Controlling the Project Financials
In Controlling the Project Cost with EVA I described how to use EVA analysis to control that project is completed within the approved budget. Now I want to discuss a complementary technique to control the project cost. This technique is called project financial control. It is based on the accounting of funding, expenses and costs. Besides, if the project is invoiced to a client, then incomes can be tracked to monitor the project margin.
Unlike EVA analysis, project financial control is more understandable by stakeholders because it does not use a complex terminology, it is easier to implement, it can aggregate projects to programs and portfolios, and it can be used for predictive or agile projects. It is not so effective, however, to produce standardized KPIs and run charts similar to these ones in EVA analysis:
Let’s apply project financial control to a case study. Imagine a project starting with the following budget breakdown:
- The project is sold to a client for €1 million.
- This performing organization need to set aside a 10% of project budget as the management reserve.
- Contingency reserves have been approved for €50K.
- The project management team estimates 15 trips, €5K each.
- It is planned to acquire a software product for €12K and a hardware product for €13K.
- Project manager dedication is estimated at 1000 hours. His selling rate for this client is 100 €/h. The standard cost rate for his professional category is of 75€/h.
- This project will require five team members internal to the performing organization, 1000 hours each, at a selling rate of 40 €/h, with a standard cost rate of 30€/h.
- Two external team members will be acquired: 1000 hours each at 50 €/h, meaning this project could spend up to 5000 hours at €50 under a T&M contract with a third party company.
- The performing organization has signed another fix price contract for €250K.
With these data, we can calculate the project margin as incomes, minus expenses, minus reserves, minus costs. Project margin is €175K in this case.
We have to distinguish between costs and expenses, since they have a different accountancy treatment. We can associate “cost” with “resource utilization”. With respect to expenses for asset acquisition, also known as Capex (Capital Expenditures), in order to simplify theh project accountancy, we consider the total purchase amount instead of amortization during the project timeframe.
We separate reserve accountancy to record how these funds are applied:
- If we apply reserve funds, for instance, to pay more for changes in the fixed price contract, or to buy a more expensive hardware, or to increase the number of trips, we will not use the expenses chapter. We have to register those as used reserves.
- If we apply reserve funds, for instance, to use more internal hours, or more expensive internal hours, or to spend more in the time and materials contract, we will not use the cost chapter. We have to register those as used reserves.
In the following chart, we can see budget details. Notice that, in this example, funding requirements and billing incomes are coincident.
This kind of executive information is usually represented with waterfall charts:
We can get quite conclusive information just comparing project funding baseline to funding used at completion:
If we compare these two charts, we notice the project margin was actually €124K instead of €175K. Why?
- +€50K was invoiced to client (€1,050K instead of €1,000K).
- +5 trips were needed (20 instead of 15).
- +€20K to increase management reserves, totally applied. Contingency reserves were also totally applied.
- –320 hours saved for T&M (1680 hours instead of 2000).
- +320 hours for the project manager and +1600 hours for the internal team members.
Following we can see the final situation in detail:
Final comparison with baseline, although very interesting, is useless since it is too late to take corrective action. The best use of these charts is at the follow-up meetings. The steering committee members are grateful to this executive, decision making helpful reports, when the time is right and the options are still open. These charts can be easily prepared in Excel.
Click here to download the project financing control Excel at the beginning of the project used in the example.
Let’s move now to an intermediate point in the project in May 2018. Due to some scope changes, schedule and budget are needed to change as well. Budget for client is increased €50K since there are more project activities. We need +1600 hours for internal resources. T&M will be reduced by 280 hours, though.
These three charts communicate the project finance situation at this moment.
Click here to download the project financing control Excel at the end of May.
- First chart with baseline shows the initial budget. This chart is not supposed to change even if we rebaseline the project.
- Second chart with financial forecast shows our best estimation at completion.
- Third chart shows the situation up to date: at the end of May we have invoiced €450K, spent €135K, applied reserves for €5K and used resources for €207K. Therefore, project margin up to date is €104K.
The final situation of the project, at completion in September 2018, is shown in the next three charts.
Click here to download the project financing control Excel at the end of September.