The Money Files

Payback period is a term that you’ll seen on business cases and in other project selection documentation. It’s a criteria that helps organisations decide if they want to go ahead with a project or not.

But what is it? And how can we use it to our advantage?

Payback period refers to the amount of time required for your investment to pay back. In other words, it’s the time taken to ‘earn’ the amount of the original investment.

Let’s say you own a hotel. You build a penthouse room on the top. It costs £100,000 to build (you get the materials very cheaply! Go with me, this amount makes the maths easier).

The price for one night’s accommodation in the penthouse is £100.

Therefore, you need to sell 1,000 nights of accommodation to break even.

 100,000 / 100 = 1,000.

The payback period for this room is 1,000 nights.

That example is SO simplistic but hopefully you get the idea. Payback period measures how long something takes to pay for itself.

What kind of payback period is best?

The best kind of payback period is the shortest!

The faster something can pay back, and start bringing in profit, the better in business terms. Once you have broken even, payback period has been completed and any money earned after that is extra – the benefits you were hoping to see.

I love using payback period because it’s easy to understand and easy to work out. If you are comparing projects, when everything else is equal, the project with the shortest payback period should be the one you do first.

Of course, in real life projects aren’t equal in all other respects. You will be juggling a range of other selection criteria, of which, payback period is only one. However, it is a useful measure to look at first, to give you an idea of the effort involved in earning anything from this project. Something that has a payback period of over 10 years might not be worth doing at all and can be eliminated from project selection.

Depending on your industry, payback periods could be short or long. Any type of large-scale construction project will necessarily have a longer payback period than launching a fast-to-market consumer app. Some projects may not pay back for years, and still be worth doing. You know your industry and projects better than I ever will, so apply your professional judgement and consider what the ‘appropriate’ kind of payback period is for your organisation.

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Project managers often get concerned about project cost control. This video talks about what project cost control actually is and why you shouldn’t be worried about getting to grips with your budget. Most of what you have to do is the same type of ‘monitoring and controlling’ you do on other areas of the project, so it isn’t really that different… just with large amounts of cash attached!

This video aims to demystify project cost control and share some thoughts about just getting started.

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Thinking about doing some project management training this year? Here are some things to consider to help you choose the right vendor for you.

You know I’m interested in the financial aspects of project management – I’m even thinking of teaching a workshop on project budgeting and accounting later this year. I feel like I’ve got quite a good understanding of the topic, but I’m constantly learning.

Having only done a very small amount of work in a team I would say is using agile practices, I am by no means an expert in the practical ways of making agile approaches work on project teams. However, there is a lot of guidance out there for people like me who want to learn more.

The Agile Practice Guide, in particular, has some interesting information about how to apply information from the PMBOK® Guide Knowledge Areas to agile work processes. From a financial perspective, here’s my interpretation of how this would work.

Project Cost Management in Agile Environments

Typically, on predictive projects you would do a lot of costing and estimating in advance. For projects with a high degree of uncertainty, or those where you don’t have a fully-fleshed out scope (hello, agile projects), then obviously you don’t have the data to do this level of cost analysis.

Instead, the recommendation is to use “lightweight estimation methods” (although no detail is given as to what these might be) to come up with fast, high level cost forecasts for resource costs. I can see this working when you are forecasting the general length of a particular engagement – even if you simply plan out the resource costs for the next financial period as a basic benchmark.

Detailed costs for things that aren’t people costs do still need to be done. You can’t run a successful business if you aren’t aware of what project work is costing you. It is OK, however, to do those detailed analyses on a more just-in-time and rolling basis.

To be honest, on some of the long programmes I’ve been involved with we’ve taken the same approach. The business case costs might have been fixed from the start, but frankly they were only ever our best estimate at the time. I then worked out detailed forecasts for the actual year we were in, so the Finance team could manage cash flow and we could accurately account for the capital outlay in the current financial year.

Where your budget is fixed, but you still need to be agile in other respects, then your choice is simply to flex scope and schedule to stay within the cost constraints.

Project Procurement Management in Agile Environments

Procurement management is another area where we incur costs, and as project managers, we need to be aware of how to manage that – in all environments.

Typically, procurements I have been involved with have had a protracted contract negotiation at the beginning to come up with a Master Services Agreement, and then you define the current engagement with a Statement of Work. As we needed suppliers to do extra things, we created new SoWs detailing that engagement. This is also how change control worked: the change control process generated either a credit note (when something was being changed and the end result was the development cost less) or a purchase order and an addendum to the current SoW.

It turns out that, according to the Agile Practice Guide, this is a pretty agile way of working.

There probably are projects where it is prudent and necessary to sign a massive contract upfront (ERP deployments spring to mind, from experience!) but generally, staying small with the engagement and working in a flexible way will suit both parties on the majority of projects.

Either way, something that is the same regardless of the project management approach you are taking is the need to document contractual arrangements and file them somewhere you can easily find them again. I have had a few moments in my career where I have sheepishly rung a vendor and asked for a copy of the executed contracts because – whisper it – it wasn’t possible to find our version of the same document.

Don’t make that mistake! Be agile. Be tidy!

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I thought it was time to look at some more financial concepts. Last time I looked at depreciation, and today it’s the turn of Present Value and Future Value.

I write them with capitals because they also stand as abbreviations: PV and FV.

The basic idea behind them both is that they talk about how much an amount of money is worth at any given time. From a project management perspective (and in life in general), it’s better to receive the money now than get exactly the same amount of money in the future. Because of inflation and cost of living rises, £10 today doesn’t buy you what it did 10 years ago. And when I think of what my parents paid for their house…!

If someone offers you £10 today or £10 next year, you’d take it today. And that’s what underpins the concepts of PV and FV.

Understanding Present Value

Present Value is a way of ‘levelling out’ how much money is worth, so you can compare its earning/spending power today and in the future. This lets your calculations account for inflation (or deflation). You can use the calculation to compare cash flow across the lifespan of a project or the benefit cycle, and you’ll be comparing on a more even basis. And by using a standard formula, everyone can clearly see how the information has been reached.

(Note: PV is not the same as Net Present Value, which in my experience is far more likely to be found on a business case. Net Present Value is useful for working out whether a project is worth doing, so it’s commonly used as a metric for project selection. There’s a worked example I found useful for calculating value in projects here.)

Present Value tells you how much the money of the future is worth today.

Understanding Future Value

Future Value tells you how much the money of today is worth in the future. I found this a lot easier to understand than Present Value – it’s pretty easy to understand that with interest and/or inflation, you need more money in the future to buy the same things. Anyone who has seen the cost of newspapers rise will get that basic idea.

For those of you who are interested in what this means for your exam prep, pop your figures into this formula:

PV = FV / (1+r)ⁿ

In real life you aren’t going to be calculating this by hand. Your Finance team will do it for you, or you’ll have some kind of project assessment spreadsheet with the formulae built in. The benefit of understanding the formula in your day job is to be able to have informed and intelligent conversations with your project sponsor and colleagues about project cost, and to be able to input into the debate about whether the project is worth doing or not.

A note on NPV

The other thing to know is how all this relates to NPV. NPV, as I noted above, is more likely to be the measure your organisation uses to determine whether to move forward with a project.

Here’s what you need to know, at a high level:

• NPV > 0 — the project is going to be profitable
• NPV = 0 — the project will break even
• NPV < 0 — the project will not be profitable.

You want your project to have a high NPV and you should discourage your sponsor from trying to pursue projects where the NPV is less than zero unless there is a really, really strong business reason to lose money on an initiative!

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