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Categories: accounting
Over the past months we have looked at payback period, internal rate of return, benefit cost ration and net present value. Today I want to introduce two other financial metrics.
Discounted Cash Flow
As with a lot of these metrics, different companies have different ways of calculating them. Discounted cash flow is all about the time value of money. You use it to work out how much stuff in the future will cost you at today’s prices.
You can use it to value a project in terms that the project board – or whoever is assessing the business case – will understand. If we do this project, the value is £x, and that project has a value of £y.
In other words, you work out how much cash your new fancy project will generate for the company, knock a bit off of because prices go up in the future, and that tells you the value of the income today.
OK, that is a terribly simplistic view of discounted cash flow. The good thing is that you probably won’t ever have to work it out yourself. Your Finance team or your project office accountant will be able to plug the right figures into the equation, use the standard discount rate for your type of project and you just add the numbers to the business case.
The only other useful thing to know is that discount rates are normally linked to the cost of the capital. So, if it costs you 5% a year to borrow money to invest in your new engineering product or to hire the land that the new shop is going on, then that will factor into the discount rate calculation. In other words, it’s not just about inflation.
Activity-Based Cost Management
Don’t you just love all this terminology? I think it’s important for project managers to understand these terms because even if we never have to work them out for ourselves you don’t want to be bamboozled by your colleagues in Finance, or even business people who are used to dealing with profit and loss accounts and business cases.
Activity-based cost management, or ABC/M, just means working out how much each activity costs. It’s a bit more scientific than just assigning day rates to different types of resources as it also looks at processes. The idea is to calculate how much different routes through the processes cost, using different types of resources including customers.
That gives you the activity-based part. You can then do the management part, which is analysing the results and working out if there are smarter ways to do things. If you know the elements that add the most cost to the process, you can work out how to influence these and deliver more stuff for less money.
Personally, I can see the value in doing this in manufacturing and engineering environments, but up until recently I couldn’t see the value in doing it in other sectors. After all, so much is non-standard, as we try to give personal service to everyone. But actually there are a lot of things that can be standardised, and even standard costs give you an indication of the success (or value) of the process. Projects drop out of this data.
For example, turnaround times in airports. If you knew which type of planes, terminals, crews and passenger combinations took the most time to get the flight in the air, you could launch a project to assess the process and speed it up. Or you could look at locations and crews that had great turnaround times and replicate the success where you could. The same goes for the cost of surgery in hospitals, supply chains, and customer service teams handling different types of customer problems.
While ABC/M takes a lot of effort and number crunching, it’s a useful tool. Does your Project Management Office do anything like this? Let us know in the comments.
Posted on: December 14, 2011 03:53 PM |
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