The Money Files

Depreciation. It’s something that you have probably heard about but might not be using day-to-day in your work as a project manager. However, if you are working towards the Project Management Professional (PMP)® exam, then you might already know you have to understand the basic concepts of depreciation. You might get asked a question about it.

Depreciation explained

So what is depreciation? I write a lot about different financial aspects of project cost management on this blog but I don’t think I’ve ever covered depreciation before!

Depreciation is a way to split the cost of an item over the life of the item. It is why some insurance companies will only offer you a like-for-like replacement after a loss. If your television is 10 years old, they will pay out on the value of the 10 year old set, not the cost of a new one (which is silly, as you are most likely going to buy a new one, not seek out one that is 10 years old – but that’s a different conversation!).

Depreciation is an accounting treatment that allocates the capital cost of a purchase over the life of the item purchased. If your goods have a finite lifespan – let’s say that TV was going to last you 12 years – then each year a bit of the cost gets accounted for. You are ‘spending’ the cost of the item over multiple years.

Straight-Line Depreciation

Straight-line depreciation has this name because if you draw the cost of the asset on a graph, you get a straight line. You depreciate the overall cost by the same amount every year, based on how long you say the asset will last (this part is accounting magic – your Finance team may have guidelines on how long an asset will last in the world of finance.)

Here’s an example.

Let’s say the lifespan of a computer is 5 years. You buy the computer at the cost of £5,000. First we need to workout the rate of depreciation. £5,000 divided by 5 years is £1,000 a year. That’s 20% of the total cost. So the value of the computer depreciates by 20% each year.

You can see how the straight line appears on the graph below.

Double-Declining Depreciation

There’s another type of depreciation to learn about too.

Double-declining depreciation works on the same principle, but the value declines doubly fast (as you can tell from the name). So in our computer example, the rate of depreciation isn’t 20% per year, it’s 40%.

But – you don’t take the flat 40% off each time. Instead, you take the 40% off the new asset value.

In the first year, you take 40% off the price paid, leaving us with £3,000. This becomes the new asset value. In the following year, you take 40% off again – but off the £3,000. That brings our asset value down to £1,800.

And so on.

When you get to year 5 in this example, you actually have £388.80 left. That’s the value of the asset at the end of its lifespan, and what you would want to try to recover if you sold it as scrap (note: don’t try to sell company computers as scrap, that’s now how to dispose of them!).

The graph of depreciation for our laptop now looks like this.

That’s quite a drop off in year one, and then it levels out a bit as it gets more and more worthless – you know what I mean.

Why you need to know about depreciation

Depreciation is a useful concept to understand when talking to finance people about the assets your project is buying or creating. It’s not something I use day to day, but you might come across it in financial projections for your projects, for example in the business case or forecasts.

Understanding the concepts will help you better understand the way your project is being costed and budgeted.

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How do you talk about risk? Do you talk about negative and positive risk, or threats and opportunities?

And do your colleagues use the same terminology? As a project manager, we need to be able to have conversations about risk – and make sure that the people we are talking to understand what we are talking about! That can be hard to do if you don’t have a standard risk language – terminology that everyone in the business understands.

In this video I talk about the benefits of standardising the way you and your team talk about risk because. With standard vocab you can gain better buy in for your risk management actions because people get what you want to do.

It also allows for comparability between risks between projects, programmes, portfolio and the enterprise level. By all using the same definition of ‘major’ to describe a risk assessment, for example, you ensure that everyone understands the same thing.

This video talks about how to have a conversation about standardisation, and what you can do as a project manager even if you think you aren’t in a position to influence corporate standards on risk.

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This question: What is project cost control? comes up quite a lot. I’m not sure exactly why, but I think it’s to do with project managers wanting to make sure they are putting adequate measures in place to monitor and control spending. After all, it’s not our money. We are responsible for making sure it gets spent in a way that supports the project’s objectives and is fiscally responsible. It can feel like a lot to ask.

In my experience, it is actually easier managing huge sums of money than it is managing smaller amounts. On a teeny budget, every dollar counts. The larger the budget, the easier it is to manage because you have latitude to make decisions within your control and tolerance limits, such as approving an extra $50 for something or dealing with an invoice that’s 10% more than you expected. Having financial responsibility is a good way to help manage roadblocks and get things done on a project.

OK, so what do we mean by cost control? Generally, we’re talking about processes to do with:

• Budget planning
• Estimating costs
• Budgeting
• Financing and funding i.e. finding the money from somewhere, applying for grants, securing financial support etc
• Managing costs i.e. the day to day operational effort of raising purchase orders for the correct amounts, receiving and matching invoices, tracking line items of project spend and ensuring that what you are spending isn’t more than what you thought you would.

