Now, we are going to discuss the economy of the project. How can a project be controlled from a money perspective? The tools used for controlling a

Transcription

1 Now, we are going to discuss the economy of the project. How can a project be controlled from a money perspective? The tools used for controlling a project builds on the same cornerstones as control of the company in general, but are adopted to the specific circumstances of a project. 1

2 The controller follows up the profitability of the project. Since many projects only involves costs (resources), not revenues (sales), this often becomes a matter of following up the costs of the project. But, to cover all types of projects, we could say that the controller follows up the money of the project. She or he does this in relation to the time used and the result, or quality, produced. This is important. For example, the project might use less resources then planned, but to the expense of a less good result (lower quality). Or perhaps the time has been shortened to the expense of more overtime, which cause higher costs. So, the triplets should always be kept in mind together. So, the controller follows up the money of the project, and is reporting to the project manager who is responsible for the profitability (or costs) of the project. She does so mainly by costing the project, and this cost estimation becomes a project budget as the project starts. This budget is then the starting point for controlling the project. After the project have been finalized, a follow-up of the cost estimation (the budget) should be done in order to learn for the next project. The methods that are described here are also used for agile projects, but in most cases not that detailed and in a more loose and relaxed way. This is because agile projects are often not that tight controlled, quit natural when it comes to their nature. 2

3 Let us take a look at some important concepts for management control of projects. A business can be viewed upon as a collection of processes. For those processes different kinds of resources or input are used. Some examples of resources are work, material, energy, machines, buildings and so on. These are then used in different processes to produce products or output. The resources are used in processes to create products and this is the flow of the business. If we want to measure what we gain from this in economical concepts, the best would of course be to compare output and see if it is more worth than the input. Then we can see if we have created economic value or not. But, how could we measure this and how could we compare? By introducing a common measure: Money, that is euro or similar. If we do that, we get the opposite flow; how much we pay for the input and how much we get paid for the output. This flow can be measured in at least three different ways. If we measure the cash flow as such, how much we actually pay or get paid, we use the concepts of cash out for what we pay for the input, and cash in for what we get paid for output. We can compare this with our private wallet. Cash in measure that we get money to the business/the wallet, cash out that we hand out money from the business/wallet. These concepts are used for investment appraisal and for finance analysis. If we instead measure the commitment, how much we agree to pay and how much our customers agree to pay us, we use the concepts of costs for input and revenue for output. When we e g order material for 500, we commit to pay 500 for the material. And when our customers order products for from us, they commit to pay us These commitments are accounted for in the company; they are noted so that we know what revenues and costs we have had. In the subject that this lecture deals with, we are often interested in the profit or loss of a period (e g year 2015 or the month of January) or an object (e g a specific project). We want to know how much we earn or loos on the project, the customer, the month and so on. To handle this, we need to compare the same revenues with the same costs for the same period or object. This is called to expense the costs: Often, we know the revenues for the specific e g project, and what we have to do is to expense the costs, to note what costs are caused by this project. Let s look at the concept of profit (loss) a little bit more 3

4 If we want to measure the profit (or loss) of a project, or for a product, an order, a customer and so on for that matter, we need to compare output accomplished with resources used for it. Is the value of the output higher than the value of the input, that is, did we economize? Earlier we learnt that the revenues are (in most cases) known for e g the project, and that we have to expense our costs. To expense our costs means to find out what costs have been caused by the project; what input that has been caused by the output. Therefore, we can measure the profit (loss) for a project, for a period of time, for a product whatever, by comparing the revenues with the expensed costs (or, if there is only costs, by expensing the costs for the e g project). The costs that have not yet been used, not yet been expensed, are assets that can be used later; that will be costs later. An example can be a machine. The machine is, when it is bought, an asset in the financial accounting of the company. Each year it is used, and the cost for this usage is called a depreciation. For each year, the asset of the machine is lowered by each years depreciation. The cost of the depreciation are distributed to the different objects (products, projects and so on) that has used the machine during the year in proportion to the usage. Please observe that the profit (or loss) is absolute, expressed in e g Euro. There is another concept, return or profitability, that is a relative measure that sets the profit in relation to the capital used to accomplish it. This gives a percentage instead. 4

