The Project Notebook

The Speed and Economics of Trust

To prepare for the PMI Leadership Institute Masters Class in October, I’ve been reading a digest of Steven Covey’s book, The Speed of Trust. He suggests that trust simply means confidence and that trust impacts (in PM terms) time and cost. We can see how this operates in the world around us:

– the cost of drug packaging increased after the Tylenol poisoning case
– the time to get through an airport increased after 9/11
– the decline of trust in corporations arguably began with Enron, resulting in costs and time for meeting Sarbanes-Oxley compliance

The summary I’m reading only gives one example of high trust (a Warren Buffett acquisition), but in thinking back, high trust has had a positive impact on my project management:

– I’ve been frequently called upon to handle failing projects or project gaps where execution was critical
– my projects have had regular reviews (weekly or monthly) while others have had more frequent scrutiny to the point where execution was slowed
– working with teams where trust is strong has helped meet or beat parameters and build high performing teams

Covey suggests that the traditional business formula of Strategy x Execution = Results is actually (Strategy x Execution) x Trust = Results. This would move trust from a “nice-to-have” to a critical position, making it required to achieve results.

The book outlines 13 behaviors exhibited by high trust leaders. The first one caught my eye — its no wonder why most politicians, used car salesmen, and many executives have an issue with trust. The behavior is “Talk Straight”. This means to communicate clearly to make sure there is no misunderstanding. No withholding, partial truth, flattery, spin or distortion of facts. (This one is easy for me… as a former New Yorker, I’m always direct).

Another concept I can readily identify with is that one of the four cores for building trust is results. Jack Welch talks about results as having clout or performance chips on the table. Results are evaluated by past performance, present performance, and anticipated future performance. Low Results = Low Trust.

This is a very difficult book to summarize because there are many dimensions of trust which are explored. So my suggestion would be to go out and get a copy because it will be a great tool for building high performance teams and achieving project excellence.

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Practical Budgeting for Project Managers – Conclusion

Budget Risk Assessment
Once you have created your draft budget, it should be subjected to the same review process as estimates discussed within the course materials. A line by line review should look for all the risks. Depending on your company and/or client policy, having a 15-25% contingency to manage risks is normal. You may want to consider an additional contingency for unplanned risks.

Most budgeting risk is centered around people. There may be project team members with unknown skill levels, insufficient staffing, outsourced work which cannot be managed as closely, or unique, specialized resources which are difficult to obtain at the right times. Another standard risk for the construction industry is the environment and weather. Each risk will require evaluation and a potential budget adjustment to ensure the best possible budget is formulated.

Longer term, multi-year projects need to consider inflation. Take the case of the interstate highway system which was constructed over a 35 year period. Inflation during the 60s and 70s was high and drove the project significantly over budget. Another example of a construction project impacted by inflation was the “Big Dig” in Boston. A factor for inflation might be added to the budget through the risk management process.

Budget Presentation
There is obviously no one single format for budgets. You should select categories according to the expense types and in alignment with your company’s financial reporting. Here an an example:

PMBOK® Guide, Fourth Edition; PMI 20081
Project Management: Engineering, Technology, and Implementation; Shtub, Bard, & Globerson; Prentice Hall 1994
Quantitative Costs in Project Management; Goodpasture; J. Ross Publishing 20042
Project Management Jumpstart; Heldman; Sybex 20052
Identifying & Managing Project Risk (2nd Edition); Kendrick; AMACOM 2009

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Practical Budgeting for Project Managers – Part II

As you start to plan your budget, you should review previous budgets for similar work if they are available. You will need to form the budget based on historical experience and performance, plus your current WBS and estimates. When the schedule is created, you will need to look at resource availability. The most difficult part of the process will be to think through ALL costs.

Basic Project Costs
Human resource costs. Here you want to use the fully burdened rate for all project team members. This includes salaries and wages, bonuses, and other benefits. For co-workers who are salaried employees, this information is usually treated as confidential, but your finance department may be willing to provide a composite rate representative of groups of employees or job classifications. Human resources costs, even for contractors, never have sales taxes involved.

Administrative costs. These are costs such as phone, copiers, office supplies in the event they aren’t supplied by your company as a part of their normal operations. These may include sales taxes and other fees.

Resource costs. These are other purchases of materials or equipment which may be needed for the project. Be sure to consider all costs, including fees and taxes.

Direct & Indirect Costs
Your project costs may be considered direct or indirect. Direct costs are those costs which are for items or resources specific to your project. These may include salaries, rentals, team training, software, and other materials. For example, the direct costs for a project to install a local area network would include routers and bridges, cabling, connectors, tools, labor to install cables and equipment, vendor training for the equipment, and so on.

Indirect costs are not directly related to the project. These may include shared costs such as the lease for the building your company occupies or utility bills for power and water. Indirect costs aren’t usually within the control of the project manager or project team, so it is rare they need to be considered in your budget. You should discuss this with your project sponsor, however, to find out how the company accounts for these costs.

