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What is project financial analysis?
Project financial analysis is a comprehensive examination of a project's financial condition at a given moment in time. It is a key element of project management.
Importantly, it does not have to be performed only when a project is completed or while it is still in a planning phase (so-called post project financial analysis); proper financial analysis can also be used to show the status of the project while it’s still in progress. In fact, it can play a key role in optimizing the project on a regular basis.
Why is financial analysis important for project management?
Financial analysis for a project is a backbone of the entire operation, as it ensures that its ultimate goal - to bring profits to the company - is met.
While this may sound quite obvious, cash flow analysis has even more benefits when we take a closer look at its details. Project financial analysis can help you:
- determine whether you should even consider completing a given project in the first place,
- calculate potential costs and profits of the project,
- see whether a long-term project will be profitable in the future,
- predict operating costs for a project, taking into account all the possible factors that may affect it,
- evaluate the financial condition of the entire project and its parts while it is being completed,
- monitor key financial performance indicators in the project,
- check whether the project is staying in budget,
- improve the financial indicators in a given project and in future operations.
Sounds good? Great - now let’s see how to create a project financial analysis for both prospective and existing projects.
Project financial analysis for a prospect project
Project financial analysis should start even before a project does, as it allows project managers to establish whether or not they should start working with a project at all.
Stages of project financial analysis
Every project life cycle starts with a financial analysis. Still, it is not a uniform process. In general, experts agree that it consists of two main parts.
Part 1: Cost benefit analysis process
Cost benefit analysis in a project financial analysis has a very simple objective: to determine whether or not a project will be profitable for your company. As such, it is extremely helpful for project managers.
This part of the analysis focuses on calculating the key measures capable of evaluating the prospective projects using objective indicators. These indicators include:
Return on investment
Return on investment (or internal rate of return), also known as ROI, is a backbone of every project financial analysis. Its objective is to compare the cost of the project to the amount of money the company is expected to earn from it. In general, ROI is expressed as a percentage; the higher percentage, the better the ROI.
Return on investment - example
For instance, let’s assume that your company has a project. Based on the tracked hours and other costs, the project has generated $150000 in project expenses. However, when you look at the settlements, it turns out that the customer paid $200000 for the job. Therefore, the ROI equals $200000 divided by the initial investment - $150000, leaving you with 133% of ROI.
Opportunity cost
Have you ever wondered what other projects you could have completed while you were busy with this one? Opportunity cost can help you measure the difference and see whether you made the right choice.
To calculate the opportunity cost, check what existing and prospective endeavors you expect to have on your hands when the project in question is supposed to take place. Then, compare their costs and estimated profits to see whether there are some more valuable opportunities you may want to consider. If the project in question is the best choice for the time being, be certain to include it in your project portfolio!
Opportunity cost - example
For the purpose of this example, let’s imagine that the IT company received an offer of completing a project worth $200000. However, according to the resource planning process, the same team could also work on another project worth 150000$ dollars, with the cost of work being the same in both cases: $50000. Therefore, the opportunity costs are nonexistent for the former project - in fact, it is also much more profitable. Therefore, from a financial perspective, it should be the one chosen by the company.
Profit margin
If you are working in an IT company, a maximum profit margin for a project is probably the apple of your eye. However, contrary to popular belief, profit margin is not necessarily the difference between the costs of work and technology for the project, and the amount a customer has agreed to pay for the execution of the project.
In the IT industry, the final margin should include all the other costs of business all the projects have to cover. That includes:
- costs and profits from people’s work,
- project overheads, such as additional equipment, subscriptions, etc.; both recurring and one-time,
- company overheads, such as bills, rent, necessary purchases, etc.,
- costs generated by other departments supporting the project work, such as sales, marketing, administration, etc.,
- costs of internal projects and operations.
Of course, each project should cover a proportional share of all the costs we mentioned above. We explained how to divide that sum in our article on cost allocation.
Profit margin - example
The company has decided to complete a Fixed Price project for 500 000 dollars. The costs of the project include:
- the costs of work: $200 000,
- costs of electronic devices purchased for the project: $10 000,
- cost of other project overheads: $5000,
- the project’s share of company-wide costs, such as support departments, rent, bills, etc.: $8000.
Therefore, the profit margin for the project is the sum of all the costs ($223 000) divided by the income (or project's profit - $500 000) and multiplied by 100. Then, deduct the result of the calculation from 100%. In this case, the profit margin is 55,4% - and it’s pretty good!
Net present value
Net present value is particularly important for the companies that plan to work on a given project for quite some time, or choose to work on retainer projects.
This indicator is commonly used in project financial analysis for such operations as it shows the difference in the current value of cash and the value that cash will have in the future. In other words, it can help you determine whether the future value and the actual profit from the project will outweigh initial investment.
Part 2: Create a project estimate
If you have already ensured that a particular project has a good chance of being profitable, you can now delve into more details by creating a project estimate for the entire operation and all its stages.
To successfully create an estimate for a project, you need to:
- create a project scope that describes all the stages, tasks and necessary resources,
- divide the project into stages and estimate the number of hours needed to complete each stage,
- create a resource forecast for a project and estimate its cost,
- add any company-wide costs that the project needs to cover.
An example of financial estimates in Primetric
However, that list can even be more detailed depending on your needs. We explore the topic of cost estimates further in one of our other articles.
