The Nuts & Bolts of Doing Project Financial Analysis
Gone are the days when financial managers would put most of their energy and efforts into filing reports. As technology moved the needle forward in automation, it reduced the time financial managers would spend collecting numbers and producing financial reports.
This has paved the way to shift the role of financial managers towards doing financial analysis and working with data in a new way. Now more often than ever, financial managers are required to move beyond simple data analysis into an advisory role, providing senior managers with ideas to maximize financial viability.
Acting as business advisors to top executives requires constant awareness of the company’s financial standing. Since projects are the lifeblood of service industries, the financial analysis starts at a project level and moves from there.
The importance of financial analysis
Reviewing project financial reports and seeking ways to reduce costs is critical for service-based companies to get insights to remain competitive.
Often, financial analysis is done to illustrate the financial merits of projects by calculating their past, present, or future value. Financial managers will act as a bridge between Project Management and Operations where critical business decisions are made.
While project managers track the project against the budget, financial managers look at the profit margins of all projects and analyze company performance over a specific period of time. In this context, their goal is to dig deeper into how an organization uses various resources from the financial perspective.
Over time, financial analysis may drive an increase in both productivity and profitability across the company.
How to perform project financial analysis
There are many elements of structuring a great financial analysis, but they all boil down to three main steps. Smaller details can add an extra level of depth and richness, but as long as you walk through the following steps, you will have the basic building blocks in place.
1. Frame the questions.
The goal you’re pursuing when doing financial analysis can be better phrased and clearly followed if you start by identifying a few simple questions. Even though this step might seem less significant than others in this guide, by writing out specific questions, you ensure you stay on course during the analysis.
- Why are we collecting this data?
- What decision needs to be made?
- Was there a problem that rushed the need to evaluate these numbers?
- Who will be making the decision and who will be affected?
- How will the results of the financial analysis be used in making decisions?
Remember that it's easy to lose sight of the original goal as you dive deep into the numbers.
Only once you have answers to the questions above will you be ready to continue with your financial analysis. If you push ahead without a specific goal for your financial analysis and answers to the above questions, there’s a high chance you might miss out on important things and unintentionally skew the results of the analysis.
2. Define the scope of the financial analysis problem.
Once you’ve identified a problem at stake, it’s time to focus on its scope. The scope of the problem you need to solve will vary based on many factors, the stage of the project in particular.
Consider an example of a financial analysis to set a profitability target for the next project. This would require looking at the similar past or running projects and their profit margins, investigating common data points like Billable hours, Internal hourly cost rates, Time registrations, Costs spent on similar projects.
Even though projects in any field – consulting, IT, marketing, etc. – are unique and hardly predictable, it is still possible to indicate important trends in their development, analyze performance, and forecast the outcome.
In all cases, your scope of the financial analysis problem will have to account for different aspects of the project, both internal and external.
3. Quantify project deliverables.
Here comes the practical part. Project financial analysis would hardly be possible without quantifying project deliverables. For each service that occurs, finance managers would benefit from three pieces of information: revenue, cost, and profit. To make it possible, according to Kiron Bondale, a trusted speaker and advisor in project management and consulting circles, financial managers need to set the stage for project managers and collaborate on a constant basis.
It all boils down to knowing where you are, knowing where you should be, and understanding the implications of any variances between #1 and #2 in the broader context of the project's success criteria, remarks Kiron.
Finding a method by which planned vs. actuals are reported out and cost estimates are validated could keep both project managers and finance managers on the same page. To sustain the flow of the right information and make sure actionable data is recorded in real time for both roles, finance managers need to pay special attention to the following areas.
Role rates & hourly costs
For starters, you need to know what you’re paying your people (internal hourly cost) and what you’re selling their hours for (role rates).
Specifying the cost for each role from the beginning makes life easier for everyone. It helps calculate the project budget and communicate the price of the project to the client, but it also sets the stage for improving reporting capabilities and making clear how each role influences profitability. In fact, fleshing out specific role rates for every project, you can maximize project profitability.
In addition to establishing billing rates for each role that will further be used to calculate project revenue and profit, it’s important to pin down an hourly cost for each team member to get the understanding of the actual cost of the project.
