Connecting the dots
THE BUSINESS OF PROJECTS
There's just no question about it: Projects are connected to your organization's bottom line. They are tied to considerations such as earnings, profit and loss, and cash generation. This is true for any company in the business of making money. It's also true for not-for-profit entities that seek to demonstrate fiscal responsibility by executing projects related to cost-effectiveness or cost savings.
Sadly, this fact seems to go unnoticed (or unappreciated) by some organizations. It's easy to tell who they are—the ones that actively argue against the use of financial criteria as a method to evaluate, justify and ultimately approve projects.
Let's be clear: I'm well aware of the challenges associated with converting certain kinds of benefits into dollars, euro, yen, etc. I'll address the process for converting so-called “soft” or intangible benefits into monetary value in a future column. But this month I want to discuss why companies should try to make that conversion.
It all begins with market value added (MVA), a company-level wealth metric that shows the difference between the market value of a company and the capital contributed by investors. A positive MVA means the value of management's long-term actions and investments are greater than the value of the capital that has been contributed to the company.
Among the contributors to a positive MVA is economic value added (EVA). Developed by former Chase executive Joel Stern, EVA is a calculation of how much wealth a company has generated above and beyond the cost of capital, recognizing that a company's use of capital comes at a price. That price is determined by blending the required return on borrowed money (debt financing) and the return required to keep shareholders happy (equity financing). In many ways, cost of capital is similar to the cost associated with taking out a personal loan—that is, the loan amount multiplied by the loan rate.
And now we arrive at the net present value (NPV) metric.
While EVA expresses how much wealth an entire company has generated above and beyond the total cost of invested capital, NPV does the same thing at the project level. If a project generates more positive cash flow than the capital required to support it, the NPV will be positive. Such a project is financially justified, and it would make good business sense to approve it. If a company has numerous financially justified projects, it makes good business sense to pursue the ones with the largest NPV. This is one of the tenets of financial-based project portfolio ranking.
If you learn the business concepts behind aligning projects to the bottom line, you can help the executive suite prioritize the company's project portfolio. And helping your organization get ahead will help you get ahead. PM
NOVEMBER 2010 PM NETWORK