5 The budget of the project is developed in five steps. First, the purpose and the content of the budget is established. The purpose is to be some kind of decision support, e g for choosing a supplier, to assign people to the project, or similar. So, the delivery and who to deliver it to is established. Then estimates of revenues (if any) and costs for the project are prepared. This is often done by several different people inside and outside of the company. There are two main methods for this. Either so called bottom-up, where the costs for each activity, decision packet or similar are cost and summed to a total. Or so called top-down, where the total cost in an earlier project, a reference project, is broken down into its parts. In the third step, the budget of the project is calculated. Later, we will see an example of this. The data for this can be found historically (from earlier projects), from check lists, key indicators, offers from suppliers, and so on. The information to the budget is collected wherever it could be found. The computation can be in form of an investment appraisal, if the time horizon is more than one year. Most appropriate is to use the Net Present Value or the Annuity method for this, but also Internal Rate of Return is an appropriate method. These will not be discussed here. In those methods, the interest due to time passing is taken in to account. In practice, often simplified methods (e g Payback and ARR, Accounting Rate of Return) are very popular. This is a pity, since they are not correct. They are probably used for historical reasons; they were easy to use back in the days where there were no computers to help with the computations. The problem with these methods is that they do not take interest into consideration and, for payback, that it doesn t take more than the first years into account. Another useful form of costing that can be used is short-sighted costing models, for shorter projects. Good examples are activity-based costing and contribution costing. Absorption costing is not that useful since it is not constructed for decision making, but can be used with care. Also, Key Performance Indicators, such as e g time to market, cost per day and such could be useful. All these could be studied elsewhere and will not be discussed in depth in this lecture. After this, the risks and uncertainties of the project and how these could influence are discussed, after which the decision is made and the budget is used for following up the project. 5

6 Management control is used in all four steps of a project: Project initiation, planning, execution and closing. In the initiation of the project, a project budget and/or an investment appraisal is often used for deciding on the project. The project budget is often of a not that detailed kind in this step. In the planning of the project, often project budgets, cash budgets, key performance indicators and management accounting are used. The project budget is then made more detailed, and also divided into different sub-projects and periods of time (in example a monthly budget). A cash budget is needed to make sure that we have enough cash month-by month or so for the outlays that the project result in. Key performance indicators like e g estimated time it takes for different sub-projects, measures for the quality that should be accomplished (for example, number of possible users, amount of material bought by a system, and so on) gives aspects to control outside of the mere economic ones. And the management accounting system is set up with the budget for the project so that it is possible to follow it up later as it is started. In the project execution, the tools are used for continuous control, to follow up the project, and to report about the project for control purposes. The same systems as in the planning part are now used on a continuous basis. Also, in many companies an earned value management system (that will be discussed later) is used in this phase. Finally, in the closing of the project, the same systems as described earlier are used to evaluate the project. In this step, the project budget, the cash budget, the pre-defined key performance indicators, and the standards set in the management accounting system, are all compared to the actual revenues, the actual costs, the actual usage of time, and so on. 6

7 Above you can see an example of a project budget, in this case for a church project in the Philippines. This is a simple example, just to show you the division in different types of work performed and different time periods. This will then be followed up by comparison with actual figures. 7

8 Earned Value Management is a tool that combines cost, time and result accomplished with each other and analyses the variances from this and where that leads the project. The model divides the variance between planned cost or planned use of resources, called Planned Value (PV) for a period of time, and the actual use of it, Actual Cost or AC, with the two reasons for the variance; a variance in cost, which is called Cost Variance or SV, and a variance in time, which is called Schedule Variance or SV. It does this by introducing the concept of Earned Value, EV, which is the planned costs for the actually performed activities for that same period. The Total Variance, TV, is, again, Planned Value less Actual Cost. The Cost Variance is the Earned Value less the Actual Cost, and the Schedule Variance is the Planned Value less the Earned Value. By this, we can see e g if a negative variance in total (we have used more resources than planned) is because we have a negative cost variance (we have used more resources than planned for the activities we have actually carried out) or for a negative schedule variance (we have performed more activities than planned, which in some respect is positive but which causes more costs than planned since each activity demands specific resources). Or, it could be a combination and one could be positive and the other negative, and so on. From this, we can also estimate where the project will land should it continue like this. We can calculate the Estimate At Completion, EAT, how much costs it will take in total for the project to be finalized by first dividing actual cost with earned value and then take it times the budgeted total cost for the project. And we can also calculate the Estimated Time to Complete, ETC, by first dividing the planned value with the earned value, and then take this times the budgeted total time. 8

9 Above you see an example of the Economic Value Method. And this ends this lecture. 9