Programme / Project financial planning and management

Programme Management

Designing and Managing Programmes

Integrate with  Communicating Financial Information  and   Control and Manage Costs Established in the Project Budget Tasks and Structure and Capitalization

Tracking of finances is an important part of Program Management; programme costs includes, besides the sum of the project costs, wider costs of administering the program

The financial plan is a critical element of any project/program plan.  This module discusses why the financial plan is so important, what financial statements are necessary, and how financial projections are made.  In addition, the module discusses common mistakes that managers must be careful to avoid.

2.  Checklist for Preparing Financial Projections

The financial plan is the culmination of the earlier section of the project/program plan.  Each previous section impacts the projected costs, sales, etc.  The following is a checklist for assembling a financial plan:

1.    Assemble the key points of the project/program plan from the previous sections of the plan.

2.    Identify the organization structure of the project/program, indicating who will be responsible for making the key decisions with regard to operations, marketing, production, financial management, staffing, and legal compliance.

3.    Identify the operational activities that are required for the project/program to operate. 

4.    Identify the operating support systems required for the organization to operate. 

5.    Identify the information that is needed to turn these activities into estimates of the following:

6.    Take the estimates and post them as entries into the accounting model.  These estimates will enable managers to compose the key statements which include:

• Balance statement

• Income statement

• Cash flow statement

7.    Modify key estimates and prepare iterations on the financial plans for a more optimistic scenario and a less optimistic scenario.

3. Income Statement

The income statement is perhaps the most noticeable element of the financial plan since it summarizes the profit potential of a new or existing project/program.  The income statement typically is divided into the following:

• Revenues – The total amount of funds coming into the project/program from sales.

• Cost of Goods/Services – The amount of funds required to produce the product or service.

• Expenses – Other areas that require funds including marketing, salaries, rent, etc.

Essentially, the revenues are totaled, and from them are subtracted the cost of producing the goods and the other expenses the organization has incurred.  What’s left is referred to as the pre-tax profit.  From this, taxes are subtracted leaving the Profit after Taxes.

It is important to consider the perspective of the audience in reading financial plans.  Lenders will be looking for stable profits that enable the organization to make the determined loan payments.  Investors, however, want to see that there is the potential for growth.  They may be less concerned about stable profits, and even be willing to see an operating loss for a few years, providing the future outlook supports growth.  In compiling the income statement, managers should be sure to note the following:

 Often elements of the plan are presented as a percentage of sales.  For example, cost of goods sold is often represented as a certain percentage of sales, depending on the product’s margin.  By highlighting the percentages, they can easily be compared to other organizations.  The percentages of the various items in the income statement should be similar to sector of activity standards or, if not, the difference should be explained.

 The income statement must be compatible with the rest of the project/program plan.  If certain limitations or restrictions have been noted in the plan, their affect must be visible in the financial plans.

 The income statement should accurately reflect the organization’s tax status.
 

4.    Balance Sheet

While the income statement highlights a organizations projected profit potential, the balance sheet provides a snapshot of the organization’s financial health.  By looking at a balance sheet, the audience can determine the organization’s financial strengths and weaknesses at a certain point in time.  A balance sheet encompasses and summarizes the following:

 Assets – These includes those things that the organization owns.  There are several types of assets.  Current assets include liquid assets such as cash, inventory, and accounts receivable.  Fixed assets are less liquid assets such as plants, equipment, etc.  Intangible assets are assets that cannot be touched – such as licenses, brand names, good will, etc.

 Liabilities – Liabilities are the things that a organization owes.  This can include any outstanding loans, accounts payable, salary payable, etc.

 Net Worth – The difference between the value of a organization’s assets and the amount of their liability is called the organization’s net worth.

A organization’s initial balance sheet is relatively simple to prepare.  It simply reflects the capital that needs to be raised (debt or equity) at start-up and how that capital will be spent (assets).  In addition to this balance sheet, managers should also project balance sheets for the next three to five years, allowing investors to see how the proportion of assets and liabilities is expected to change.  In addition, managers should consider the following in preparing balance statements:

 First-time managers often believe they can fund a new project/program entirely through debt.  However, almost all lenders require some portion of the capital be provided through equity to other investors.

 Lenders and investors also want to see a significant financial commitment from the manager.  This indicates that the individual is committed to the success of the project/program because they have personal wealth to lose.  Investors and lenders don’t want to support a organization where the manager can simply walk away.