Capital Budgeting
Capital budgeting involves large ticket purchases. The capital budget is usually determined by techniques such as Net Present Value to maximize shareholder return. The large ticket purchases are usually paid for immediately in cash, but the company is permitted to recognize the expense over time.

By representing the expense over time, it is believed investment will be encouraged. This is perhaps done through a compromise. First, the impact of the expense on the company balance sheet is lessened, enabling a more favorable picture. Second, the time period is determined by an accounting concept of “useful life”. The standards for “useful life” are usually shorter than the operating time of an asset. Computers, for example, are often written off over a three year period, but can often run in production for many years beyond their “useful life” period. Once they have been fully written off (all the expenses recognized), companies still have an operating asset and can invest on other needs, establishing a cycle of upgrades to plant and equipment which enable continuous improvement to the operations of the business.

Capital budget items might include upgrades to plant and equipment, purchase of expensive new equipment, or expensive software licenses. The expenses are usually recognized over time by a technique known as depreciation. Depreciation determines how much of the expense needs to be recognized every year and is usually based on the reduction of value due to wear and tear, the passage of time (obsolescence), depletion, or inadequacy. Capital budgeting and depreciation are complex topics and should not be approached without discussion with your finance or accounting department.

Depreciation Illustrated
This chart adopted from Quantitative Costs in Project Management by Goodpasture illustrates just two of several techniques to manage depreciation. It illustrates the effect on the company balance sheet and a P&L; statement which could represent project expenses passed on to the project manager’s budget.

In the depreciation technique known as “straight line”, equal amounts of the expense are represented on the P&L; statement each year (in the case of the crane, one fourth of the $500,000 expense). So in the year the crane was purchased, we see the $500,000 asset on the balance sheet and no depreciation. In subsequent years, the value of the asset is decreased by the $125,000 amount of the straight line depreciation.

The software license illustrates a technique known as “sum of the years”. In this case, a fraction of the expense is represented on the P&L; statement each year. The fraction is determined by the number of years added together as the denominator (4+3+2+1=10). I’ve written the years in backwards order, since this is the order in which the years become the numerator. So for the first year, 4/10 or 40% of the expense is represented on the P&L; statement. 30%, 20% and 10% are applied for subsequent years until 100% of the asset is fully depreciated.

As I’ve mentioned, the depreciation techniques and decisions are typically made by senior management and the finance department. Be sure to consult with them if there are questions about capital budgets. For those interested in the handling of revenues, the applicable term is amortization.

Next week: budget risk

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Practical Budgeting for Project Managers – Part I

[In a recent update to an online course, Controlling Project Costs and Risks, I added a version of this material]

What is a Project Budget?
Let’s start with the PMBOK® Guide, Fourth Edition definition:

[Budgeting] is the process of aggregating the estimated costs of individual activities or work packages to establish an authorized cost baseline.

Project budgets constitute the funds authorized to execute the project. Project cost performance will be measured against the authorized budget.

Unlike corporate balance sheets and income statements, project budgets are normally about expenses and not revenues. Revenues are normally considered a part of the sales process or product management process, where sales must meet revenue targets established by senior management. Senior management initiates projects to create products and services, and the project manager is often responsible at some level for the budget.

Consistent with the PMBOK® Guide, this presentation is going to exclude consideration of revenue. Those managing product development may indeed be required to look at revenue, and the budgeting principles are very much the same as for expenses. Those managing products also need to be able to trace the flow of money at times to defend their product. For example, I was once turned down funding for a product which was given to all users for free. Tracing how the money flowed, I found that more than half of the revenue of a particular high profit margin product would be cut off if the “free” product didn’t exist. Using that argument, I was successful in securing the necessary funding to improve the package for which I was responsible.

The Project Manager Role in Budgeting
Project manager involvement in the budget process often depends on company culture, process, and policy. During my career, I’ve been personally involved with budgets at different levels:

-Projects where all resources were salaried employees and their costs were not tracked at the project level.
-Projects where I was provided with a budget and had to work within its constraints.
-Projects where I created a plan, then a budget, and negotiated the final budget with senior management.
-Business units including projects with projects managed to one of the above levels.

Understanding some basics of budgeting will enable you to successfully work in any project environment.

There are many ways to approach budgets. The high level budget presented in the project charter is usually top down, based on rules of thumb or heuristics. To successfully manage project costs, the project manager will need a more detailed understanding of the project and should create a budget bottom up based on the work packages of the work breakdown structure. For larger projects or rapid application development projects, the bottom up budgets may be reviewed iteratively.

Next week: We’ll look at the budget considerations for types of costs.

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© 2010-2012 Ray W. Frohnhoefer, MBA, PMP, CCP