There are many companies out there whose approach to project management is “Fire, Aim, Ready!” However, even for those companies that practice one of the project management methodologies, the financial implications are overlooked. Most people view project management as a way of getting things done but do not understand what project management can add to their financial strategy.
In the second edition of my book, Project Management Accounting, there is a case study about a recycling company that decides to increase market share by upgrading their plant and equipment. Due to poor planning and execution, the upgrade project had a seriously negative effect on the company’s financial results: Return on Equity was reduced by 9 percentage points, Return on Capital by 4.5 percentage points, and Net Profit Margin by 2 percentage points. In addition to not planning, the company made no link between the project financials and company financials. It was only in hindsight that those connections were made. Proper planning and linkage could have changed not just the project results, but the company’s results.
The project management methodology that I have used with success comes from the Project Management Institute (PMI). PMI’s methodology contains 5 phases: Initiation, Planning, Execution, Control and Closing. We will take up the first 4 phases with a short description of how each phase builds up a reliable financial model that not only predicts and verifies project financial outcomes, but can be linked to financial outcomes at a strategic level.
Initiation: the objective of the first phase of this methodology is to understand who the project owner and stakeholders are, as well as to define the objectives and deliverables of the project. Without specific deliverables as the guideline of project scope, the project will be subject to scope creep. When a project’s scope creeps, so does project cost. Initiation is the first line of defense for project and company financial performance.
Planning: The second phase of the PMI project management methodology is the phase most often skipped. People are anxious to get going on a project, hence the prevalence of the “Fire, Aim, Ready!” school of projects. Planning is meant to take the deliverables and answer the questions, “What is the work to be done and in what sequence must the work be done?” Deliverables are broken down into discreet work packages or tasks, quantifying both the effort and materials needed for the each.
The tasks are then sequenced to understand how interdependencies between the tasks come into play. The quantifying and sequencing of tasks builds the foundation of a project schedule and budget. Finally, risk analysis will help to qualify what risks the project may encounter and quantify how those risks could affect project schedule and budget.
At this point, the first encounter between the project and company finances should occur. Pro forma worksheets should be created to model how the project budget and outcomes may affect the future financial picture of the company. Those models should be linked to the company’s pro forma Income and Expense statements, Balance Sheets and Cash Flow statements. Risk management can guide “what if” scenarios to see under what circumstances the project might be cancelled or revised if not going as planned. In addition, questions about how the project may be financed, (debt or equity, for example) can be taken up. Financial analyses of the project such as Internal Rate of Return and Net Present Value can help to determine if the return on the project meets the returns that the company requires.
Execution and Control: These two phases of the project management methodology run in parallel; during execution the planned work is carried out while control monitors how well the project is adhering to the plan. Formulas for Earned Value and Estimate to Completion, among others, will show whether the project is on time and budget. The most important financial factor here is to determine how actual results may be affecting company finances. The information generated about project execution can be entered into the pro forma financial models to predict the effect on company financials. For example, if a project is running 15% over budget, the project numbers can be run through the company financials to see the real effect.
In particular for small companies, where capital may be difficult to come by these days, understanding how your projects will affect financial performance is a key to success.