What are Project Financials?
Project financials encompasses everything that is linked to the budget involved in a particular project. When this money is strategically planned, tracked, and managed, it increases the chances of success and profitability of the project.
Implementing a system for project financial management helps to regulate and monitor project costs. Project accounting, project health, project progress, project billing and project resources are all included in project financials.
In addition, certain aspects of project financials need to be continuously monitored, such as the planned budget versus the actual budget spend. Decisions about project financials can be supported using forecasts and trendlines, which offer the opportunity to plan and predict future needs. To do this, businesses need a robust project financial management strategy to be put in place.
Project financial management help keep the project within the set budget. This does not just help to manage projects in a better way but also impacts positively on business growth. Project financial management helps balance the investments and expected results from the project, the impact of an ongoing project on other projects that are in the pipeline, and measuring the overall impact the project has on the company.
Components of Project Financials
Project financials involve every aspect of handling money, from financial justifications to cost estimation, budget creation, and cashflow. Listed below are the four major aspects of project financials.
When businesses decide to spend money on a new project or activity, they have to justify the need for the project and the expenses involved. This is called a financial business case and it rationalizes the expenditure or spendings of the project. These expenditures are justified based on the savings and/or the expected revenues expected from the project. Businesses have to compare the revenues or savings with the costs that are required to deliver the project to show that the expenditure will be beneficial. For this, parameters like return on investment, payback period, internal rate of return, or net present value are used.
Cost Estimation, Budgeting, and Cashflow Finalization
One of the first steps to create project financials is the budget calculation. The budget includes direct and indirect costs like material and labor, variable costs, fixed costs, and committed costs like performance guarantees and bank guarantees. It also includes all other costs that may fall under this project such as travel, food, and accommodation.
Once the budget is set, the project has to be delivered within that budget. The project management team captures the inflow and outflow of cash during the entire project duration on a daily, weekly, or monthly basis, based on the requirements of the project. This helps them ensure that the project stays within budget.
Tracking Costs, Cashflow, and Revenue
To keep project financials accurate, the actual cost of expenditures of the project must be tracked. To do this, everyone involved with the project management team should:
- Review every outgoing cost and ensures that they are correctly reported.
- Acknowledge, approve, pay, and file vendor invoices based on the agreed upon terms and conditions.
- Track the actual cashflow as against the planned amount.
- Recognize revenue based on completion of the project deliverables.
This should be done as per the contract terms and conditions and the applicable accounting standards. Billing the customer for the completed tasks and ensuring that the funds are received accordingly is also an important part of project financials.
Reporting and Decision-making
Project managers, business analysts, and others who look at project financials should report on performance against the approved budget and also explain reasons if there are any unfavorable variances. The financial reporting analysis must have the following:
- Actual costs of the project against the set budget
- Actual cash flow against the planned cash flow
- Actual profitability against planned profitability
The financial management team should have corrective and preventive plans in place to ensure that the financials are on track if there are any problems. If no plans exist, they need to be implemented to avoid cost and project overruns.
What is the Importance of Project Financial Management?
Every business wants to optimize profit. For publicly listed companies, this is visible in the form of per-share earnings and the market price of shares. Share market price is determined by factors like profitability, revenue, compounded growth rate of the company, growth of competitors, and industry growth.
Whatever the services or the products being delivered by the organization, what matters is the financial results. This is one of the main reasons why businesses need to focus on the financials of every project they take up: Profitability matters. Whether people are accountable to shareholders or the business owners, projects need to fit within the budget in order for the overall organization to remain consistently profitable.
Financials are managed through a robust project financial management system. A good project financial management system is important for a variety of reasons.
Every business has a certain amount of funds that can be invested in products and services. These investments are made considering their benefits in the form of payback period, return on investment, internal rate of return, and net present value. Project financial management allows businesses to evaluate new projects from a financial point of view and allocate funds in the best possible way accordingly.
Better Resource Management
If the business has a good understanding of their project finances, they will be able to dedicate resources in a better way based on the budget of projects and their ranking on the priority list. This means that if there are certain resources that are limited, they will be placed on such projects that are most important and support the strategic goals of the business.
Cost Estimation and Budgeting
When costs are controlled internally, they influence the revenues externally. If the costs are controlled and well estimated, profit is almost guaranteed. Businesses need meticulous financial planning, disciplined cost estimation, and fixed budgets. The different costs include:
- Direct and indirect costs like labor and materials
- Variable costs, fixed costs, and committed costs like bank guarantees
- Other costs including travel, food, and lodging
Proper project finance management can cater to all these needs. Estimating projects is a huge and detailed task, and it’s easy to miss costs. Having everything set up means there are no oversights or missed expenses in the budgeting stage.
Keeping Projects on Track
Managing project financials well provides the metrics and financial roadmap of the project. This helps organizations understand where the project stands in the pipeline and also keeps the project on the budgeted track.
If the project goes off the rails, it’s easy to see where and how this has occurred. A great project financial system helps to identify why this happened and resolve it if possible. It can also pinpoint who should have managed this; was it the estimation team that budgeted correctly, or an oversight by a team?
Knowing how things occurred can help organizations fix the problem so it doesn’t happen again.
Along with having cost estimates and budgets, it is important to manage cash flow. Through project financial management, businesses can ensure that their inflows and outflows of cash are positive. Cash inflow includes interest income, and customer receipts, while the outflow includes payment to vendors, and employees.
