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A project’s success is primarily determined by whether project owners are able to finance it without any disruptions. In this context, funding sources are critical because different financing methods have varying implications. This paper provides an overview of the current practices in project financial management and conventional methods of funding the project. It also discusses some of the challenges that may occur when managing costs.
Project Financing
Project financing is a funding scheme used to finance large projects. It is vital to protect the rest of the company’s assets from potential debt and liabilities when conceiving a new venture. Therefore, it is common that companies register a new firm to relieve themselves from any obligations if the project goes bankrupt (Yescombe, 2017). Then, some mix of equity and debt may be used for capital expenditure. The company may rely on external investors or internal sources to raise money. Some examples are venture capital, private equity, angel investors, and internal cash accruals (Yescombe, 2017). It is also possible to borrow money from banks or individuals in the form of loans.
The best option for financing a project is to use personal capital – there will be no interest to pay, and the profit will not be shared with external parties. However, such an option is not always possible because it is hard to save substantial amounts of cash that would be sufficient to fund a venture fully (Yescombe, 2017). Also, when relying only on personal capital, emergencies may require additional resources, which may not be available because of the insufficiency of funds. Such a situation would put the project to a significant risk.
Other types of equity, such as external investments, are also a valid option because such financing does not require immediate payments during the implementation phase. Therefore, the project goes smoother because there is no external pressure (Yescombe, 2017).
Also, shareholders get only a part of the profit – if the project deliverable is not operating well, the shareholders receive fewer dividends. Loans, however, require businesses to pay a fixed amount each month until the debt is repaid, along with interest. The company will have to pay the same amount even if there is no profit from the project (Yescombe, 2017). There are, however, financing options that use both equity and debt, but rely on cash flows. In other words, the debt is paid after the implementation phase ends, and the project enters the operations phase. Not all ventures may be suitable for such a scheme, however.
Benefits and Risk of Joint Ventures
A joint venture is when two or more companies partner over a shared project. It can take any legal form and is popular among international corporations wishing to enter a new foreign market. There are many benefits of joint ventures that may be interesting to both large and small businesses. First, it is an opportunity to acquire new knowledge and expertise from a partner company (Yescombe, 2017). Joint ventures also provide access to a broader pool of resources, which may be necessary to support a particular project (Yescombe, 2017). These are not only financial sources but also the required human capital and technology.
All participants share the risks, and no single company is responsible for failure. Such an environment increases the level of responsibility because each company will try to meet their obligations (Yescombe, 2017). Long-term business relationships are among the possible outcomes of joint ventures. Upon the successful accomplishment of a specific task the companies joined for, there will be more trust and mutual understanding between the organizations. Joint ventures also ensure the project is well-funded throughout its lifecycle, because of a more significant number of sources.
Joint-venture arrangement, however, may also pose risks to long-term projects. Despite the high availability of resources, problems in communication, and imbalance in responsibilities may become the sources of challenges (Yescombe, 2017).
For instance, it is rare when all objectives are clearly communicated to all individual participants of the joint venture. Misunderstanding and clash of corporate cultures may lead to distress among employees, and one of the parties may want to leave the alliance (Yescombe, 2017). If it happens, the project will be put to high risk because of the absence of required funding. Therefore, long-term plans may not be suitable to pursue using a joint-venture scheme. Finding a reliable partner is also a challenge – if the other party is involved in machinations, the shared project will fail because of associated consequences, such as spoiling of the image, or even legal procedures.
Processes of Financial Management
Project financial management (PFM) is a collection of steps, procedures, and processes required to determine how to fund the project. If a set of resources requires specific procedures, then these will be part of the financial management. Daily operational costs are not considered within the scope of PFM (Project Management Institute, 2017). Instead, the responsibilities of the finance manager include monitoring net cash flows and income sources.
Assessing risks that may pose hindrances to the project’s completion is also part of the manager’s job. While PFM is closely related to monitoring capital sources and associated risks, it also ensures that all funds invested in the project are allocated adequately and used efficiently (Project Management Institute, 2017). To accomplish this broad range of significant tasks, PFM utilizes a set of processes – planning, control, and administration and records (Project Management Institute, 2017). When viewing PFM as a single extensive process, these three mentioned elements can be described as steps for the successful delivery of the project.
