Summary of Important Points


Summary of Important Points

Table 5-11 provides the highlights of this chapter.

Table 5-11: Summary of Important Points

Point of Discussion

Summary of Ideas Presented

Financial statements

  • The general body of knowledge for accounting standards is contained in the Generally Accepted Accounting Principles.

  • Four statements for project managers are: the P&L expense statement, the cash flow statement, the balance sheet, and the trial balance.

P&L statement

  • The expense statement, sometimes known as the income or P&L statement, is an ordered list of the revenue and expense items for the project.

  • Expenses within the project WBS are coded and identified according to the expense statement.

Balance sheet

  • The balance sheet is where the unrecognized expense is maintained until the time comes to "expense" it to the expense statement.

Cash flow statement

  • The cash flow statement is commonly thought of as the place to put down the sources of cash and uses of cash in the project.

  • There are only two ways a company generates cash: (1) decrease an asset or (2) increase a liability.

Discounted cash flow

  • DCF is taken to be the present value of net cash flow or net cash flow from operations.

  • The discount rate, sometimes called an interest rate, but also called the cost of capital rate or factor, is the discount applied to future cash flows to account for the risk that those flows may not happen as planned.

  • IRR = discount rate for which NPV = 0.

Trial balance

  • The trial balance is a report of debits and credits by account.

Capital budgeting

  • Capital budgeting is about how to budget and spend cash for the big-ticket items on the project.

  • Capital budgets refer to those project budgets for which cash is paid out now, in the present during the project execution, but for which the expense will be recognized in the future when the item is put into use.

Opportunity cost

  • The opportunity cost of the difference in returns, after risk adjust ment, between one project opportunity and the next most favorable opportunity that is competing for the same capital.

Net present value

  • Present value (PV) = Future value/(1 + k)N.

  • NPV = PV (all inflows) - PV (all outflows).

  • Decision policy: Only projects with NPV $0 will be selected for execution.

Economic value add

  • EVA is a risk-adjusted quantitative measure of project performance.

  • A project should earn more in profits than the cost of the project's capital employed.

  • EVA = EAT - k * CCE.

  • NPV (net cash flow from operations) = EVA (after-tax earnings).



References

1. Pike, Tom, Retool, Rethink, Results, Simon & Schuster, New York, 1999.

2. Higgins, Robert C., Analysis for Financial Management, Irwin McGraw-Hill, Boston, MA, 1998, chap. 1, pp. 16–21.

3. Higgins, Robert C., Analysis for Financial Management, Irwin McGraw-Hill, Boston, MA, 1998, chap. 1, p. 19.

4. Higgins, Robert C., Analysis for Financial Management, Irwin McGraw-Hill, Boston, MA, 1998, chap. 1, p. 238.

5. Finegan, P.T., Financial incentives resolve the shareholder-value puzzle, Corporate Cashflow, pp. 27–32, October 1989.

6. Tully, S., The real key to creating wealth, Fortune, pp. 38–50, September 1993.



Chapter 6: Expense Accounting and Earned Value

Overview

Every individual endeavors to employ his capital so that its produce may be of greatest value.

Adam Smith
The Wealth of Nations, 1776

Most project managers keep track of two financial measures for their project: the dollar amount budgeted and the dollar amount spent. If the project manager spends less than budgeted, then very often the project is considered a success, at least financially:

  • If: $Budget - $Spent $0, Then: OK; Else: Corrective action required

However, the two measures of budget and actual expenditures taken together as one pair of financial metrics do not provide a measure of value obtained and delivered for the actual expenditures. The fact is that all too often the money is spent and there is too little to show for it. Thus, in this chapter we will "follow the money" a different way and introduce the concept of "earned value," which often draws a different conclusion about project financial success:

If: $Value delivered - $Spent $0, Then: OK, Else: Corrective action required Before getting to the earned value concept, however, we will revisit the P&L (profit and loss) statement discussed in Chapter 5 to understand the various expense items that might show up on an earned value report in the categories of $Spent and $Value delivered.