Why Monitoring and Evaluating Your Capital Project Investment IRR Is Critical?

Although for those who are involved in investing in capital projects have many criteria to decide if the project opportunity worthwhile investing in or not, nevertheless, two of the most important measures that will always appear on this list are the Risk Attractiveness and Internal Rate of Return (IRR). Those interrelated measures identify the organization’s appetite when it comes to investing in capital projects as the common sense always says the higher the risk is, the higher the return should be.

Assessing Project Risks

Assessing the risk attractiveness of a project requires the organization to implement a formal management process to identify, analyze, respond, monitor and control project risks. A Project Management Information System (PMIS) like PMWeb not only enables the organization to implement their project management process across their complete projects’ portfolio but to also monitor and evaluate how the risk attractiveness of a project could change over time. The risks captured during the project life cycle stages across the organization’s projects’ portfolio provide a risk knowledge database that no organization can afford not to have. The real-time risk register will be used by the organization to monitor and evaluate their risk exposure and trigger needed actions to keep it inline with the organization’s risk policy.

Assessing Project Internal Rate of Return (IRR)

Assessing the project IRR requires have a consolidated cashflow project of all project costs and revenues. The project cost will include all construction direct and indirect cost for building the project asset, professional services, price of land, statutory fees, operation cost, funding and financing cost, pre-sales commission, marketing and promotion fee, contingency and management reserve allowance among others. On the other hand, project revenue could be from building assets sale, short and long -term lease, operation revenue like school fees, hotel room and restaurant revenue, healthcare revenue, interest received among others.

WBS and Control Accounts (CA)

To estimate the project cost, the organization needs to define the work breakdown structure (WBS) which will detail the project scope of work. The more detailed is the WBS is, the more accurate cost estimate the organization will have. The WBS will also become the Control Account (CA) which will be used to capture other project cost components including in addition to cost estimate, budget, budget adjustments, commitments, changes, actual cost, revenue contracts, revenue adjustments, actual revenue collected and project funding.

Cost Estimate

For each Control Account (CA) level, the quantity of the work needs to be calculated in accordance with international recognized quantity take-off standards. If Building Information Model (BIM) is in use, then those quantities can be extracted from the BIM model. Again, the level of accuracy depends of the BIM Model level of detail (LOD) which will improve as the project design moves from concept to detailed design development.

Project Schedule

The Control Account will also enable the organization to develop the project’s delivery schedule taking into consideration design, authorities approvals, contracts and material procurement, construction, commissioning, handing over and other scope of work needed for delivering the project asset. In addition, the schedule should include all revenue, maintenance and operation activities during the complete revenue generation stage of the asset life cycle. Applications like Oracle Primavera P6 is usually what capital project owners would use to develop the detailed project schedule. The schedule which is aligned with the WBS needs also to be aligned with the cost estimate to ensure that scope of work and level of effort to delivery is fully captured in the integrated project schedule.

Project Budget

The control accounts, cost estimate and project schedule will be imported into PMWeb to have a single repository of those important components who will be used to develop the other records needed to come up with the project consolidated cashflow to calculate the Internal Rate of Return (IRR) as well as other measures like Net Present Value (NPV). The project budget will be the first record to be generated from the approved cost estimate. Of course, different budget versions will be created depending on the cost estimate revisions.

The project will be appended with additional records that were not covered by the cost estimate. Those could the project finance and funding cost, price of land, contingency, management reserve among others. PMWeb allows having multiple currencies within the budget itself to allow for the currency exchange rates to determine the impact on the budget if those were not covered under other budget line items. Each budget line item will be also linked to its relevant project schedule activity to determine their planned spending dates. When those schedule dates are revised or updated, a new budget version needs to be created to reflect the new schedules while keeping track of previous budget versions. PMWeb allows distributing the budget amount using predefined projection curves like linear, bell-shaped, front-ended and back-ended. This will help in getting a more accurate budget cashflow projection.

Budget Adjustments

All adjustments to the approved budget will be captured using budget request module. Those adjustments could be to reflect budget increase or decrease due to some changes, transferring approved budget amount from Control Account to another. One of the most common budget transfers is the one associated with project contingency and management reserve for which the organization needs to keep track of the funds drawdown during the project life cycle. Each budget adjustment needs to be posted to the financial period that it had occurred at.

Revenue Contracts

The revenue contracts module in PMWeb will be used to capture all planned and actual income sources for the project. This would usually include building assets sale, short and long -term lease, operation revenue like school fees, hotel room and restaurant revenue, healthcare revenue, interest received among others. Similar to the budget, each revenue source will be linked to the relevant control account and the project schedule activity. This will ensure that the revenue projection is captured in the consolidated project cashflow.

