Why Managers Use Budgetary Controls
Determining the cost of a project is one of the most important initial steps for a project manager. If a project manager cannot stay within a controlled budget, they may not have the funds to complete the project. The budget and financial plan is typically created during the initial stage of project development. Costs and resources should be set during the initiation stage to adequately plan and allocate costs.
Some tools that project managers can use to control finances and budget include payback period and other financial forecasting calculations, and budgeting techniques, including variance analysis. These tools are critically important for project managers who need to control resources to ensure project completion. If resources are mismanaged, the project will be characterized by sunk costs (i.e., investments that procure no returns).
Budgeting Techniques
Budgeting involves determining how much money will be needed to complete a project and the timeframe for spending it. The budget may be determined on an annual or monthly basis depending on how long the project is projected to run. An important part of budgeting is setting a plan that can be followed over the course of the project.
Example Budget Plan
Budget plans can be used to project incomes and expenses over the span of several months.
One way to determine whether the budgeting plan is being adhered to is to compare the budget allotted for a certain period of time with the actual amount of money spent during that time. This is called a variance analysis. A variance is the difference between a budgeted, planned, or standard amount and the actual amount incurred/sold. Variances can be computed for both costs and revenues to show a project manager whether they are adhering to the project budget.
Financial Forecasting Calculations
Financial forecasting calculations, such as payback periods, calculate the period of time required for the return on an investment to repay the sum of the original investment. For example, a $1,000 investment that returned $500 per year would have a two-year payback period. Payback period intuitively measures how long something takes to "pay for itself." All things being equal, shorter payback periods are preferable to longer payback periods. Payback period is widely used because it is a simple and clear measure.
Payback period is limited by the fact that it does not include the time value of money; that is, people prefer to receive money sooner rather than later. Net present value (NPV) is a financial forecasting calculation that does include the time value of money. It determines the "current value" of a sum of money on an annual (or monthly) basis, the value that cash paid out years from now would have if it was paid out today. This is a complex financial forecasting model that derives real rate of return using interest and inflation to localize currency chronologically.
Both payback period and NPV can be used in project management in order to determine how much profit a project will bring in and when. It is important for a project manager to conduct these financial forecasting calculations and budgeting controls to identify budgetary constraints well before costs are incurred and to secure funding from top management. Once a project receives funding, the project manager will need to use budgeting controls such as variance analysis in order to stay within the budget and ensure the success of the project.