THREE PERCEPTIONS OF PROJECT COST
♦This is a shortened version of the “Three Perceptions of Project Cost—Cost Is More Than a Four Letter Word” Article. You may find the full article in Project Management Journal, June 1986. ©1987 by the Project Management Institute.
Project cost seems to be a relatively simple expression, but "cost" is more than a four letter word. Different elements of the organization perceive cost differently, as the timing of project cost identification affects their particular organizational function. The project manager charged with on-time, on-cost, on-spec execution of a project views the "on cost" component of his responsibility as a requirement to stay within the allocated budget, while satisfying a given set of specified conditions (scope of work), within a required time frame (schedule). To most project managers this simply means a commitment to project funds in accordance with a prescribed plan (time-based budget). Others in the organization are less concerned with the commitment of funds.
The accounting department addresses expense recognition related to a project or an organizational profit and loss statement. The accountant's ultimate goal is reporting profitability, while positively influencing the firm's tax liability.
The comptroller (finance department) is primarily concerned with the organization's cash flow. It is that person's responsibility to provide the funds for paying the bills, and putting the unused or available money to work for the company.
To be an effective project manager, one must understand each cost, and also realize that the timing of cost identification can affect both project and corporate financial performance. The project manager must be aware of the different cost perceptions and the manner in which they are reported. With this knowledge, the project manager can control more than the project's cost of goods sold (a function often viewed as the project manager's sole financial responsibility). The project manager can also influence the timing of cost to improve cash flow and the cost of financing the work, in addition to affecting revenue and expense reporting in the P&L statement.
Three Perceptions of Cost
To understand the three perceptions of cost—commitments, expenses, and cash flow—consider the purchase of a major project component. Assume that a $120,000 compressor with delivery quoted at six months was purchased. At time 0 an order is placed. Six months later the vendor makes two shipments, a large box containing the compressor and a small envelope containing an invoice. The received invoice is processed immediately, but payment is usually delayed to comply with corporate payment policy (30, 60, 90, or more days may pass before a check is actually mailed to the vendor). In this example, payment was made 60 days after receipt of the invoice or 8 months after the order for the compressor was given to the vendor.
Commitments—The Project Manager's Concern
Placement of the purchase order represents a commitment to pay the vendor $120,000 following satisfactory delivery of the compressor. As far as the project manager is concerned, once this commitment is made to the vendor, the available funds in the project budget are reduced by that amount. The project manager deals with commitments, when he s/he plans and reports project costs. Unfortunately, many accounting systems are not structured to support project cost reporting needs and do not identify commitments. In fact, the value of a purchase order may not be recorded until an invoice is received. This plays havoc with the project manager's fiscal control process, as he cannot get a "handle" on the exact budget status at a particular time. In the absence of a suitable information system, a conscientious project manager will maintain personal records (manually or electronically) to track his project's commitments.
Expenses—The Accountant's Concern
Preparation of the project's...
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