While there may be many projects that could get initiated organizations usually don’t initiate all of the prospective projects they possess. The reason why? M-O-N-E-Y. Companies only have so much capital to invest in projects. Furthermore, companies only have so many resources (as in folks like you) that are available to do project work. So project managers, project sponsors, and management as a whole have to make some tough decisions as to which projects will get initiated and which projects will be tucked away for later usage, discarded, or dismissed. While there are lots of inputs to selecting a project most companies use one or a combination of the following selection criteria in their project’s Go/No-Go Decision process.
- Historical Information. If this type of project has been completed before and it was successful in the past there’s reason to consider this type of project for funding. Historical information is always as good input for any decision-making process.
- Murder Boards. Sounds cheery, huh? A murder board is a group of executives, managers, key stakeholders, and maybe even vendors, that asks the potential project manager of a potential project every conceivable, devil’s advocate type question about the proposed project in order to expose a project’s strengths and weaknesses. You might know a murder board by the friendlier name of a project selection committee. (I think murder board is more fun to say, though.)
- Scoring Models. A scoring model assigns values to all of the different aspects of a potential project, such as timeline, investment costs, return on investment, risk, and more. Each facet of the project is scored accordingly. Every potential project passes through the scoring model. The projects with the highest scores are initiated while the other proposed projects are dismissed. A scoring model can also be known as a weighted scoring model if some categories, such as return on investment, carry a higher score than the other facets of the project.
- Benefit-Cost Ratios. This is one of the simplest, and therefore one of the weakest, selection models. It’s a simple ratio of cost-to-benefits for every project. You may know these as BCRs; the benefit side of the ratio should always outweigh the cost side of the ratio. For example, a project with a BCR of 3:1 is good, while another project with a BCR of 2:5 is not-so-hot.
- Management horizon. Management horizon, also known as the payback period, defines that point in the future when the project is expected to earn back the original investment the project needed to get started. For example, if your project required $4 million to get started how long until the project’s deliverable will return the $4 million to the company? Beyond the management horizon is the promised land: the project is earning a profit.
- Future Value. Future value is a formula that predicts how much an amount of money today would be worth in thefuture. Basically, if your project needs $250,000 today to be initiated and your project won’t be done for five years, we could compare the $250,000 investment to your project’s promised return on investment. Here’s how the formula works: Future Value = Present Value(1+i)n where
investment amount for your projecti is the known interest rate (if we socked the money in the bank)
n is the number of time periods (years, quarters)
Here’s the formula in action with an interest rate of six
percent:
Future Value = $250,000(1+.06)5
Future Value = $250,000(1.338226)
Future Value = $334,556.50
This means that your project had better be worth more than $334,556.50
when it’s completed or the company actually lost money by
investing in
your project.
- Present Value. This project selection method takes a future amount of money and puts it into today’s dollars. For example, your project promises to be worth $875,000 in three years but requires $520,000 to get started. Management can compare, with this formula, if the startup cash is less than the $875,000 your project promises to deliver. If the startup capital is more than $875,000 in today’s dollars the project isn’t a good investment. If the startup capital, hopefully, is considerably less, then your project is a heck of a deal for the company. Here’s the formula in action with a six percent interest rate: Present Value = Future Value/(1+i)n where
Future value is the
project’s worth in the future
i is the interest rate
n is the number of time
periods.
Prevent Value =
$875,000/(1+.06)3
Present Value =
$875,000/1.191016
Present Value = $734,666.87
Your project is looking
pretty good. You need $520,000 to earn
$734,666.87 in today’s dollars. That’s a potential
return over $200,000.
- Net Present Value. While future value and present value do show the time value of money they both have one distinct disadvantage: they don’t account for monies earned while the project is in motion. While many projects, like construction for example, don’t realize a return on investment until the project is completed, other projects, like IT, retail, and healthcare, realize return on investment in phases.
For example, consider a retail company that has 1,500 stores across the nation. A new cash register point-of-sale system is to be installed in all 1,500 stores. 250 stores will convert to the new system each quarter over the next two years. The new system is predicted to save each store nearly $15,000 in inventory and resources and is predicted to help boost sales by at least $12,000 for each store. If management only considers the present value and future value for the whole project they’re not seeing the return for each store for each quarter.
Net present value helps determine when the organization is reaching the management horizon on the project. Here’s the formula:
1. Determine the cash flow for each time unit (in this instance it was quarters).
2. Convert each time unit’s cash flow to present value using the present value formula.
3. Sum all of the present values for the project.
4. Subtract the project’s investment for the project from the sum of the present value.
5. This final value, from step four, is the net present value. If all’s well the net present value is considerably larger than the original project investment. Fascinating.
While all these benefit measurement methods are good, your organization is likely to use a combination of these approaches – and maybe some of their own. There are instances, such as a new law or regulation, where the costs of the project don’t promise a return on investment, but your organization is required to do the project anyway. Regardless of whether you participate in the project selection process or not, it’s good to understand how your organization chooses a project and what the project’s return means to your organization. Why? It’ll help when you need to negotiate for additional resources, cash, and time.
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