ICG-Capability

Financial knowledge has always been a crucial part of successful project management. Whether it’s healthcare, automotive, or services industry, it’s always necessary to keep track of all the financial streams that flow through the company. If we are going to implement a new project, it is even more important to estimate these financial streams. Errors in the “planning phase” could eventually cause implementation of a project that is not profitable from its beginning. The management of financial flows in the loss-making project will no longer help any more, and we are just monitoring the impending financial catastrophe.

So what do we do to successfully master the planning phase? First of all, it is essential for the project manager to understand the industry, both operationally and financially. The knowledge of the operation is gained by doing the job itself, but the knowledge of corporate (project) finance requires the following: learn the basic terminology (which is transferable to any sector), understand the financial statements and be able to plan financial flows. It is important to understand the differences between revenues and incomes and costs and expenses. But the biggest work comes with the analysis of financial statements and the searching for links between numbers and real world. This is especially about the sentiment and time we invest in.

Financial planning of a “comparable” project

If we operate in “traditional industries” such as wholesale, banking, or logistics, there are countless information sources where we can find industry-specific financial indicators. In addition, we can use, for example, a business register where financial statements of specific companies can be obtained for free. Here we can read the data on turnover, wages, or profits after tax, and you can get a detailed idea of how the company works. From financial statements (balance sheets and profit and loss accounts), we can further calculate indicators such as ROA, ROE, EBITDA, and various levels of liquidity and debt.

So, if you are going to implement a project or set up a business company in some traditional industries, these publicly available data can make it easier for you – setting out the profit margins and the percentage of your costs, and you just slightly “refine” your plans.

Financial Planning Project on “Green Meadow”

However, if you are going to implement a project that is specific and you do not have any financial data available for a similar project, you have the only option – to model these financial statements and cash flows by yourself. At this stage, it is crucial for the project manager (and for the project itself) to avoid overestimation of project revenue and undervaluation of project costs. It is necessary to understand deeply all the costs and their breakdown. Financial accounting uses a different cost division in contrast with cost accounting which is tracked by project managers and executives.

For the successful completion of the financial plan, it is therefore essential to capture all the associated costs and revenues that the project will generate over its useful life. It is common for managers to underestimate or forget to include some costs. In order to avoid this problem, there are several methods.

The Top-down method (picture below) is one of the ways to identify project costs: We move from top to bottom, and the total cost of the project is then divided into lower-level activities. This “mental map” will help us think about project costs in a structured way, but it cannot be used to further planning of financial flows. This is traditionally done by MS Excel.

Top-down method

If you would like to learn how to read the financial statements of other companies, identify costs and plan the cash flow of your project, visit our training Project Financial Management.

Author: Tomáš Kábrt, ICG