact on other projects in the portfolio, and the overall impact on their business results. This paper discusses approaches to project financial management that benefit the customer by providing them with meaningful, powerful financial information that can be used to manage their business. The first part of the paper explores the overall context and criteria for providing powerful project financials and is followed by specific approaches for planning, managing and reporting on project and portfolio performance.
Every executive, manager, and project manager knows that financial management is an important, and sometimes critical, element of his or her job. Executives are held responsible for the overall profitability of the business, middle managers are concerned about department budgets and meeting revenue targets and project managers are accountable for making sure that projects are accomplishing their objectives within a set of financial constraints.
Successful execution of each of these roles is dependent upon having timely and accurate financial information. But just having spread sheets filled with numbers is not enough; for financial information to really add value, it must be must be relevant, timely, and accurate. It must provide a true picture of performance and provide fact-based information needed to make realistic forecasts of future performance.
What Are Powerful Project Financials?
Powerful project financials means different things to different people. In general it means they have the information necessary to make informed business decisions. To a portfolio manager, powerful project financials means they have a way of allocating scarce resources to the projects that best support the strategic goals of the business. Likewise, the portfolio manager is able to understand the performance of their projects and can use that information to periodically reallocate project budgets. They might decide to redirect funds from a project that is struggling to gain momentum and may prove to be less important to the business than when it was authorized. From the point of view of a project manager, powerful project financials means the project manager has the information needed to manage the execution of their projects and to identify areas requiring course correction before it is too late by allowing early detection and intervention of troubled projects. To a project team leader or individual team member, powerful project financials means they know how their assigned tasks are going and helps them understand their direct impact to the project. Lastly, to the project sponsor, powerful project financials means they know what’s been spent to date on a project, how that compares to the plan and how much it should cost to complete it.
By taking these viewpoints into consideration, the ability to produce powerful project financial information means:
- Projects are correlated to the budgets that fund them
- Project financial information is transparent and relevant to the Sponsor
- Budget, actual spend, and variance calculations are consistent across the portfolio
- The forecast is based on project performance to date
- Financial performance can be aggregated for a project and across multiple projects
- Financial performance for components or deliverables within a portion of a project is available
So how do we determine what information about the portfolio or an individual project is most meaningful and relevant to the customer? What needs to be done to make sure that the needed information is timely, consistent, and accurate? How can we communicate this information to the customer in the most meaningful and actionable way?
Getting to Powerful Project Financials
First, powerful project financials require clear definition, well-defined processes, and a centralized integration point to ensure data quality and consistency. In many organizations, it is the project management office (PMO) that is best positioned to play this role and becomes the focal point for financial reporting. It is the PMO that establishes the processes and mechanisms for financial management at the project level and is ideally situated to integrate the information flowing in from those projects to provide the portfolio-wide view.
Obviously, powerful project financials are only possible if the data and information used to create them is accurate and can be collected efficiently. Ideally, a project management information system acts as the “system of record” for project financials; more mature organizations will make use of the best methods available to them for capturing data on financial performance and creating forecasts. For example, using earned value management metrics is an excellent way to forecast future results based on the actual experience of the project team. While this information is useful in itself, it becomes more powerful when correlated to the budget item(s) that are the source of funding for the project. This is especially important to the customer when, as is frequently the case, the relationship between budget line items and projects is not one-to-one. In other words, some budget line items fund more than one project while other projects are funded by more than one budget line item.
The PMO must work closely with its customers to understand how the customer views its business from a financial perspective. How budgets are constructed, tracked, adjusted, and reallocated may all affect what information is needed by the customer for decision making. For example, many companies have a software application that is used to propose, manage, and report on budgets. Once a proposed budget is approved, the customer periodically measures what has been spent and reforecast their “spend” for the remainder of the budget period (typically annual). These review periods provide excellent opportunities to evaluate the performance of the portfolio and reassess priorities or budget allocations in light of current business conditions. In this scenario, providing information late is useless; timely information about what has been spent is useful; what is spent and a forecast of what is remaining is very useful; and an automated feed to the budgeting system that relates actual and reforecast to specific budget categories or line items is powerful.
Getting and Giving the Right Information
While establishing processes to support the collection, analysis, and reporting of project financials is important, collecting the right information is critical. This may require moving beyond a project-centric or portfolio-centric view to the broader business view and understanding the financial drivers for the customer’s business as a whole. While we have provided some examples of what information may be meaningful, such as relating project costs to budget line items, the actual definition for one enterprise or even a department within an enterprise may be radically different from another. An enterprise’s size, age, strategy, lines of business, products, and a host of other factors will determine which financial information will be most meaningful for decision making.
