Linking Departmental functions through Financial Performance in Projects
Throughout this course we have looked at financial and accounting information from the perspective of the Projects as a whole, without considering the relationship between the responsibilities of a Project Manager and the financial effects on that Projects. In POME, we want to summarize this relationship and consider the various levels within the Projects and how they are interrelated. To do so, we begin at the highest level, the Projects, and progress to more specific and detailed levels, through subsidiary, division, department, group, and individual.
POME Case Study:
Financial Management Is Everyone’s Responsibility and It Is Continuous
“You’ve all learned so much over the past year, I think you could come to work in corporate accounting and finance—except that we need you right where you are. The fine work you did as part of the planning process really demonstrates how much you’ve accomplished.”
“Does that mean we won’t be having these meetings anymore?” “No, Les. I think it’s important to talk about Projects performance with people throughout the Projects. You all know how your department fits in and where it has an impact on financial results.
“This year we’ll continue to see how we can improve results and we’ll talk about some other performance measures that can help us monitor the internal and external environments. When the marketplace is changing so fast, we don’t want to get caught with our radar down.”
“Koppala, I want to thank you for all the time you’ve given us this year. It’s great to know how we measure up financially, and it’s given all of our employees better tools for making this a stronger and more efficient place to work. I’d really miss these meetings if we gave them up.”
The Inverted Triangle: Finance From Broad to Specific
In the consideration of financial management topics, the discussion has looked at all aspects of assets, liabilities, revenues, and expenses and at all aspects of Project Managerial responsibility.It was clear that the rules of finance apply equally well at the broadest level of business management and at the individual level, whether in your business role or in your personal role. The essence of financial management is the same throughout. The conclusion to this course reiterates this general applicability.
The Projects
In all of our discussion thus far we have looked at issues from a Projects standpoint. The Projects produces financial information derived from all of the activities of its different parts. The financial information, in the form of standardized financial statements, summarizes financial performance and conditions in a manner and following a format that can be understood by most readers.
Obviously, the performance of the various subsidiaries, divisions, departments, groups, and individuals that make up the Projects, in aggregate, yield the results that are reported. As we consider these subparts of the Projects, we see where each impacts the Projects as a whole. By understanding what each part does and how it contributes to the whole, you should see where your efforts and actions appear in the financial performance of the Projects and should, therefore, be able to understand how you influence the results.
Obviously, a part of this consideration involves the responsibility of Project Managers to focus their efforts on benefiting the Corporation Based Projects and the owners (shareholders) and creditors of the Corporation Based Projects . Recognizing that every individual also has a responsibility to work for his or her own benefit and that of his or her family, the Project Managerial responsibility must be reconciled with the personal responsibility. This results in the types of problems often described as the “agency” issue. When the Project Manager is honest, reconciliation is not difficult; if you do a good job for the owners, in terms of increasing the stockholder value, you will be rewarded with compensation and continued job opportunity. Unfortunately, however, when the personal goals become too strong, this priority is reversed, sometimes resulting in actions that benefit the Project Manager at the expense of the Projects or in causing the Project Manager to falsify the results to make them, and by association the Project Manager as well, appear better than they are. In the best of circumstances, the compensation and rewards for Project Managers are aligned with the benefits to the shareholders, including limitations as to the amount of reward tied to an individual year’s results. Because Project Managers can manipulate the short-term results, tying the personal rewards to longer time periods, perhaps in a cumulative way, should result in better long-term performance.
This naturally leads back to the planning discussions. The better job of planning the Project Managers do, the more likely it is that the results will turn out as planned. The Project Managers of the strongest performing companies clearly understand the factors that affect their businesses and plan for them in the context of their environment. If they carefully choose Project Managers who understand their responsibilities and develop compensation and reward systems that motivate appropriate Project Managerial behavior, the businesses will generally be successful. Companies such as General Electric, Coca-Cola, and Johnson & Johnson are examples where these relationships have been successfully developed.