At the initial stage of financial management, as part of the planning process, roles and responsibilities are divided between the employees, and the budgetary requirements are identified. The team should find primary sources of funds and alternative options if the source ceases to exist (Project Management Institute, 2017). The planning process’s goals also include determining the legal entity that is most suitable for a given project, analyzing the economic environment, and forecasting any possible fluctuations on the market, and determining how taxes will be paid.
After the planning is complete, its outcomes are given to the control phase, which ensures that all project activities are within the budget’s constraints. This process also controls resource allocation, seeking efficiency, and audits the usage of proper financial practices and accounting methods (Project Management Institute, 2017). The administration and records process deals with the standardization of the data within the company, the quality of reports, consistency in their formats (Project Management Institute, 2017). One of the most significant responsibilities of this process is ensuring that all documents, financial records, and other information is traceable and can be easily found (Project Management Institute, 2017). This outcome is reached by enforcing uniform standards for the creation and storing of data.
Aspects of Financial Management Plan
Resource planning is the task allocation process in which the work is distributed in such a way that it maximizes the efficiency of each resource. In summary, it is a process to seeks to minimize the idle time of employees and machinery (Project Management Institute, 2017). For instance, if there are ten cup painters, but only one person is responsible for delivering cups to each painter, then the majority of the time is wasted merely waiting for a cup to arrive. This example shows unfavorable resource planning and inefficient usage of resources.
Cost estimating is the process of providing an approximate price of a project. Accuracy of the estimate largely depends on the end goals – it may be preliminary or definitive (Project Management Institute, 2017). There are various methods of estimation, but the most common use resource expenses or a comparison with a similar project to determine the approximate cost (Project Management Institute, 2017). For instance, if the company previously built a one-mile long road for a million dollars, then it can be estimated that five million dollars would be required to deliver a five-mile driveway. Similarly, the estimated cost of a building can be given by multiplying the price of resources by the amount necessary.
Cost budgeting is the aggregation of all estimated costs and enforcing a fixed budget. The process also monitors whether the real expenses are aligning with the estimates (Project Management Institute, 2017). For instance, after determining that it would require five million dollars to build a five-mile road, the company develops a budget and allocates costs between activities on the project schedule. Each event has its own estimate cost – these details allow for better cost control.
Cost control is used to manage expenses properly and takes place after the project works begin. Considering the example with road construction, after each mile, cost control is used to compare estimates with how much was spent, and corrections are made either to the budget or to other processes, such as resource allocation (Project Management Institute, 2017). Because each activity on the schedule has its own estimate, careful investigations and calculations are possible.
Biggest Challenges
There are many challenges with project financial management, mainly related to cost control activities. One of the problems is inaccurate forecasts pertaining to expenses. During the planning phase, people responsible for estimates often use too much detail that tends to change over time. Therefore, when the project starts, many corrections need to be made because those variables that were used when approximating the costs changed their values.
Also, previous estimates are often used for building new cost calculations, which means that erroneous data is inherited. This problem shows other shortcomings too – a lot of time is wasted for constructing inaccurate forecasts. New forecasts should not rely on previous information, and the project should not spend too much time and resources to develop detailed approximations.
Another challenge with cost control in contemporary project management is that opportunities for improvement are not identified during the design phase. For instance, when the control system determines that expenses are not aligning with the budget, only minor changes are applied to bring the costs down. However, there are no opportunities to enhance the processes to decrease the expenses while the project is running. In other words, cost control systems are only sound when they identify the source of high costs after investigations. They are, however, do not determine potential areas for improvement during the implementation phase. Because of this shortcoming, changing anything in the design of the processes is more expensive as the project develops.
Conclusion
Financial resources and competent human capital that is capable of managing them are among the critical elements of any venture. When a company cannot afford the project on its own, a joint venture can be considered as a viable option. The team needs to develop an appropriate financial management plan, and adequately estimate the costs. After the funds are secured, it is vital to control the expenses. This paper presented some of the ways to finance the project and critical aspects of financial management.
References
Yescombe, E.R. (2014). Principles of project finance (2nd ed.). Waltham, MA: Elsevier.
Project Management Institute. (2017). A guide to the project management body of knowledge (PMBOK guide) (6th ed.). Newtown Square, PA: Project Management Institute.
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