“Meaningful”—It All Starts With the Customer’s Business
In the context of either an individual project or a portfolio of projects, any discussion of financials must start with understanding the customer’s business and the business case for undertaking a project. In its elemental form, a business case contains the “what,” “why,” and “how much” and identifies the expected benefits or financial return from the effort while establishing the expected investment required to achieve those outcomes. The business case is used to determine if the cost of a project is justified, then it becomes the yardstick by which the project’s financial performance can be measured. By understanding the elements of the business case, the project manager is in a better position to understand what is relevant and meaningful to sponsors and stakeholders.
It should be noted that in some cases there is very little effort required to justify a project because of a regulatory requirement that the business must meet. In this environment, projects are routinely approved; however, they should still be managed and tracked from a financial point of view, but in a different way from those projects justified based on some other benefit or return on the required investment.
The content and focus of a business case may differ widely across industries and disciplines: a business case for a new product or service may focus on generating incremental revenue or increasing market share; the business case for a new business system may focus on increasing efficiency or reducing costs; and the business case for implementing processes required for regulatory compliance may focus on avoiding costs associated with non-compliance, such as fines or business impacts associated with loss of reputation or public image.
The form of the business case may also vary widely. In some organizations, it is a standalone document or part of a proposal. In others, it is embedded in a statement of work (SOW) or project charter.
What all business cases have in common is the two sides of an investment equation: costs vs. benefits. Understanding one side of the equation without understanding the other is only seeing half of the story. Additionally, some common questions are, or should be, answered in the business case:
- Does this investment support the organization’s strategy? How?
- How much can we expect the investment to return? How quickly? How will the return be measured?
- Are there any intangible (unmeasurable) benefits?
- What types of investment/expenditure are needed? Capital vs. expense? Labor vs. non-labor?
- What is the relationship between costs and benefits?
Knowing the answers to these questions, in the context of your organization, will guide how to best plan, track, manage, and report on the finances of the project.
Defining and Tracking Expected Benefits
While planning and managing the cost side of the business case has its challenges, we see a lot more process maturity in that area. However, if the rationale for a project is linked to the expected benefits associated with the project’s deliverables or outcomes, it behooves us to plan and manage to these as well. Take the case of evaluating scope change—if the change increases the amount of a benefit, some additional cost or time might be justified.
Benefit planning is about identifying what the expected outcomes or benefits of the project will be, establishing how they can or how they will be measured, and for those that are tangible, identifying when the benefit is expected to occur. Additionally, we need to establish the current level of performance for use as a baseline for future measurement. Obviously, the answers to these questions will vary depending upon your business and the type of project. Exhibit 1 shows some examples of the different ways to characterize benefits for planning purposes.
Exhibit 1 - ways to characterize benefits for planning purposes
While not all projects have financially quantifiable benefits, when they exist, those measures need to be identified and established early. In some cases, the mechanisms for tracking returns become part of the scope of the project.
But what about those projects where some or all of the benefits are intangible? In those cases, one approach to planning is to establish a scoring mechanism that quantifies each benefit (tangible or intangible) with a score such as a quantity or percentage rather than a dollar figure. The aggregate score is then used as the basis for quantifying the project’s relative value; for planning, we can then map out the value score against the project delivery timeframe.
From a portfolio management perspective, having a benefit plan provides essential information for focusing organizational resources on projects based upon return and strategic alignment. The benefit plan also supports selecting a diverse set of projects that will provide long-, short-, and mid-term returns.
From a project perspective, the benefit plan supports managing project changes so that costs and benefits stay in alignment. The plan also provides a basis for evaluating approaches to accelerating project returns such as, for example, iterative development, or incremental releases of products or services.
The Cost Side—What Does This Require?
When addressing the cost side of the business case equation, the first question is, “What costs am I managing and how detailed do I need to be?” Not every organization tracks project costs in the same way. Sometimes labor costs are managed by the project manager while sometimes they are not. Some projects are required to track and report capital expenses separately from operating expenses while in others the differentiation and tracking of capital expense is handled by accounting. Likewise, there is diversity in the naming and categorization of non-labor expenses: equipment, supplies, facilities, and travel may each describe something different and be allocated to projects in different ways. As with benefits, the starting point for managing costs starts with the business case.
Ideally, the business case describes both the total budget (expected cost) for the project and provides a breakdown by category of cost (i.e., capital vs. operating expense, labor vs. non-labor, etc.). By mirroring the structure of costs in the business case for both tracking and reporting, the project manager ensures that what is reported is meaningful to the sponsors and stakeholders receiving the reports. If the project sponsor is planning to fund the project partially from a capital budget and partially from an operating expense budget, reporting how much is being spent in each of these categories will be more meaningful than just reporting against a lump sum amount. A review of the business case in conjunction with a discussion with the finance department (in case something was missed in the business case) about which expenses will be charged to the project narrows the universe of possibilities and lets the project manager focus his or her tracking and reporting efforts on what is most important.
