How much a Project Manager should know about Accounting?

 

We always talk about soft skills and leadership, negotiation, communication but how much managerial accounting that PM should know? Let us see the difference between both fields

Accounting field

1. Financial accounting                                        2. Managerial Accounting

 A. General Accounting                                                 A. Cost Accounting

 B. Tax Accounting                                                        B. Budgeting & Planning

 C. External/ Internal Auditor                                           C. Internal Auditor

 D. Consultant                                                                D. Consultant

Most common action would be Recording – Estimating – Organizing – Summarizing

Now let me give briefing of both fields:-

(Financial Accounting)

Reports to outside the organization (Owners, Lenders, Tax authorities, Regulators) Emphasis on summaries of financial consequences of past activities, objectivity and verifiability of Data, precision are emphasised, preparation of data for entire organization is required, MUST FOLLOW GAAP ( Generally Accepted Accounting Principles) as mandatory for external reports.

Hence, as Project Manager you do not need to follow (GAAP), or (AcSB) Accounting Standard Board which has adopted the (IFRSs) International Financial Reporting Standards but what falls under 2nd field that PM should have to know is

(Managerial Accounting)

Reports to those inside the organization for

Planning – Directing and Motivating – Controlling – Performance evaluation

Emphasis on decision effecting the future and relevance

Focus on timeline and non-monetary data, prepare detailed segment reports regarding departments, products, customers, and employees.no need to follow GAAP, not mandatory

Therefore, it is prudent that PM understand basic accounting, capital cost v/s Expenditures, Relevant cost; sunk cost – opportunity cost – out of pocket cost, cash flows, salvage value / cost, variance cost, Planning, estimating, budgeting.

The PM also needs to understand Project Analysis Financial Techniques like following;-

1. ROI: return on investment (accounting)
2. Payback period = Investment / Annual costs
3. NPV: Net Present Value (DCF) discounted cash flow: time value of money
4. IRR: Internal Rate of Return(DCF)

IRR: the interest rate that makes present value of cash inflows = present value of outflows. In other words the rate of return that makes Net Present Value equal zero.

Hence Hurdle rate is discounted rate – represents the minimum acceptable rate of return most organization choose hurdle rate typically based on their management context:

Traditional – Weighted average cost of capital (WACC)

Competitive – at a threshold higher than WACC to reflect required return

Cash strapped – High level to ensure only projects with quick returns are approved – at best it is set at highest borrowing rate for the organization

Risk level – High hurdle for high risk projects and lower hurdle (WACC) for lower risk projects.

Remember projects with negative NPV will not be approved,  must be zero or even better with positive value.