Planned Cashflow Projection and the IRR

With both, the planned budget spending and revenue, the planned consolidated cashflow projection for the project will be generated. This will also enable the organization to make adjustments for the those captured values. For example, for the planned budget per period, the organization might decide that the Earned Progress Value should be 90% of the budget amount, allowing for the 10% retention, and it needs to be delayed by 30 days for the review and approval period. This earned value amount will become the Actual Cost to be paid but again with another 30 days delay to accommodate the payment terms. The Internal Rate of Return (IRR) and Net Present Value (NPV) at 18% measures will be calculated using the formulas that are common to reporting tools used by PMWeb. Should the organization be interested in running “what if scenarios” on the project cashflow without modifying the budget and revenue data captured in PMWeb, the projection cashflow report can be saved in MS XLS file format to enable the organization to run different scenarios and calculate the associated IRR, NPV and other needed financial measures.

Should the organization be interested in running “what if scenarios” on the project cashflow without modifying the budget and revenue data captured in PMWeb, the projection cashflow report can be saved in MS XLS file format to enable the organization to run different scenarios and calculate the associated IRR, NPV and other needed financial measures.

Of course, the monitoring and evaluation of the IRR, NPV and other financial measures will continue to be needed during the project life cycle stages. This entails that control accounts that are part of bid packages awarded to consultants, project management firms, contractors, subcontractors, vendors, suppliers among others will become the basis for the planned cost spending rather the budget planned spending. In addition, actual cost incurred for scope of work delivered plus the actual cost of all miscellaneous invoices will be used to record the past periods actual cost. Those cashflow adjustments will automatically result in recalculating the IRR, NPV and other financial measures.

Awarded Commitments

The commitment of the organization to spend the approved project budget is usually linked to the award of contracts, subcontracts, purchase order among others. The procurement of those commitments need to follow a formal process that will include defining the bid packages, which include all relevant control accounts, qualifying the bidders for each bid package, create the contract documents for bid packages, invite qualified bidders, capture the submitted proposals by those bidders, reviewing and analyzing those bids and finally award those commitments. Each commitment will include the payment terms for the approved completed work. The anticipated commitments spending, which also referred to as the Contractor’s Cost Loaded Schedule needs to be reviewed and ensure that is aligned with the approved budget spending plan.

Changes to Awarded Contracts

All potential and actual changes, whether they are approved, under review, rejected or disputed, will be captured in PMWeb. This will enable the organization to have real-time understanding of the revised committed project cost and the projected at completion project cost. Again, as a best practice, all those changes need to be captured in a single document that will also detail the changes in the approved budget as a result of those changes. This document is known as the change event. Similar to budget adjustments, commitments changes need to be posted to the financial period that it had occurred at.

Actual Cost and Actual Revenue

The actual cost for approved work in place for each awarded commitment contract will be captured using the monthly progress invoice for which the project schedule activity percent (%) complete for each control account will be imported. This will be repeated for each period. In addition, the actual cost for all miscellaneous invoices incurred at each period will be also captured in PMWeb. Similarly, the actual revenue from building assets sale, short and long -term lease, operation revenue like school fees, hotel room and restaurant revenue, healthcare revenue, interest received among others will be captured using the revenue requisitions module.

For some organizations, there could be a requirement that all actual costs and revenues to be captured using their accounting and ERP applications like SAP, Oracle, MS Dynamics, JD Edwards among others. Should this be a requirement, PMWeb provides the option to import the actual cost and revenue data into PMWeb using the Integrator Manager. In addition, there is an option to create more advanced integration using the application programming interface (API) which is a set of clearly defined methods of communication between various software components.

Monitoring and Evaluating IRR, NPV and Other Measures

The organization needs to continue monitoring and evaluating the IRR, NPV and other financial measures including but not limited to project budget, revenue, commitment, earned value, actual cost, paid amount, cost performance index (CPI), schedule performance index (SPI), cost variance (CV), schedule variance (SV), contingency drawdown among others.

Conclusion

Those involved in capital project investments require a number of financial, risk among other measures to ensure that their investments are still viable. The Internal Return on Investment (IRR) is one of those important measures that executives would like to track to ensure that the return on investment is still attractive. PMWeb PMIS provides a single web-enabled platform to capture the data needed to calculate the IRR, NPV and the many other key performance indicators needed to monitor and evaluate project investments performance. Thus, not only enable those investors to have real-time single version of the truth performance status but the insight to make better and faster informed decisions to keep their investments on track.