Financial evaluation for an existing project
Project financial analysis may come in handy also when your project is already in progress or close to completion. By then, you can also monitor the project financials in your operation using various indicators that can help you assess the condition of your project. Let’s take a look at them.
Key measures for financial analysis for an existing project
Project profitability
Just like in the example with profit margin above, profitability of the project depends not only on the ratio of cost of work to the planned profits, but also on the costs of other company’s endeavors a project budget has to cover. To get a bigger picture of all the finances while the project is still in progress or close to an end, you need to take into account factors such as:
- cost of work based on the number of tracked hours (time tracking tool can help you gather that information),
- cost of additional purchases for the project, i.e. electronic devices, software, subscriptions, necessary travel expenses, etc.,
- project’s share of company-wide overheads, such as costs of bills, support departments, rent, etc. (learn how to calculate these costs in our article on cost allocation),
- any other costs that affect both the project and the company as a whole.
Each of these factors can act as a separate financial indicator for your post project analysis, too.
Only after deducting all these expenses from the expected or settled profits will you see exactly how much your project earned (or lost!).
Of course, this process can be automated - for example, Primetric gathers the data in the real time to create a comprehensive profitability report whenever you need it.
Monthly profitability report in Primetric summarizes the finances of all the project
Project profitability - example
Just like in the example with profit margin, to calculate the profitability of a project we need to have information on all the costs it needs to cover. In this case, they included:
- the costs of work: $200 000,
- costs of electronic devices purchased for the project: $10 000,
- cost of other project overheads: $5000,
- the project’s share of company-wide costs, such as support departments, rent, bills, etc.: $8000.
At the same time, the customer agreed to pay $500 000 for the projects.
Therefore, to determine the profitability of the project, we need to deduct all the costs from the price of the project. Based on the information we have, the profitability of the project is $277 000.
Employee profitability
As you can see from the list above, profitability includes dozens of different financial factors. Let’s focus on the most important of them - the costs of work.
What should be included in calcuulating employee profitability?
In the service companies, people’s work is the main source of income and expenses. However, in some cases it contributes to the latter more - for example, when a person spends too much time on a mundane task, or when a senior specialist works on a simple feature that could have been produced by their junior colleague.
Therefore, to ensure the profitability of the project as a whole, in the project financial analysis you need to check:
- who is generating too large costs, and why (sometimes additional spendings are necessary!),
- whether there are any delays or other problems that may have caused a sudden spike in the costs of work,
- if there are any people who have completed their work while having some hours in their schedule left.
How to calculate employee profitability?
Calculating the profitability of a particular employee of a given specialist is fairly simple. To do so, you need an information on:
- person’s salary in a given period - x,
- the number of tracked hours for a given period - y,
- hourly wages in the projects the person tracked the time in - z.
Then, you calculate the profitability using a formula (y*z)/x.
Of course, project managers may also encounter some more complicated cases. If that happens, it is recommended to include the capacity in the equation to come up with a reasonable hourly rate for the specialist.
Cost performance index
Cost performance index is an element of project financial analysis that is capable of showing you exactly how the project is doing compared to its budget. This indicator shows whether the number of hours in the project has exceeded the expectations. Therefore, this indicator can be later used to show a fraction of the budget that is left to be used.
Cost performance index - example
Let’s assume that half of project A is already done. It was supposed to take 1600 hours. However, completing the work up to this point took 750 hours. Therefore, we have to multiply the progress (in this case, it is 0,5, because 1 stands for a fully completed project) by 1600 estimated hours, and then divide the result by 750. In this case, the CPI is 1,07 - the project has used 7% more budget than it was supposed to.
How can I measure all of these things?
Naturally, calculating all of these indicators for a project financial analysis by hand is simply impossible - or at least it would take ages. To add to that, manual calculations are often prone to mistakes that may affect the decisions you make (and we bet you wouldn’t like to deal with bad decisions, would you?).
Fortunately for project managers, such calculations do not have to be done on paper. Instead, you can use tools that combine business intelligence with project accounting to show you exactly what your budget looks like. Primetric is one of such tools!
What can you do in Primetric?
Primetric offers a variety of financial tools you can use to create a project financial analysis in just a few minutes.
The tool can help you:
- gather the information on the logged time and convert them into costs using the information on wages and salaries included in the system,
- estimate the costs of each phase of the project,
- allocate resources that will fit in the project’s budget - a search bar will help you do that if you specify a maximum wage of a specialist you are looking for,
- control the costs of work as the project progresses,
- monitor the additional cost in the project, as well as company’s overheads that should be included in the profitability calculations,
- manage settlements,
- compare the actual costs with planned ones to ensure that your project stays in the budget.
Project progress report in Primetric can show you exactly how your operations are going - and how much they cost.
And that’s just a fraction of the features included in Primetric! You can discover all of them right now - simply book a demo, during which our advisors will show you all the possibilities included in our software, or start a trial to see what we are capable of on your own.
Do you want to know more about project finances?
We have prepared numerous resources you can use to expand your knowledge.
Visit our blog and read more about:
- financial performance and how to measure it,
- Jira invoices and other financial features,
- billable and non-billable hours (and why you should use them),
- measuring business performance,
- forecasting revenue.
Or, if you are already looking for a tool that can help you manage your finances, simply book a demo with Primetric experts or start a trial right away!
