Profit before taxes
>f, that such excesses increase the project's cost The functional staff should be prepared to jus-" tify an incremental investment which was made to gain additional performance insurance. Arbitrary and excessive conservatism must be avoided.
Execution of the project work must be con-,' trolled. The functional groups should not b^ allowed to stretch out the project for the sake'--of improvement, refinement, or the investiga; tion of the most remote potential risk. When'a-; functional task has been completed to the", project manager's satisfaction (meeting the^ task's objectives), cut off further spending* to prevent accumulation of charges.
The project manager is usually responsible fofc controlling the project's contingency budgef5 This budget represents money that one «w pects to expend during the term of the proiei®, for specific requirements not identified at thif project onset. Therefore, these funds must carefully monitored to prevent indiscriminate spending. A functional group's need for a pof»"' tion of the contingency budget must be lust^J. fled and disbursement of these funds shoukj;, only be made after the functional group exhibited an effort to avoid or limit its use 4. is imperative that the contingency budget b& held for its intended purpose. Unexpectgjj problems will ultimately arise, at which ting® the funds will be needed. Use of this bud® to finance a scope change is neither adva geous to the project manager nor to mans ment. The contingency budget represents project manager's authority in dealing wi corrections to the project work. Managemen must be made aware of the true cost ofr change so that financing the change will, based on its true value (cost-benefit relating ship). fi
In the procurement of equipment, and subcontract services, the specified tfi-quirements should be identified and the lQ% est priced, qualified supplier found. Adequa'§, time for price "shopping" should be built in!&. the project schedule. The Mercury Pr°I^S proved to be safe and successful even thoji John Glenn, perched in the Mercury caps"
atop the Atlas rocket prior to America's first earth orbiting flight, expressed his now famous concern that "all this hardware was built by the low bidder." The project manager should ensure that the initial project budget is commensurate with the project's required level of reliability. The project manager should not be put in the position of having to buy project reliability with unavailable funds. Procurement of material and services based on partially completed drawings and specifications should be avoided. The time necessary for preparing a complete documentation package before soliciting bids should be considered in the preparation of the project schedule. Should an order be awarded based on incomplete data and the vendor then asked to alter the original scope of supply, the project will be controlled by the vendor. In executing a "fast track" project, the project manager should make certain that the budget contains an adequate contingency for the change orders which will follow release of a partially defined work scope.
Changes should not be incorporated in the project scope without client and/or management approval and the allocation of the requisite funds. Making changes without approval will erode the existing budget and reduce project profitability; meeting the project manager's "on-cost" commitment will become extremely difficult, if not impossible. During periods of inflation, the project manager must effectively deal with the influence of the economy on the project budget. This is best accomplished during the planning or estimating stage of the work, and entails recognition of planning in an inflationary environment for its effect by estimating the potential cost of two distinct factors. First, a "price protection" contingency budget is needed to cover the cost increases that will occur between the time a vendor provides a firm quotation for a limited period and the actual date the order will be placed. (Vendor quotations used to prepare an estimate usually expire long before the material is actually purchased.) Second, components containing certain price volatile materials (e.g., gold, silver, etc.) may not be quoted firm, but will be offered by the supplier as "price in effect at time of delivery." In this case an "escalation" contingency budget is needed to cover the added expense that will accrue between order placement and material delivery. Once the project manager has established these inflation related contingency budgets, the PM's role becomes one of ensuring controlled use.
• The project's financial cost (interest expense) can be minimized by the project manager through the timing of order placement. Schedule slack time can be used to defer the placement of a purchase order so that the material is not available too early and the related cash outflow is not premature. There are several risks associated with this concept. Delaying an order too long could backfire if the desired material is unavailable when needed. Allowing a reasonable margin for error in the delivery cycle, saving some of the available slack time for potential delivery problems, will reduce this risk. Waiting too long to place a purchase order could result in a price increase which can more than offset the interest savings. It is possible to "lock-up" a vendor's price without committing to a required delivery date, but this has its limitations. If vendor drawings are a project requirement, an "engineering only" order can be placed to be followed by hardware release at the appropriate time. Deferred procurement which takes advantage of available slack time should be considered in the execution of all projects, especially during periods when the cost of money is excessively high.
• Vendors are frequently used to help "finance the project" by placing purchase orders which contain extended payment terms. Financially astute vendors will build the cost of financing the project into their sell price, but only to the extent of remaining competitive. A vendor's pricing structure should be checked to determine if progress payments would result in a reduced price and a net project benefit. A discount for prompt payment should be taken if the discount exceeds the interest savings that could result from deferring payment.
• Although frequently beyond the project manager's control, properly structured progress payment terms can serve to negate most or all project financial expenses. The intent is simple. A client's progress payment terms can be structured to provide scheduled cash inflows which offset the project's actual cash outflow. In other words, maintenance of a zero net cash position throughout the period of project execution will minimize the project's financial expense. In fact, a positive net cash position resulting from favorable payment terms can actually result in a project which creates interest income rather than one that incurs an interest expense. Invoices to the client should be processed quickly, to minimize the lost interest resulting from a delay in receiving payment.