Once you know what is being managed, you need to define the targets that are being managed against or the baseline of measurement for project costs. While the business case provides the first baseline cost target for the project, there are multiple factors that may require budgets to increase or decrease over the life of the project. Scope changes, material or supply costs, or unanticipated risks may all affect the cost(s) called out in the business case. Baseline changes may occur as an outcome of project change management reviews, phase reviews, or stage gates. These review processes are intended to provide managers and executives an opportunity to review the project’s performance against the business case and accept or reject changes to the project parameters (scope, schedule, or cost). In some cases, this review will result in changes to the baseline budget; in others, the project may be canceled so that organizational resources can be focused on efforts more closely aligned with the organization’s strategy and objectives.
In support of these reviews, the role of the project manager is responsibility for tracking and reporting the costs used in the decision-making process. The project manager is also responsible for controlling project costs, ensuring that expenditures are reasonable and aligned with the targets established in the business case. To effectively meet these responsibilities, the project manager must establish and maintain processes to ensure that project finance information is accurate and timely. More often than not, this requires the project manager to maintain records of financial commitments, such as purchase order amounts, as well as actual expenditures. This recordkeeping may be in addition to that maintained in the financial or enterprise resource planning (ERP) system, which, while accurate, may not reflect expenditures until months after the purchases have been made. The intent is not to duplicate the accounting function but instead to provide the basic reporting needed to control and report project costs.
For tracking project costs, the simplest approach is to maintain a project checkbook where expenditures are subtracted from the budget and the project manager, at any point in time, can determine how much of the budgeted amount is remaining. While this is effective in tracking expenditures, it assumes that the remaining budget is adequate to cover the remaining costs of the project. Alternatively, the project manager may examine both the actual cost and the planned cost of the work remaining in the project. If the scheduled cost of the planned work is different from the amount of money remaining in the “checkbook.” a budget variance is reported. While this approach is more complete than the first, it assumes that the estimates for that remaining work are up to date; unless the project manager goes through a rigorous re-estimating, the estimate to complete may be misleading.
Many organizations are adopting earned value management (EVM) as a means of providing more reliable financial performance and forecast information. What makes EVM different is that earned value ties the incurred cost to the work performed. Rather than looking just at the costs incurred to date, EVM also looks at how much work was accomplished for cost. For example, assume that you have a project with a budget of $1,000. Halfway through project completion you determine that the work is 50 percent complete while your costs thus far are $600.
According to earned value, the “value” of the work equals what you planned to pay for it ($1000). At 50 percent complete, one-half ($500) of the cost has been earned. The difference between what was spent and what was earned is the cost variance ($100). If you divide the earned value by the actual cost, the result is the cost performance index (CPI), a measure of how efficiently money is being spent to accomplish the work. In this example the CPI is 0.83, meaning we are earning $0.83 of value for each $1.00 spent. More simply put, it is costing more to do the work than was originally planned. Furthermore, if it took more money to accomplish the work for the first half of the project, it is highly likely that we will need that much more to accomplish the remaining work. By dividing the original budget ($1,000) by the CPI, we can forecast that the total amount actually needed for the project will be $1,204.
Achieving Powerful Project Financials
To achieve powerful project financials, the PMO and the customer must have a true partnership. The customer must be committed to achieving the results and actively sponsor the effort. Commitment is more than support; it is the dedication to achieving the results and recognizing that the resulting level of transparency will cause angst. This is true not only for the project managers, but also for the portfolio managers who made the business case for their projects in order to achieve budgetary approval. The various stakeholder groups will not support this kind of effort just because the PMO says so, hence, the importance of the customer’s sponsorship.
Another very important point to consider is the use of terminology familiar to the customer when designing and implementing such a system. This makes the information relevant to the customer’s organization in a way that sophisticated earned value metrics cannot. The key to managing the cost side of the cost/benefit equation is to be transparent about what is being managed and having the appropriate mechanisms in place to plan, track, and report expenditures over the life of the effort.
Finally, the initial attempt to implement powerful project financials into a large project environment will likely need to be refined, and it is best performed in an incremental fashion. The implementation must be performed to not disrupt the in-flight portfolio while producing meaningful and valuable results quickly.
Powerful project financials are the key to successfully managing and controlling project costs. In this paper, we have identified some of the criteria that help create powerful project financials as well as identified the roles and obligations of those project participants who help create and utilize the information. There are numerous ways to measure a project’s performance; some are proprietary to the customer and others that have been widely adopted, such as earned value management. It should be obvious that there is no singular method that will satisfy all customers’ needs; every reporting system has to be tailored to the customer’s individual requirements.
It is important to begin with the customer: its needs will likely differ from other customers, even if the project closely parallels work previously performed elsewhere. Clearly, defining the customer’s needs is crucial and communicating on the same level is essential.
© 2011, Sean Wilson and Claire Schwartz
Originally published as a part of 2011 PMI Global Congress Proceedings – Dallas, TX
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