Project Financials

What are Project Financials?

In simple words, Project Financials involves with every aspect of a project that has something to do with money!

Project Business Case

When organizations plan to initiate new projects, the Project Sponsor must justify the project in the form of a thorough business case.  Broadly, a project business case has two major components – technical and financial.  As part of the financials, a business case tries to justify the project based on expected revenues or savings via process/productivity improvement or automation.  The revenues or savings are compared with costs needed to deliver the project.  Different financial parameters are used to review the financial viability of projects including payback period, return on investment, net present value, or internal rate of return.

Project Budget

When the project is approved, the team moves to project planning.  An important aspect of project planning is computing the ‘project budget’, within which, the project team executes the project.  The project budget includes different types of costs such as:

• Direct costs: material and labour
• Indirect costs: material and labour
• Fixed costs
• Variable costs
• Committed costs such as bank guarantee, performance guarantee, etc.
• Other costs such as travel, team lunch/dinner, rewards & recognition, etc.

Project Cashflow

It is important for the project team to capture the project cashflow (inflow and outflow) across the duration of the project.  It could be daily, weekly, bi-weekly, or monthly depending on the needs of the project.  The project team must capture both the dimensions of project cashflow – planned and actuals.

Tracking Actual Costs & Cashflow

The project manager and the team must ensure that the actual costs being spent on the project are well within the approved budgets.  For this, everyone on the project must closely review every dollar being spent and ensure that they are accurately reported for performance reporting.  The project team must also track the actual cashflow against the planned cashflow.  Further, the project manager must ensure that the team members report actual effort and thereby the actual costs in a disciplined manner so that the project financials data is accurate.

Revenue Recognition

A key aspect of external customer projects involves ‘recognizing revenue.’  Based on the terms and conditions of the contract as well as the accounting standards applicable, the project team must recognize the revenue based on the completion of project deliverables.  Examples include Fixed Price, Milestone-Based, Time & Material, Cost-Plus, etc.

Customer and Vendor Invoicing

The critical part of project financials involves billing the customer for the work completed and ensuring that payments are received.  On similar lines, all vendor invoices must be acknowledged and paid as per the terms and conditions agreed upon.

Reporting Project Financials

Project managers must report their actual performance against the approved budget, explain reasons for any unfavourable variances along with action plans to bring the financials back on track.  The project financials reporting should focus on:

• Budget vs. Actual Costs
• Planned Cashflow vs. Actual Cashflow
• Planned Profitability vs. Actual Profitability

What are the main steps in project financial management?

Project Financial Management involves with every aspect of a project that has something to do with money!

Step 1: Project Financial Business Case Approval

When organizations plan to initiate new projects, the Project Sponsor must justify the project in the form of a thorough business case.  Broadly, a project business case has two major components – technical and financial.  As part of the financials, a business case tries to justify the project based on expected revenues or savings via process/productivity improvement or automation.  The revenues or savings are compared with costs needed to deliver the project.  Different financial parameters are used to review the financial viability of projects including payback period, return on investment, net present value, or internal rate of return.

Step 2: Estimate Costs and Create a Project Budget

An important aspect of project financial planning is estimating and computing the ‘project budget’, within which, the project team must execute the project.  The project budget includes different types of costs such as:

• Direct costs: material and labour
• Indirect costs: material and labour
• Fixed costs
• Variable costs
• Committed costs such as bank guarantee, performance guarantee, etc.
• Other costs such as travel, team lunch/dinner, rewards & recognition, etc.

Step 3:  Determine the Planned Project Cashflow

The project team captures the project cashflow (inflow and outflow) across the duration of the project.  It could be daily, weekly, bi-weekly, or monthly depending on the needs of the project.

Step 4: Tracking Actual Costs & Cashflow

The project manager and the team track the actual costs being spent on the project.  For this, everyone on the project must closely review every dollar being spent and ensure that they are accurately reported for performance reporting.

The project team must also track the actual cashflow against the planned cashflow.  Further, the project manager must ensure that the team members report actual effort and thereby the actual costs in a disciplined manner so that the project financials data is accurate.

Step 5: Revenue Recognition

Based on the terms and conditions of the contract as well as the accounting standards applicable, the project team must ‘recognize the revenue’ based on the completion status of project deliverables.  Examples include Fixed Price, Milestone-Based, Time & Material, Cost-Plus, etc.