• Similarly, the project manager can influence receipt of withheld funds (retention) and the project's final payment to improve the project's rate of cash inflow. A reduction in retention should be pursued as the project nears completion. Allowing a project's schedule to indiscriminately slip delays project acceptance, thereby delaying final payment. Incurring an additional expense to resolve a questionable problem should be considered whenever the expense will result in rapid project acceptance and a favorable interest expense reduction.
• On internally funded projects, where retention, progress payments, and other client related financial considerations are not a factor, management expects to achieve payback in the shortest reasonable time. In this case, project spending is a continuous cash outflow process which cannot be reversed until the project is completed and its anticipated financial benefits begin to accrue from the completed work. Unnecessary project delays, schedule slippages, and long-term investigations extend system startup and defer the start of payback. Early completion will result in an early start of the investment payback process. Therefore, management's payback goal should be considered when planning and controlling project work, and additional expenditures in the execution of the work should be considered if a shortened schedule will adequately hasten the start payback
• On occasion, management will demand project completion by a given date to ensure in elusion of the project's revenue and profit within a particular accounting period. This de mand usually results from a need to fulfill prior financial performance forecast. DelayJ project completion by only a few days cou' shift the project's entire revenue and profi from one accounting period to the next. Tl\ volatile nature of this situation, large sums ' revenue and profit shifting from one period" the next, results in erratic financial perfo mance which negatively reflects on manag. ment's ability to plan and execute their < forts.
• To avoid the stigma of erratic financial perfr mance, management has been known to suds denly redirect a carefully planned, cost, effective project team effort to a short-te usually costly, crash exercise, directed to a project completion date, artificially nec tated by a corporate financial reporting n Unfortunately, a project schedule driven by fluences external to the project's fundamen v objectives usually results in additional and reduces profitability.
• In this particular case, the solution is sim if a percentage of completion accoun*' process can be applied. Partial revenue margin take-down during each of the pro| accounting periods, resulting from this p. dure (rather than lump sum take down 1 single period at the end of the proiect, as. curs using conventional accounting meth will mitigate the undesirable wild swings, reported revenue and profit. Two s) benefits will result. First, management's enue/profit forecast will be more accurate less sensitive to project schedule chang. Each project's contribution to the overall foie cast will be spread over several account)]; periods and any individual performan , change will cause the shift of a signifies".» smaller sum from one accounting period., the next. Second, a project nearing compj, tion will have had 90-95 percent of its r t enue/profit taken down in earlier periods which will lessen or completely eliminate management pressure to complete the work to satisfy a financial reporting demand. Inordinate, unnecessary spending to meet such unnatural demands can thereby be avoided.
• An Investment Tax Credit*, a net reduction in corporate taxes gained from a capital investment project (a fixed percentage of the project's installed cost), can be earned when the project actually provides its intended benefit to the owner. The project manager should consider this factor in scheduling the project work, recognizing that it is not necessary to complete the entire project to obtain this tax benefit as early as possible. Failure to substantiate beneficial use within a tax year can shift this savings into the next tax year. The project manager should consider this factor in establishing the project's objectives, diligently working toward attainment by scheduling the related tasks to meet the tax deadline. Consideration should also be given to expenditures (to the extent they do not offset the potential tax savings) to reach this milestone by the desired date.
• In managing the corporate P&L statement, the need to shift revenue, expenses, and profit from one tax period to the next often exists. By managing the project schedule (expediting or delaying major component procurements or shifting expensive activities) the project manager can support this requirement. Each individual project affords a limited benefit, but this can be maximized if the project manager is given adequate notice regarding the necessary scheduling adjustments.
• Revenue/profit accrual based on percentage of completion can create a financial problem if r r-——
Co ProP°sed tax law revisions under consideration in
8ress at the time this article was written include a provi-
1 *hicl1 eliminates the Investment Tax Credit.
actual expenses greatly exceed the project budget. In this case the project's percentage of completion will accumulate more quickly than justified and the project will approach a theoretical 100 percent completion before all work is done. This will "front load" revenue/profit take down and will ultimately require a profit reversal at project completion. Some managers may find this desirable, since profits are being shifted into earlier periods, but most reputable firms do not wish to overstate profits in an early period which will have to be reversed at a later time. Therefore, the project manager should be aware of cost overruns and, when necessary, reforecast the project's "cost on completion" (increasing the projected cost and reducing the expected profit) to reduce the level of profit taken down in the early periods to a realistic level.
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What you need to know about… Project Management Made Easy! Project management consists of more than just a large building project and can encompass small projects as well. No matter what the size of your project, you need to have some sort of project management. How you manage your project has everything to do with its outcome.