Something that has probably crossed your mind while reading all about project management has been the cost of everything and how you would manage that whole area as well. This post is meant to be an introduction into the world of project finances. We will discuss some of the basics of what we call “Project Cost Management” and some of the terms and concepts that come with the idea. The reason that we will discuss this is because of the need for project managers to understand a lot of the terms that a board, product owners, business owners might understand more. It is hard for someone with no experience in the IT field to understand IT terms, but it would be a lot easier for you as a project manager to learn and understand finance terms. This helps not have a disconnect between the development team and the board that might be providing funding for the project. Now that we understand the importance, get ready to delve a little bit into the world of finances!
Profits
This is the one term that most people will automatically understand so I won't provide too much explanation here. But simply put, your profits are what you actually make off of whatever you are selling or providing. Once you count the revenue associated with the project, minus whatever you spent to make it and then you have your profit. There is also another term people associate profit with and that would be profit margin. Profit margin is “the ratio of profits to revenues (Schwalbe)” and is normally displayed as a percentage.
Life Cycle Costing
Now this is something that you will definitely need to understand as it is very important to the financial state of a project. This is not something that is just for the period of time that the project is in development but the purpose of this is to look at it the entire time that this system will be in use. This is the big picture view of the finances of a project and helps you and others to get a good estimate of what the benefits, profits and expenditures of the project will be for the future.
One of the reasons why this is a good idea is because of the tendencies of project spending within companies. Companies tend to spend less money than necessary at the beginning of the project and this leads to very bad things down the road. Knowing what the Life Cycle Costing of the project is will help with this because you know how much money to put into the project upfront and also how long you expect this system to be in use. Having an important IT service be down for any amount of time can cost a company millions of dollars, so it is good to be sure that you have put the money and work in upfront to prevent these kinds of losses.
Cash Flow Analysis
This is especially important because of the value that it has in management circles and it is very important that you learn what it is as well. To begin with, Cash Flow Analysis is a method that helps you determine “the estimated annual costs and benefits for a project and the resulting annual cash flow. (Schwalbe)” The end result of performing this process is net present value. A company's management must be able to see the cash flow analysis of each project so that they know what they can afford to spend money on. If too many projects have high cash flow needs, then they will need to decide what projects are worth spending the money on.
Tangible and Intangible Costs
These two terms help define what the costs and benefits of a project will be. Tangible costs are much easier of a thing to define when it comes to a dollar amount associated with an item. This really just relates to how much money the company spends directly to develop the project.
Intangible Costs are a lot more difficult to measure in a dollar amount because they are harder to quantify. Take for example there is an IT project that you and your team are working on that requires some members of the team to use some of their personal time to research certain things that may help on the project or are required knowledge for it. That would be an example of intangible costs because the hours that are being used to research things are not billed hours so it is hard to estimate the work and cost that went into that time.
Direct Costs
So these are the costs of the project that are directly related to making the product. This could mean that the salaries of the people working on it, cost of hardware and software purchased to complete it, etc. These are very easy to define as well because they are just numbers on a spreadsheet.
Indirect Costs
Just like the difference between tangible and intangible costs, the difference between direct and indirect costs is the fact that indirect costs are not directly related to creating a project. Some examples of indirect costs include the costs of running a building in which multiple projects are being worked on. These are a lot harder to have control over than direct costs and that is where the biggest difference is between the two.
Sunk Cost
This is an important term to understand as not only a project manager, but also as someone who is taking part in a business where money is at the forefront of thought for the most part. Sunk Cost is money that has been spent in the past and is gone. There is no recovery of this money, which is why it bears the term “sunk”. Imagine that at the company you work at, a couple of years ago they decided to put $3 million dollars into a project that ended up failing. That $3 million dollars would be considered sunk cost. One of the mistakes that people make when thinking about this money is that since there was already so much money put into it, even though it failed, that they should consider putting more money into it to try and revive the project. Heed my warning, this is a terrible idea. Do not fall into a gamblers trap of throwing money on the table just because you have already lost money and are trying to recoup your losses. That money is long gone now and the best thing you can do is move past it.
Media from Wix
Reserves
You should be familiar with this term but we will talk about it anyways. This is money that is stored away as a way to mitigate risk because you have some financial stability should something happen out of the blue. There are a couple of different types of reserves though.
Contingency Reserves: These just allow for situations that can be partially planned for and also are most of the time included in the financial plans for the project.
Management Reserves: These are more of what you think of because they allow “for future situations that are unpredictable”(Schwalbe).
Sources
Schwalbe, Kathy. Information Technology Project Management. Available from: Yuzu, (9th Edition). Cengage Learning US, 2023.
Comments