Introduction to financial & cost management
Financial management is the process of estimating and justifying costs in order to secure funds, controlling expenditure and evaluating the outcomes.
The financial structure of projects, programmes and portfolios takes many different forms but the financial management process is common to all.
The first step is to estimate what the work may cost and the value of its expected benefits. These estimates are made and refined in parallel with other planning processes for establishing the scope of work and estimating schedule, resources and risk.
The balance of cost and benefit is analysed using investment appraisal techniques and documented in the business case. Work is approved if it can be shown not only that the benefits outweigh the costs, but also that the organisation cannot get a better return by investing the same funds elsewhere.
The process of securing funds continues in parallel with these steps. During the early phases of the life cycle, funds may only be committed in principle, pending a more detailed understanding of the work.
As plans are defined in ever greater detail, with increasing levels of confidence, funds will be fully committed and approval given to commence work. Financial governance therefore involves:
- initially: committing funds to the concept phase of the life cycle and reserving funds for the definition phase;
- at the end of the concept phase: committing funds for the definition phase and reserving funds for delivery;
- at the end of the definition phase: committing funds for delivery, or at least the first stage or tranche of work;
- at each review: funds for the next stage or tranche will be dependent upon a viable business case.
As work proceeds, cost-control mechanisms need to be implemented. These will forecast when funds need to be released and track progress of actual expenditure against planned. Funding is reviewed at the end of each stage or tranche of work. Funds are never unlimited and costs have to be balanced against time and scope in accordance with stakeholder requirements.
Financial management arrangements range from the very simple (e.g. a small project within a department) to the highly complex (e.g. a portfolio of international projects and programmes owned by partner organisations), but the principle is always that of ensuring that costs are controlled and exceeded by the value of benefits delivered.
The approach to financial management within a project, programme or portfolio is highly dependent upon the policies, procedures and standards used in the host organisation. These, in turn, are affected by the regulatory and legislative environment.
At the outset, financial procedures must be established that comply with all necessary standards and enable exchange of information with the host organisation’s financial systems.
The detail of financial management on a project will depend upon its scale and context.
Small and medium-sized projects will not be able to justify any investment in financial systems unique to the project. They will be serviced by the accounting systems of the host organisation. These are often unable to aggregate and apportion costs according to the project structure, so additional local processing will be necessary.
Larger projects may be able to justify specialist financial systems, ideally linked to the project scheduling systems for progress reporting and forecasting.
In terms of context, a project may be stand-alone or be part of a programme; it may be an internally sponsored and funded project; or a project performed by a contractor on behalf of a client. Financial management must adapt to the context with clear policies for the collection and reporting of cost data.
Programmes will need to consolidate financial data from three sources: the projects, the business-as-usual activity and the programme management infrastructure.
Finance and accounting policies need to be consistent across the programme. This is a particular challenge where the programme is international, multi-company, or both.
The programme sponsor should pay particular attention to the mechanisms for financial management defined in the definition phase of the programme, and be assured that they are adequate to accurately reflect the financial health of the programme.
If an organisation decides to formalise its management of projects and programmes in a portfolio, it will need to ensure that its systems can capture and provide the type of information required. This may include the ability to build portfolio cost accounts or activity-based costing into the organisation-wide financial systems.