The Project Notebook

PMP® Challenge Question – 4/15

Happy Tax Day! Just a little late with the post since I took the day off in celebration. On 4/1, I asked what does each abbreviation stand for:

CR – Cost Reimburseable. This is a contract where the seller is reimbursed for their costs. There is usually a fee or some other payment representing the profit.
CPFF – Cost Plus Fixed Fee. The contract is a variant of cost reimburseable with a fixed fee component. This type of contract tends to favor the buyer.
FPFT – Fixed Price, Fixed Time. This is a contract in which the seller absorbs all the risk by guaranteeing a price and time to complete.
CPRC – Oops? Did you think this stood for something? Its not a valid procurement abbreviation.

Now for the 4/15 challenge:

Explain the function of sum of the years depreciation.

Good luck with the challenge!

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

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.

“Yours, Mine, or Ours”: Is Outsourcing the Answer?

By: Susan Peterson, M.B.A., PMP
Copyright 2008, Susan Peterson, All Rights Reserved

Both private and public service sector organizations face an ongoing challenge to determine whether functions should be performed internally or externally. While much is written about how to make this decision from an organizational strategic perspective, there are few guidelines for the project manager to use during the initiation and planning phases. Too often outsourcing decisions are made on the basis of past practices rather than assessing the current project situation. This month’s column is the first in a multi-part series that addresses project-related considerations regarding whether to outsource, insource, or employ a hybrid approach. The first area of focus covers some considerations of the initial decision.

“How could the core competencies have changed?”
It might appear that an organization’s core competencies are “cast in concrete”. However, in this environment of continual mergers/acquisitions, spinoffs, virtual entities, and other structural impacts, project managers often find that the composition of their teams changes frequently. What an organization once considered a strength, such as specialty engineering design or innovative research capabilities, may drop in priority and thus no longer be supported through effective hiring practices or major budget funding. In determining if appropriate in-house personnel will be available, a project manager needs to perform a scan of other current and proposed projects. What activities are being outsourced for other projects? Does the outsourcing appear to be the result of personnel shortages due to short-term allocation issues or to an overall lack of skilled personnel? If the constraints are short-term, then outsourcing may be a viable alternative. However, if the constraints are long-standing, a decision needs to be made by the organization to address long-range outsourcing/insourcing strategies.

“Who can keep a secret?”
Access to proprietary, competitive, and/or classified information may be an essential part of conducting a project’s activities. There are a number of legal agreements that are signed by employees and outsourcer organizations alike that stipulate restrictions on the use of knowledge obtained in the course of performing work. Typically, severe penalties are also documented in these agreements. In reality, violation of confidentiality may be difficult and/or costly to prove. Once proprietary information is “on the streets”, punishing the guilty does not mitigate the damage. Therefore, the primary consideration in assessing the risk of divulging company secrets to an outsourcer organization is to research its actual ethical conduct (not website statements) and its personnel practices.

“All of the problems will vanish.”
In so many cases problems do not disappear just because an outsourcer organization is contracted. The root causes of problems need to be analyzed to determine if the issues are internally based. For example, an organization may be experiencing project management problems due to its lack of understanding of effective project practices. In this type of situation an “outside” project manager may be a strong asset not only in leading a specific project but also in providing a positive example of good project management that the organization can emulate in the future. However, if the project management problems arise from constantly shifting priorities among multiple projects that cascade to under funding and inadequate resource allocation, then an “outsider” will also get pulled into the whirlpool of project dysfunction.

“Ours” blends diverse strengths and needs.
Outsourcing is not necessarily an “either or” decision. In some situations a “hybrid” approach may be effective both in the short term and in the long term. This approach involves outsourcing specific team responsibilities that will not be needed after the project is implemented. Internal employees are then assigned to roles on the team that will either continue after implementation or that will transition to other projects. Additional contract workers may be used to augment certain project tasks that need extra people only for the duration of the project. This approach provides the long-term benefit that knowledge learned during the project remains within the organization while addressing the short-term need for specific expertise and additional labor.

By this point in reading this column, readers may note that nothing has been mentioned about costs. Too often illusions about costs drive the outsourcing decision without regard for project needs. Next month’s column will include cost considerations that should be addressed only after the true project needs have been identified.

Susan Peterson, M.B.A., PMP, is a consultant who manages diverse programs and projects in both the private and public sectors for individual organizations and consortia. She also conducts enterprise assessments of project portfolio management practices. An overview of her program and project specialties is available at http://www.pmi-sd.org/Consultants. She teaches the Project Management Simulation capstone course in the University of California, San Diego, Project Management certificate program and is a member of the curriculum committee. She can be contacted at susanada@aol.com.

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