Step 6: Customer and Vendor Invoicing

The critical part of project financials involves billing the customer for the work completed and ensuring that payments are received.  On similar lines, all vendor invoices must be acknowledged and paid as per the terms and conditions agreed upon.

Step 7: Reporting Project Financials

Project managers must report their actual performance against the approved budget, explain reasons for any unfavourable variances along with action plans to bring the financials back on track.  The project financials reporting should focus on:

• Budget vs. Actual Costs
• Planned Cashflow vs. Actual Cashflow
• Planned Profitability vs. Actual Profitability

What are the four elements of financial management?

Financial Management involves with every aspect of a project that has something to do with money!

Financial Justification

When organizations need to spend money on any initiative / activity, business leaders must justify the need for the same.  This is known as the financial business case which justifies the ‘spending’ based on expected revenues or savings via process/productivity improvement or automation.  The revenues or savings are compared with costs needed to deliver the initiative.  Financial parameters such as payback period, return on investment, net present value, or internal rate of return are used.

Cost Estimation, Budget & Cashflow Finalization.

An important aspect of financial management is estimating and computing the ‘budget’, within which, the business must deliver.  The budget comprises of direct costs: material and labour, indirect costs: material and labour, fixed costs, variable costs, committed costs (bank guarantee, performance guarantee, etc.), and other costs such as travel, team lunch/dinner, rewards & recognition, etc.

The project team captures the project cashflow (inflow and outflow) across the duration of the project.  It could be daily, weekly, bi-weekly, or monthly depending on the needs of the project.

Tracking: Revenue, Costs, and Cashflow

Cash Outflow

Business leaders track the actual costs being spent on the project.  For this, everyone involved must closely review every dollar being spent and ensure that they are accurately reported for performance reporting.  Additionally, all vendor invoices must be acknowledged and paid as per the terms and conditions agreed upon.

The business team must also track the actual cashflow against the planned cashflow.  Every team member must report actual effort and actual costs in a disciplined manner so that the financials data is accurate.

Cash Inflow

Based on the terms and conditions of the contract as well as the accounting standards applicable, the project team must ‘recognize the revenue’ based on the completion status of project deliverables.  Further, the critical part of project financials involves billing the customer for the work completed and ensuring that payments are received.

Reporting & Decision Making

Managers must report their actual performance against the approved budget, explain reasons for any unfavourable variances.  The financials reporting should focus on:

• Budget vs. Actual Costs
• Planned Cashflow vs. Actual Cashflow
• Planned Profitability vs. Actual Profitability

The business team must put in place corrective and prevention plans to ensure that the financials are back on track.

Why is project financial management important?

The purpose of any business enterprise is to optimize shareholder value, which is represented in the form of earnings per share and the market price of the shares.  The market price of a company’s shares is determined by various factors including revenue, profitability, organization’s compounded annual growth rate, competitors’ growth, industry growth, etc.

The bottom line is clear – whatever products or services an organization deliver, ultimately, the market focuses on the financial results.  The implications are obvious – every project undertaken by an organization must focus on the financial dimensions.

For Optimized Investment Allocation

Businesses have a specific amount of money that could be invested into products or services.  These investments must deliver significant benefits in the form of shorter payback period, higher return on investment, better net present value, or higher internal rate of return.  For better investment allocation, business leaders must thoroughly evaluate new projects, programs, or initiatives from a financial angle.

For Immaculate Cost Estimation & Budgeting

Revenues are externally influenced while costs can be internally controlled.  When costs are well estimated and controlled, profitability is guaranteed.  Organizations must drive meticulous financial planning via disciplined estimation of costs along with fixed budgets.  The budget comprises of various types of costs such as:

• direct costs: material and labour
• indirect costs: material and labour
• fixed costs
• variable costs
• committed costs (bank guarantee, performance guarantee, etc.)
• other costs such as travel, team lunch/dinner, rewards & recognition, etc.

Business leaders must ensure that teams are accountable to the estimates and the associated budgets.  Appropriate control thresholds and escalations must be defined to protect profitability.

