If you can’t measure it, you can’t improve it.
The cost of poor project management can be astronomical. How does UK£11 billion sound?
That is the amount the UK government wasted on creating a national electronic health record system in 2012. In 2010, Queensland Health's payroll system project also failed. In this case, the IBM bid was $98 million to secure the project only to cost the taxpayers A$1.2 billion. Victoria's transport project was overspent by A$550 million.
In the private world, Woolworths took six years and A$200 million to replace their old IT system with a SAP solution, which didn't work well when implemented. Royal Bank of Scotland spent UK£56 million in fines when their IT project failed, leaving 6.5 million customers with account problems for nearly two months. The list goes on and on, and this does not include the opportunity costs the organisations lost by not executing other projects.
The financial management of projects is one of the critical tasks project managers should not overlook. For a project to be successfully delivered, it needs to be implemented within scope, to high standards and completed within the approved schedule and budget. This article touches on the key aspects of financial management every project should consider.
1. Planning
The initial stage involves planning the scope of the project. This requires assessing what resources are required for the project, such as labour, materials, IT software/hardware, consultancies, plant hire/purchase, and the like.
2. Cost Estimation
This stage involves estimating costs. The aim is to get the costing as accurate as possible with reasonable buffers. The more significant the difference between estimated and actual costs, the higher the chance of cost overruns and subsequent project failure further down the line.
For projects similar to what has already been delivered by your organisation, you may choose a top-down costing approach that allows experienced staff to estimate costs. A bottom-up approach involves calculating cost estimates at the task level where costs are combined and rolled up to the top. If your organisation has no experience with the project you want to deliver, this is the preferred approach to use.
Your project may also compete with other projects for available funding, and it needs to pass the expectations of senior management in your organisation. Moreover, you may need to cost different options and solutions for your project to help identify which approach to go with. Calculating net present values (NPV), returns on investment (ROI), break-even point (BEP), and benefit-cost ratios (BCR) will assist in selecting the most profitable projects to invest in.
A few factors to consider during this process are:
- The timeframe allocated for starting and finishing the project
- Applying the most appropriate indexation rates (for example, labour costs at 1.5%, raw material costs at 3%, and the like.)
- Applying discount rates for NPV calculations
- Allowing for contingency provision, overhead costs, and
- Estimating savings and revenue streams accurately.
The common traps in this process include not accounting for overhead costs, understating contingencies and not recognising appropriate residual values. Also, overestimated savings and revenues can also present challenges in the long term.
3. Project Cost Budgeting
The next stage is project cost budgeting which means allocating and periodising budgets across project deliverables for a specific period, for example, every quarter or year. The initial budget cashflow sets a baseline for the project manager and also provides a starting point for measuring and evaluating project performance.
4. Monitoring
The last stage involves implementing a monitoring process to review the project's progress against cash-flowed budgets and time. The budget monitoring process is a continuous process done regularly, usually monthly. It is essential to have a process around what is to be measured, acceptable variation thresholds (monitoring lights), and to have a defined process around who has the authority to make decisions and reallocate funds.
Earned Value Method (EVM) is a widely used method of measuring project performance. It effectively brings together project costs, time and project scope as part of reporting. Using additional monitoring tools can add value, such as using a burn rate which indicates the level of funds you go through for a certain period.
Early detection of budget issues can save money, prevent failure and provide an opportunity to come up with funding strategies. With our PMO, project management and finance expertise, we can work with you to successfully deliver projects.