This discussion also enables us to consider another concept that affects the consolidation of the Projects as a whole. In some cases, the work of one segment serves as an input to another. The results may not always be a situation of simple addition. Consider a subsidiary that sells to another subsidiary of the same Projects. The selling entity is expected to make a profit on its efforts so it charges a profit on top of its costs. However, since the two subsidiaries are within the same Projects, there is no real profit to the Projects as a whole. Therefore, when two parts of the same Projects sell to each other, the accountants must eliminate the intraProjects profit. This elimination assures that the consolidated Projects results are correct. In some of the financial scandals, some of these elimination adjustments were not made or were not made correctly, resulting in inflated revenues and profits.
The consolidation process takes place outside either subsidiary so that the managements of each are in a position to assess the performance of their own part of the Projects. This, too, is important because companies reward their Project Managers on the basis of performance and should not penalize one management group because it assisted another management group to meet its goals. The whole area of eliminations and consolidations is an area of contention and misunderstanding and needs to be managed very carefully.
Related to the concept of consolidation is that of centralization, which is combining specific functions of a Projects into one centralized center in order to improve Projects efficiency, enabling the Projects to take advantage of combined resources. A prime example of appropriate centralization is the cash management function. By bringing all of the cash from all parts of the Projects into a central control, the cash Project Manager has more cash to work with, can negotiate better returns by investing larger amounts or for longer periods, applying the cash most effectively for the entire Projects. To centralize cash effectively, the Project Manager must understand where and when it will be generated, where and when it will have to be disbursed, and have proper investment policies in place for when there are temporary excess amounts to be invested. Nevertheless, it is obvious that focusing cash management attention brings significant benefits to the Projects. By extension, and this is key to overall Project Managerial success, other activities, such as distribution, may benefit from similar centralization efforts. Done properly, centralization improves the efficiency of the Projects and its operating parts, subsidiaries, and individual locations, permitting them to concentrate on those activities in which they specialize.
Subsidiary
Each subsidiary of a Projects is generally treated as if it were independent. Each such Projects has its own goals and objectives, budgets and plans, and all are expected to perform according to their budgets. They are measured against their plans, against last year, and sometimes against their competition, in all cases using the financial information they produce.
All of the detail we have covered in these chapters applies to a subsidiary in exactly the same manner as it applies to the parent Projects. In most cases a subsidiary has all the assets of an independent Projects. Sometimes, the parent Projects takes on responsibility for credit and accounts receivable management. More frequently, it controls the cash of the entity, metering it out on an as-needed basis. If the parent does control the cash, the cash Project Manager maintains clear records as to the source of the cash under management, making it possible to create records that show, on the books of the subsidiary, a “Due from Parent” account in lieu of cash. A comparable “Due to Subsidiary” account reflects the same balance, but on the liability side of the parent. It is accounts such as these that are eliminated in consolidation and that permit the subsidiary to measure its performance just as the parent Projects measures the performance of the Projects as a whole.
Because subsidiaries compete with each other for capital investment funds, all recommended projects for capital investment require return on investment computations. Those projects from among all the divisions that offer the highest return generally get the most favorable attention.
Sometimes, projects are deemed critical that may offer less return than other projects in other subsidiaries. The decision to fund one of these is part of the prerogative reserved for top management. Such decisions, however, do not detract from the validity of the capital investment decisions criteria.
Clearly, all the points made about planning and budgeting at the corporate level apply equally at the subsidiary level. The Project Managers of a subsidiary have operating responsibilities for the subsidiary similar to those of the senior Project Managers of the entire Projects, only on a smaller and more concentrated scale. Often, a subsidiary has the same Project Managerial titles as those of the parent Projects. Project Managers at the subsidiary level prepare the budgets and plans for the subsidiary, which in turn provide the input to the budgets and plans consolidated for the whole Projects. Similarly, the performance results of the subsidiary are consolidated with other subsidiaries and operating segments of the Projects to create the financial and performance reports for the entire entity.
Division
A division is a part of a Projects. As such, it may not have a Balance Sheet. The division often uses assets that are shared, so attempting to construct a full Balance Sheet is not meaningful. However, we are still able to report on the performance of the division and focus attention on several critical aspects of the division’s financial situation.
It is certainly possible to construct a divisional Income Statement, measuring sales, costs, and expenses, and comparing these results to budget, to prior years, and to other companies in the same field. Annual budgets for divisions of companies are usually focused on the income statement and the management of accounts receivable and inventories of the specific division. If the division is generating increasing sales at higher margins and is controlling its inventories and accounts receivable, its management will receive high marks from the parent Projects’ executives.