Having a positive cash flow is very important because a negative cash flow shows that the collection of money by a business is being done at a slower rate than the disbursals. Even if the projected outcomes are good, poor cashflow can bankrupt a project or organization in the interim.
Businesses need to monitor and control the project costs very closely or it can compromise profitability. Financial management systems help put mechanisms and processes in place that can help in proactive financial control, leading to better financial performance and higher shareholder value.
What are the Steps to Effective Project Financial Management?
Project financial management involves many steps. Based on the project financial aspects explained above, it can be broken down into seven broad steps.
Step 1: Approval of Business Case
The first step to be taken when a business plans a new initiative, is justifying the project to the sponsor in the form of a business case. Any project has two major components, financial and technical. When it comes to financials, the business case aims to justify the expenses of the project and expected revenue or savings against the automation process or productivity improvement required. The savings and revenues are compared with the cost required for project delivery. Financial parameters like return on investment, payback period, and net present value are used to justify the business case.
Step 2: Budget Creation
Preparing a budget for project implementation is the second step of project financial management. Here, the different types of cost like direct, indirect, fixed, variable and other costs need to be calculated and a consolidated budget should be prepared that will be followed to execute the project.
Step 3: Determining Project Cashflow
The financial management team needs to determine the inflow and outflow of cash during the implementation of a project and ensure it is on track. The project cashflow can be captured on a daily, weekly, or monthly basis, based on the requirement. For example, determine if payments will happen at project milestones or completion rates, and will the funds be available at those predetermined points.
Step 4: Tracking Actual Costs
The financial management team needs to closely monitor the actual cashflow, including both inflow and outflow, and compare it with the planned cashflow. This helps keep the project budget on track.
Step 5: Revenue Recognition
The project financial management team needs to recognize the revenue based on the preset terms and conditions. This should be done based on the status of project deliverables and revenue recognition options, such as time and materials, fixed fee, retainer-based, recurring services subscription, to name a few.
Step 6: Invoicing
A very important aspect of project financial management is billing and invoicing. This includes billing the customer once the work is completed or at agreed milestones and ensuring that the payment is received. It also includes acknowledging and paying vendors on time as per their agreed upon terms and conditions.
The last and the most important step is reporting the project financials. Financial managers should report the actual performance of the project financials against the budget that was approved. If there are any unfavorable variances from the pre-approved budgets, managers should be ready to explain them along with suggesting action plans that can help in bringing the finances back on track. Some major things that should be looked into are budget versus actual cost, planned versus actual cashflow and planned versus actual profitability.
Best Practices of Project Financial Management
Let’s explore some of the best practices that businesses can use while implementing project financial management systems.
- Choosing the right goals for project financial to pursue like earnings before interest, taxes, depreciation, amortization (EBITDA), or Profit After Tax (PAT)
- Defining time periods like quarterly, half-yearly, or annually for the selected financial goals
- Breaking down financial goals for specific units of the business and the projects undertaken by these units
- Integrating financial goals with the performance metrics of employees
- Ensuring that every employee, in any role or position, is aware of the basics of financial management and where they are accountable
- Having clear decision-making protocols and processes for project financial management
- Ensuring that capital expenditures (CAPEX) are backed by a robust financial business case
- Ensuring that operating expenditure (OPEX) is linked to profitability and operating revenues
- Having a proper project budget in place
- Project budgets should be accompanied by project cashflow analysis
- Every dollar spent on the project must be accounted and budgeted for
- Additional expenditures should have approvals and strong justifications
- Revenue recognition rules should be defined and documented
- There should be clarity about deliverable progress and billing in customer projects
- Project financials should be tracked and reported in real time
- The project financial management system should be digitized using a good software solution.
Challenges with Managing Project Financials
It is not easy to plan and manage project expenses. To do this, project managers and others involved in financial planning and reporting need complete access to the financial data of the project so they can make informed decisions about the project. While handling project financials, team members are often faced with certain challenges. However, implementing good project financial management software can help solve all these problems. Listed below are some common challenges faced when tracking project financials.
Monitoring Unnecessary Project Metrics
A very common problem that project managers face is tracking unimportant or large numbers of project metrics. This ends up making the entire financial management process unnecessarily complicated, making the process of decision-making more complex than it needs to be.
Incorrect Tracking of Financials
Instead of having a centralized tool comprising all financial metrics, project managers often have to look at multiple sources and spreadsheets for data. This increases the chances of human errors. Financial management software can help in easily tracking the project cash flow, revenue, earned value, and profit, all in one place. Advanced tools can also help with financial reporting and forecasting.
Lack of Consistency in Data
Many project managers face challenges while calculating the actual cost, profit, and revenue because they use different formulae for each. By the end, the numbers do not line up or make sense. This happens because there is a lack of consistency in project data measurement. This can be easily avoided by setting up fixed rules and formulas for all calculations. The best way is to have a financial management tool do these calculations automatically instead of doing it manually.
Lack of Risk Management
Project managers often struggle when it comes to ensuring that the project is completed within a set deadline, budget, and other scope. This happens when there is no risk management strategy in place. A good project financial management system can help identify risks and provide solutions to handle them if the need arises.
Project Financial Management Can Be Challenging
Managing a project is tricky, and if the financial system managing it is a chaotic mess, the end result will be similar. The success of a project includes consistent financial tracking, positive cashflow, and on (or under) project budget costs.