Control & Oversight
Seasoned project managers quote the statistics, according to which two-thirds (yes, 67%) of all large-volume projects – fail. It could be less or more, but the failure of a large-volume project for any given company – is a catastrophe. There is a challenge here: The top management is not and cannot be familiar with engineering or technological details indicating the progress of a given project. They must rely on low-resolution details reported to them by their subordinates. In many cases, percentage-of-completion (POC) reporting will satisfy them. Their subordinates may also be relying on lower-level reports. But somewhere, somebody knows: we have a problem. It will take some more time before this information comes up and explode in that big conference-room.
The following chronology is known: Shock of the engineering estimations that did not reflect the real progress, revenues that have been recognized, and now need to be reversed, required provisions, demand to investigate how all that happened, one or two managers that will have to leave, more controls to prevent repetition of similar events and more… until we meet again over similar circumstances. Over the years I have managed to learn that financials prevented issues from floating early, and financials can help to identify such evolving cases. That’s right; financial analysis can control engineering inputs. Here is how that can work.
The following analysis should be maintained along a project’s duration and based on four types of data:
A project’s initial pricing. That may be a set of detailed, complex Excel files that could make a person go blind. Such files go down to the smallest priceable details, as predicted when preparing the proposal. Overall, that pricing process and outputs got top-management approval, not before clearly indicating the expected margin.
Contractual milestones. These set the conditions for each and every payment to be made along a project’s duration.
Changes and additions. Changes in projects’ scope usually have both operational and financial implications. As far as financials are concerned, both costs and revenues could be or should be affected. As such, changes should also be appropriately approved.
Reported Percentage of Completion (POC). This indicator has a direct impact on the revenue recognized periodically, and as such, over the profit or loss to be presented in the financial statements. Top managements and accountants face a real challenge when evaluating the reasonability of that indicator. Sometimes, overestimations are overlooked.
How can we integrate these data items and build a capability of evaluating the status of a project? The following guidelines generate the logic:
- The initial, priced margin (%) should be used for project-status evaluation along with a project’s duration. If actual costs exceed the plan – we may witness a deviation (see also: changes).
- Changes in either scope or time usually lead to higher cost or revenue, if any. Relevant amounts, as approved by the company, are added to the initial plan. If the actual cost does not reconcile with planned and approved cost – we may witness a deviation.
- Contractual milestones usually reflect the cost accumulated up to their accomplishment. If the actual cost accumulated up to a given milestone is higher than the plan and approved changes – we may witness a deviation.
- A POC which is higher than the one equivalent to the next milestone – should not be accepted without a decent justification, if any.
Financial analysis integrating the guidelines presented above shall provide top managements with clear inputs regarding the status of a given project, without getting into the engineering or technological details. Specifically, such an analysis should clarify if financial and contractual data reconcile with the %POC being reported. It’s a %POC sanity check.
Please note: The %POC sanity check described above does not provide full assurance, therefore should not replace any other oversight practices and controls being used. Any implementation requires a tailored, professional advice.
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