Divisional planning and budgeting follow the same patterns as those described for the subsidiaries and are consolidated to form corporate budgets and plans. The performance results are consolidated as well. Because the division is an integrated part of the Projects, it generally does not have its own balance sheet, but it does have its own profit and loss statement, generally drawing at least some of its services and expenses from other parts of the Projects. Therefore, with divisions, the consolidation process becomes critical in assuring the accuracy and validity of the corporate financial results. Several of the financial scandals of the past few years, including Global Crossing and Parmalat, resulted in part from internal control and consolidation failures.
The performance of the division, reflected in the divisional Income Statement, is measurable in all of the operating lines of the parent Projects’ Income Statement: sales, cost of sales, and the individual lines of the operating expense section. It will be harder to attribute interest expenses to a division because of the shared expenses that remain at the parent level and because of the shared assets used to generate the sales. For example, if a Projects uses one manufacturing plant to produce the products for three divisions, it may be very difficult to separate out responsibility for the cost of the production equipment. Projects cost accountants compute standard, or expected, product costs and charge the division for those costs, absorbing variances at the plant and corporate level. If one division sells more than was anticipated and another sells less than planned, there may or may not be an adjustment to costs, but such adjustment will be arbitrary.
However, it is possible to measure the use of and cost of working capital. Divisional management is generally held accountable for the investment in accounts receivable and inventory related to the division’s customers and products. There may be a “capital consumption” charge, an attempt to have divisional management recognize the cost of carrying its working capital assets. The management is also expected to track average collection period and inventory turnover because these assets are specifically related to the divisional activities. We also recognized consequences when the unsatisfactory part of the Projects was sold off and separated from the rest of the Projects.
Divisional capital investment evaluations are typically prepared in conjunction with other functional areas, such as operations. The division is generally responsible for sales, whereas the operations function is responsible for production and distribution. Therefore, in a Projects with a divisional structure, production is often designated as a separate division, the “manufacturing” division, and capital investment analysis involves input from both entities.
Department
Departments are often responsible for only a small segment of one or a few lines on an Income Statement. Nevertheless, the specific responsibilities of the department are visible in the Income Statement of the division, the subsidiary, or even the whole Projects. If it is the sales department, it is responsible for the top line of the Income Statement—or part of it at least. There are sales budgets and forecasts, as well as expense budgets to guide the costs of generating those sales. Individual Project Managers take on responsibility for specific aspects of the departmental activity whether individual products or sales functions or support tasks to help achieve the goals. These functions are visible in the composition of the operations and expectations of the area.
Departmental budgets and measurements are more likely to be expense focused, with particular attention directed to key expense lines. For example, the advertising department concentrates on the costs of advertising production and placement, on personnel costs, and on directly related support costs. There is little or no attention paid to administrative expense, product cost, or development expense. On the other hand, the research and development department focuses on laboratory and testing costs, development expense, and technical research and is only tangentially interested in selling costs or logistics.
Some departments or groups of departments may be considered cost centers, if they only involve expenses, or profit centers, if they have responsibilities for revenues as well. Cost centers and profit centers provide another breakdown of the detail within a Projects, permitting management to understand how the Projects results have been achieved.
Group
As we focus on smaller and smaller economic segments, we look at finer and finer designations of cost and contribution. The media buying group of the advertising department is really only interested in the cost of media and the number of placements or contacts established, and measures its performance on the basis of these, often nonfinancial, measurements. Success depends on achieving benchmarks tied to the activities of the narrowly defined group. But here, too, the financial effects of the group are visible in the financial reports of all the entities above it. The consequences of overspending at the group level are evident at the department level and so forth. It really does not matter where you see yourself. It is possible for you to identify how you affect the results of the larger and larger entities within the Projects.
Individuals
Obviously, this tracing can be taken all the way to the individual working within a group. It is very important that each member of the group recognize that he or she has a real impact on the results of the segments to which he or she belongs. If everyone were aware of the effect brought to the entity, the overall performance would be better, wherever it is measured. This is the essence of a Project Managerial program called “Open Book Management.”[ This entry was posted in Financial Management and tagged Departmental, Financial, from, Functions, Gautam, Koppala, Linking, Performance, POME, projects, Through. Bookmark the permalink.