For Positive Cashflow

While cost estimates and budgets are important, managing their cashflow and their timing (daily, weekly, monthly etc.) is more critical to run the organization.  There are instances when profitable companies have struggled due to poor cashflow management.  Cashflow considers both inflow (customer receipts, interest income, etc.) and outflow (payments to employees, vendors, etc).  Business leaders must ensure that they are always cashflow positive.  A negative cashflow implies that the organization is collecting money at a slower rate than its disbursal.

For Financial Rigor

Unless business managers closely monitor and control costs, organizational profitability can be easily compromised.  Organizations must institutionalize mechanisms and processes that support proactive financial control.  Better financial controls lead to better financial performance, leading to higher shareholder value!

Project Financial Management Best Practices

Project Financial Management involves with every aspect of a project that has something to do with money!

Leaders must inculcate certain financial practices as part of the organizational DNA.

1. Organizations must choose project financial goals to be pursued (EBITDA, PAT, etc.)
2. The selected project financial goals must be defined for specific time-periods (quarterly, half-yearly, yearly, etc.)
3. The chosen financial goals must be broken down for specific business units and projects undertaken by them.
4. The financial goals must be integrated with employees’ performance metrics.
5. Leaders must ensure that every employee (irrespective of roles) is aware of basics of financial management.
6. Organizations must have clear processes and decision-making protocols for project financial management.
7. Capital expenditure (CAPEX) must be backed by a strong financial business case.
8. Operating expenditure (OPEX) must be linked to operating revenues and profitability.
9. Project budgeting is non-negotiable.
10. Project cashflow analysis should accompany budgets.
11. Every dollar spent on projects must have been budgeted for.
12. Exceptional expenditures must have strong justification and approval protocols.
13. Rules for revenue recognition must be defined and documented.
14. Customer projects must be clear about deliverable progress and billing.
15. Payment terms for customers and vendors must drive profitability and better cashflow.
16. Tracking and reporting on project financials must be real-time.

Project financial management must be digitized via a robust software solution.

How should you account for project expenses?

Step 1:  Create a clear project work breakdown structure (WBS).

Better project financial project is built on the strong foundation of a robust work breakdown structure.  The WBS is a hierarchical decomposition of the project scope to be successfully executed by project delivery organizations. The WBS represents higher-level deliverables broken down to lower-level deliverables and further to activities and sub-tasks.

Step 2: Assign clear ownership to every deliverable / activity.

Every project deliverable must have clear ownership that is accepted by identified team members.

Step 3:  Tie every WBS deliverable / activity to a financial account.

To be able to accurately account for every dollar spent on the project, project managers must ensure to tie every deliverable / activity to a financial account.  Doing so enables accurate estimation and budgeting as well as tracking actual costs.  Further, this ensures that the team members “must” report actual costs to a WBS deliverable that is in turn linked to a financial account.

Step 4: Estimate the costs for every WBS deliverable / activity.

The project team must now estimate project costs at a granular level and bottoms-up, starting with tasks.  Tasks then roll-up to deliverables, then to work packages, and finally to the project.

Step 5:  Arrive at the project budget.

The costs estimated at a granular level gets rolled-up to the project level.  Based on the needs of the project and organizational standards, contingency is added to the rolled-up costs.  With this, the project budget is ready.

Step 6:  Set rules for the project team to spend and report their costs.

The important aspect of project financial management is to ensure that the team knows the process of spending the available budget as well as reporting them for financial consolidation.  Based on accounting standards suggested by the company’s finance team as well as project cost control techniques such as Earned Value Management, guidelines must be defined to remove arbitrariness and ambiguity for the team to spend and report project costs.

Step 7:  Use a robust project financials software.

Business leaders must institutionalize a digitized and systemic approach to managing project costs through robust project financials software, that removes the need for paperwork, spreadsheets, and emails that weaken the ‘cost traceability.’

Step 8:  Reconcile with finance team.

With a solid project financials software in place, the need for reconciliation is negligible or could be eliminated.  However, a reconciliation of project financials with the finance team drives transparency and trust about the numbers presented.

Step 9:  Report financial performance

Again, with a top-class project financials software, project cost performance reporting is seamless and real-time.  This eliminates the ‘non-value-adding’ activities of data extraction, review, modifications, approval, etc.