All of these help to ensure the project can be completed within the approved budget.

One of the biggest areas of focus for cost control is budget tracking.

What do you track in a budget?

Let’s say you’ve started the work. What is it that you should be tracking through the project?

You can track:

• Forecast expenditure: What you are predicting to spend for the rest of the project
• Actual expenditure: What you are actually spending.

Actual expenditure itself is a bit of a vague term because it’s often used to encompass three other terms:

1. Committed spend: money you have definitely committed to spend. For example, you’ve raised a purchase order or placed a firm order for services or goods.
2. Accruals: where the work has been completed (or partially completed) but you haven’t paid for it yet, or you haven’t paid all of it yet.
3. Actuals: this is what we typically think of as ‘actual expenditure’. It’s money out the door, leaving the bank account, to settle an invoice or otherwise pay for something. The money has been physically spent.

Tracking budget KPIs

Another part of cost control is making sure that any financial reporting for the project is complete. Cost is normally a big factor in deciding whether the project is on track for success or not – I’ve certainly found execs to be very interested in the cost performance of projects, especially the larger budgets. They want to know the money is being spent in the way they expect and that we’ve got enough of it to get to the end.

Cost is typically a key performance indicator, but you might find it worthwhile to track other budget related KPIs. In a programme, you might track return on investment for projects that have completed, for example.

Who does project cost control?

The project manager is often fully responsible for project budget management, but you could also have a Finance person attached to the project (I had this once – he was great). Depending on the size of the project, and the size of the budget, you may be able to have someone on the project’s senior team leading on cost tracking.

Your corporate Finance team will also be involved, even if much of the day to day handling of invoices etc comes to you. They may rely on you to approve invoices (because you are best placed to confirm the work is complete) but they’ll be processing the payments in operational systems and checking they have been correctly posted to the right cost centre for accounting purposes.

Checking viability

Another part of cost control happens when the project is formally reviewed. The review happens anyway, and cost is part of the discussion, and part of the decision about whether the project is still viable.

One of the factors to take into consideration is sunk costs – costs that can’t be recovered because they have already been spent or committed including costs that would be incurred if you cancelled a contract or similar.

However, execs sometimes look at sunk costs and think they must continue the project because they’ve already spent money on it, even if all other signs point to the project being stopped. The viability check needs to take that into account: but why throw good money after bad? If you can’t salvage the project, don’t spend more on it just to get it to ‘done’. That would continue to be a waste of resources.

The project manager’s role is to input to these kinds of discussions with full facts and an approach that draws on commercial acumen, so the team ends up making the right decision for the future of the project.

Planning for risk

Finally, cost control also involves planning for financial risk – in fact, planning for any type of risk.

Dealing with risk costs money, because you’d want some kind of budget to pay for risk management actions such as mitigating the potential problem. Risk and issues can mean paying out for things you didn’t expect to have to fund.

The more risk budget planning you can do, the better prepared you will be, and the less likely it is that your overall budget will suffer. You’ll have more time and money to deal with the problems because you planned for them.

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There are loads of things that make a project complex, and in the past I’ve written about criteria for complexity and what ‘true’ complexity means.

However, I’m now leaning towards the opinion that if you think it’s complex, it’s complex. The benchmark from which to approach managing complexity is whether you are worried about it being complex. Because if you are struggling with all the moving parts, then other people in your business probably are as well, and you all need strategies to get things feeling more comfortable.

OK, your project might not tick all the boxes for ‘pure’ complexity as defined by academics, but who cares about that, right? We want YOUR project to be successful, and that means meeting you where you are, and dealing with the stakeholders and the situation you find yourself in.

So when you’re feeling like things are getting out of control and the complexity level on your project is spiralling, what can you do about it? The infographic below sets out – in a high level way – three ways you can start to approach complex situations. Ultimately, the aim is for you to feel like things are under control.

Take whatever steps you need to that help you identify where the complexity is coming from and then break it down to deal with each part.

There’s more information about how to reduce complexity on projects in this article.

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We all know we have to do risk management on projects. And beyond that, our businesses should have enterprise risk management in place, because… well… it’s the right thing to do.

However, if you’ve ever had to convince a project sponsor that it’s worth spending time on risk in a project board meeting, then you’ll know that sometimes not everyone feels the same way about risk management.

When you need to have conversations with your stakeholders and teams – and perhaps even the leadership in your organisation – about why risk management is a worthwhile endeavour, then this video will help.

I talk about the benefits of managing risk at an enterprise and project level. Specifically, we do risk management:

• Because it meets mandatory requirements
• For assurance
• For effective decision making
• For process efficiency.

Watch the video below and then let me know – what are the benefits of risk management that are the most important to you?

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