 Young organizations require liquid assets to survive.  They need cash and other liquid assets to be able to weather unexpected emergencies.

Cash Flow Statement

The cash flow statement is the most critical of all the financial forecasts in a project/program plan.  While many may look to the income statement to get an understanding of the profit generated by the organization, the cash flow statement documents the amount of cash actually flowing into and out of the organization.  Thus, the cash flow statement represents the organization’s net cash position, rather than the profit.  The cash flow statement is extremely telling, because it shows where cash is going. A organization can be delivering profits and still be bleeding cash or heading towards danger.

The cash flow statement springs from the income statement.  Some key differences are:

 The cash flow statement reflects the actual receipt of cash from sales or other sources.  The income statement records revenue when it is earned, not when the funds are actually collected.

 The cash flow statement includes the receipt of cash from all sources, including sales, money from debt or equity, sales of an asset, etc.  The income statement will not include all of these.

 Cash flow statements reflect the expenses actually paid, while the income statement reflects the expenses incurred.  This is important, especially with expenses that are paid over a period of time.

 Income statements record the depreciation of assets such as plants and machinery.  However, since this is an expense that does not involve the outflow of cash, it is not represented in the cash flow statement. 

 Acquisition of equipment or the payment of dividends or loan principal is not considered expenses on an income statement.  However, they do involve cash, and are therefore represented on the cash flow statement.

Early in a organization’s life, cash is more critical than profitability because it represents the organization’s ability to survive and maintain operations.

6.    Ratios

Often when looking at financial statements, any single elements on a balance sheet or income statement will have little meaning.  However, by comparing the elements relative to one another, a great deal of information can be determined about a organization’s financial health.  This is accomplished by looking at key ratios of elements of the income statement and balance sheet.  These rations include the following:

Liquidity Ratios – These ratios typically compare all of some of the organization’s current assets to its current liabilities. This can show how liquid the organization is and how well they can meet their debt obligations in the near term.  For example, the current ratio is the current assets divided by the current liabilities.  The ratio should be positive, indicating that there are more current assets than the liabilities that are coming due.

Asset Management Ratios – These ratios can illustrate how well the organization is employing the assets that are at the organization’s disposal.  For example, the inventory turnover is determined by the dividing the cost of goods sold by the amount of inventory.  This indicates how often the inventory is being turned over.  The higher the number, the faster the organization is selling inventory and the less time the product is sitting on the shelf.

Debt Ratios – These ratios help show how the organization is capitalized and how highly the organization is leveraged against lenders.  These ratios allow readers to understand how the stable the organization is and what their capacity for raising further capital is.  For example, the debt ratio divided the organization’s current liabilities by the total assets.  This provides a percentage of the organization’s assets that are debt.  The higher the percentage, the more leveraged the organization is and the more limited their ability to raise capital is.

Breakeven Analysis

Often times managers feel it is helpful to include a break-even analysis in the financial plan section.  A break-even analysis demonstrates the level of sales that are required for a organization to meet its cash obligations and expenses.  Essentially, once a organization passes the break-even point they begin generating profits.  This is useful for investors who are eager to see returns on their investment and lenders who are concerned with the organization’s capacity to service debt.  In addition, the break-even analysis demonstrates how long the organization expects to operate in a deficit.  The break-even point is typically a major milestone in the life of a organization.

In order to conduct a breakeven analysis, managers should follow these steps:

1.    Divide all cash obligations into fixed or variable obligations.  Fixed obligations are those that do not vary with the level of sales such as rent or debt repayment.  Variable obligations do vary with sales, such as cost of goods sold.

2.    Calculate the total fixed costs and the total variable cost.  Total fixed costs should be stated as an absolute number (i.e. $50,000) while total variable costs should be stated as a percentage of sales (i.e. 55%).

3.    Insert these figures into the following formula:

Break-even sales = Fixed costs/contribution margin

(Note: the contribution margin = 1 – variable costs as a percentage of sales)

For example, using these examples, the break-even would be:

Break-even sales = $50,000/1-.55

Break-even sales = $111,111

This figure does have a number of limitations.  The size of the operation will have a large impact on the break-even level of sales.  However, this calculation can provide managers with an idea of what volume is needed in order for the organization to become a self-supporting enterprise.