After you’ve filled in the role rates and internal hourly cost, it’s now the project manager’s turn to estimate tasks. Having duration defined for each task not only makes it easier to tot up the plan price. It will eventually help you get a clear picture of how finances you planned to spend differ from the actuals.
Time registrations are especially useful for payroll, but apart from that, they can set in motion various financial reports and help monitor the budget via resource allocation. This data point, together with project task estimations at a task level, prove to be really beneficial when it comes to calculating the net present value of a project. Comparing how much time has been planned for the project vs. how much time has been actually spent you can get an understanding of project profitability and see if the budget is on track. Keeping timesheets up-to-date could give you visibility necessary for any kind of financial analysis.
Ensuring the above information is collected, finance managers and project managers can get systems like Forecast to crunch numbers for them automatically.
4. Bonus tip: Analyze a project as part of the big picture.
Financial analysis of an individual project without paying attention to its role in the bigger game would have lesser value for top executives, says Jan van Egmond, a Project Management Consultant with 25 years of experience for multi-project organizations. Its impact on company finances overall, however, is always welcome.
When organizations lose themselves in cost control, they lose an overview of the flow of projects, and everything gets stuck and jammed. So the best cost control measure to boost financial performance is starting to manage their finances without losing reference to the pipeline of projects. There are sufficient case studies and success stories that show how organizations boost their performance by starting to manage their pipeline.
Key metrics & numbers to sift through
Usually, the overall purpose of the financial analysis is ratio analysis to reflect on project profitability at a higher level, but depending on the scope of the problem you need to solve, you might need to watch out for the following numbers as part of your dashboards and drill down from there. Real-life management situations will call on you to carry out a financial analysis that involves far more than assessing a project’s profit.
- Planned Revenue, Cost & Profit
Planned revenue, cost, and profit is your baseline against which you’ll track how your finances progress when the project is in execution. If you have this number, you’ll clearly see the total amount of money the client paid your company for specific services.
- Actual Revenue, Cost, Profit & Margin
What is important to investors, top-tier management, and stakeholders, is how the costs get subtracted in the course of time and what is your actual profit today, based on the work that has already been done. Businesses are generally considered viable when the revenue generated exceeds the cost involved in business operations.
- Actual Variance to Plan
You’ll benefit from the knowledge of how finances you’ve planned to spend on projects differ from what’s actually happening. This metric gives you the understanding of how accurate the project plan was from the beginning. If there’s a notable difference between the two, it drives you to check what went wrong and fix it as you see it or revisit the strategy in the future. It encourages you to learn your lessons as you go.
- Remaining Revenue, Cost & Profit
For anybody performing the role of the finance manager, remaining finances is an important number to track.
- Registered & Remaining hours
You will want to know how many hours have been registered at a particular project, and how many are left to complete it. These metrics will be helpful when doing a financial analysis during the execution phase and the initiation phase of your next project. Now you know how many hours a similar project might take and pass these insights to the decision-makers.
- Profit Margin
In a financial analysis, profit is the most important of all KPIs. It’s the amount of income that remains after accounting for all expenses and operating costs. This metric is needed to compare your performance against industry standards.
Challenges and opportunities
Project financial analysis may be tricky, especially if you want to see true numbers. The reason why the figures are sometimes messy and way off-the-mark is because deliverables don’t get proper attention from the beginning.
In addition, the main problem with numbers is that they won’t tell you which processes to improve and how to optimize for better performance. They only give you a hint. Continuous process improvement is all about drilling down to disassemble the numbers to check up on the numbers and see what’s dragging you down. In project-based companies, resource planning and utilization data is as important as financial figures and losing reference to it will just make everything worse.
To keep numbers transparent, real-time, and connected to every part of the project, Forecast rolled out a Financial Portfolio Report with the metrics you need to keep track of a project portfolio.
We automated our Financial Portfolio Report in a way that makes sure you can break down each number to see the milestones and roles behind, so there’s never a dead end, and you can track the relationships between costs and specific roles within the company. This way, you’re able to decipher what needs urgent attention. Financial analysis becomes less of a stress with a platform that connects project management and financial insights.
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