Posted by: Nir Chen | February 18, 2012

Can finance significantly impact the cost results of the project?

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Finance has a critical role in the success of construction projects. His main roles are funding, supporting and controlling.

Funding refers to finance’s responsibility of requesting the money for the project from the firm’s management while justifying rentability. This usually requires good analyzing and benchmarking skills.
Supporting refers to the financially assist that should be provided to the project manager. Finance should provide the project’s management ongoing information about the status of the project’s budget, cost risks and opportunities . He/She should alert the project manager in advance when he predicts that the desired scope of the project cannot be done in the current budget restriction. This requires good forecasting skills as the timing of the warning can be critical.

What about the controlling role?  How can finance cost control the project?
Usually if you’ll ask a new finance analyst what does it mean to have a good cost control on the project he will answer something like – “making sure the project is cheap and that we lower the cost as much as possible”.
This is amateurish answer. Making project as cheap as possible will probably cost you in other factors like quality or schedule as there is a tradeoff between the three. A professional analyst will just say that a good control on the project means to take care that things will be done efficiently.

Efficiency means either to minimize the cost of the project while maintaining all other factors fixed (scope, quality, schedule, safety etc.) or to maximize all those factors in a fixed cost. It also means to invest funds in scope that will yield good rate of return to the company and shareholders. In simple words – the scope of the project should worth its cost.

This means that in a budget challenged projects, the scope with the highest marginal benefit for the firm should be preferred upon a scope with a lower marginal benefit.
In a superfluous budget projects, a scope should be done only if its marginal output is larger than its marginal cost.
I bet some of you will find the above two sentences a bit fuzzy so in order to understand this principle i will give a very simple example: 
Imagine that you have endless budget in your project and that you need to decide if to invest in specific scope. The cost of that scope is one dollar (i.e. marginal cost). If you’ll execute it, it will increase the firm’s income by five dollars next year (i.e. marginal output). In this case , this scope is profitable as it yields profit of four dollars or rate of return of 500%. If the marginal cost is larger than the marginal output, then you shouldn’t invest money in that scope. If it’s equal, you are indifferent. It reminds me that every time someone ask me to describe what I learned in my Economics B.A I shortly answer – “marginal equals marginal”.

I will end this post with a fresh case that demonstrate what I just wrote – recently we had a fit up project in a floor of one of our campuses. The project ended with extra budget and the project manager wanted to invest the surplus funds in renovating the restrooms in the floor. The cost of the renovation was pretty small – around $70K. In one of my visits to this campus I took the opportunity to take a look on the restrooms and I found it to be in a good conditions. I talked to the project manager and he explained that he wants to renovate it to a very high standard restrooms so he can provide a “wow” effect to his customers. This is a typical thinking of the operations – they naturally wants to provide the best project to their customers, with the best quality and in relatively short time. However, this was a clear case of wasting money – the benefit of renovating those restroom was pretty low. After small discussion, a decision was made not to renovate those restroom and to give back the funds to the corporate so it can be invested in more beneficial projects.

So, what about my question in the title of the post? Can finance significantly impact the cost results of the project? It depends on him. If he can influence the project team to follow the above principles, then the answer is yes.

Yours,

Nir.

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Responses

  1. Great article Nir!
    Thanks for joining.

  2. My plessure 🙂 Will post more in the near future

  3. very nice and reflective… took me more than 5 min… probobly my english 😉 or else??


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