8.    Assumptions

In order to make projections about the future, managers must make a certain set of assumptions about the market, the competition, the sales levels, the economy, etc.  managers often feel uneasy about making these assumptions, however they are a necessary and normal part of making financial projections.  However, managers must consider each assumption carefully, and strive to make them as strong as possible.  Financial projections are only as reliable as the assumptions they are based upon.

Since assumptions are so important, managers should spend some time in the financial plan discussing their assumptions and how they came to them.  Readers want to know why the founders feel their assumptions are valid.  The following are key areas that managers need to make assumptions when creating a financial plan for a new project/program:

 Inventory turnover

 Accounts receivable collection period

 Accounts payable payment period

 Startup and future capital expenditures

 Useful life of the organization’s assets and depreciation schedules

 Interest rates on debt

 Income tax rate

 Expected capacity and utilization of plants and equipment

 Production levels, seasonality, etc.

 Sales and share of the market

 Growth and success based on management training and the learning curve

 Sales by market and product and the respective margins of each

managers can use sector of activity data, effective research, common sense, and many other methods to determine what assumptions to use.  However, when in doubt, more conservative assumptions should always be used.

Know the Numbers

It is not enough for an manager to merely complete a financial plan; they must also understand how the various elements interact with one another.  This is often difficult for many managers, especially those without a solid background in accounting and finance.  However, skilled managers need not be professional accountants, they only need to understand the basic relationships between each aspect of their organization’s financial plan.

For example, potential investors or lenders are going to ask tough questions to an manager prior to providing the capital for the enterprise.  These questions could be specific questions about how the manager believes he or she will be able to reach the projected sales level, or what would happen to the organization’s income if the cost for a key product ingredient increased dramatically.  managers must understand these questions and know how to answer them.

In addition, managers must know what the projections are and be able to track the organization’s progress along with them.  They must know how fast inventory is turning over, how sales are going, and how much of the organization is leveraged with debt.  Each of these questions will be critical for ensuring the organization is on the path to meeting the financial projections.  If the organization is going to fall short of these projections, then the manager must understand what is wrong and attempt to correct it in a timely matter.

Each of the instances speaks to the fact that managers cannot be passive with regards to the financial projections of the organization.  They must have a strong understanding, but also a level of comfort with the financial projections and progress of the organization.  Otherwise, the organization will drift off course and the managers will be unaware that there is a problem.

10.  Common Mistakes

Crafting a set of financial projections is no easy task.  However, by understanding the common mistakes made by others, managers can increase the likelihood of their financial plans being a success.  The following are a list of these key errors:

•  Failure to provide financial statements – some managers ignore the need of providing financial projections, hoping to convince investors on the strength of their ideas alone.

•  Unrealistic incomes/profit potential – Investors are wary of managers who pain a picture of a future that is a little too rosy.

•  Failure to clarify assumptions – When managers fail to clarify their assumptions, they leave the reader confused and doubtful.

•  Underestimating expenses – Many managers assume they’ll be able to keep expenses very low, which is difficult for a young organization.

•  Salaries are too big – No investor wants to provide capital for a organization that plans on overpaying their employees.

•  Failure to project the downside – By not providing a sensitivity analysis, managers risk the appearance that they have not considered what happens if the organization performs below expectations.

•  Failure to have the statements checked – managers often rush to have their financial projections completed, however they do not have their statements reviewed by a reputable accountant.  This can leave glaring errors or poor assumptions that could have been easily corrected.

•  The proposed rate of return is too low – Often managers create a financial plan that offers investors a rate of return that is lower than what they could earn from similar project/programs. 

•  Crafting a plan to provide a specific return – managers who are eager to show a strong return often craft a plan that show the organization meeting that goal.  However, the underlying power of the project/program is not enough to support the goal.

Assignements

See also the  9 topic areas  of project management knowledge, i.e.: Integration, Scope, Time , Cost, Quality,  Human Resources, Communication , Risk, Procurement. 

See also

• The 9 topic areas of project management knowledge: Cost,

• Introduction to creating a budget

• What is the cost tracking process?

• How do you create budgets and track costs against them?

• The steps for Creating a budget

• Control and Manage Costs Established in the Project

• Earned Value Management

• With MS Project How do you create budgets and track costs against them?

   

   

Templates:

Project Execution, Control and Closure Checklist