Microsoft Project 2013: The Missing Manual

Picking the Right Projects

There’s never a shortage of projects, but there’s not enough time, money, and staff in the world to complete them all. Before you begin managing a project, make sure it earns its place in your organization’s project portfolio. Throwing darts or pulling petals off daisies isn’t the answer; you’re better off knowing what’s important to your organization and picking projects that support those objectives.

Project-selection criteria are just as helpful once projects are under way, because projects don’t always deliver what they promise. If a project isn’t meeting expectations, the management team can decide whether to give it time to recover or cut it loose. Similarly, if a juicy new project appears, you can compare its potential results to those of projects already in progress to see if it makes sense to swap it for a project that’s partially complete.

Note

Selection criteria can save time and effort before the selection process even starts. People thinking about proposing a project can evaluate potential results before facing the selection committee. If the results don’t pass the test, there’s little point in presenting the project to management.

To make good decisions, you need some kind of consistent selection process, whether you’re a small-business owner allocating limited resources or a committee setting up a multiproject portfolio. (The box below provides an example of how a committee might evaluate and select projects.) You can then evaluate the candidates and choose the projects with the most compelling results. When you run out of money and resources, you can put any remaining projects that meet your selection criteria on the waiting list.

UP TO SPEED: Picking by Committee

Management by consensus has a bad reputation, but a project-review board is a good way to make sure your organization selects the right projects. An effective project-review board includes decision makers from every area of your organization with a variety of skillsets, and it applies agreed-upon selection criteria to choose projects as objectively as possible. Without an impartial jury, project sponsors and their project managers may choose projects for less compelling reasons: They find the project intriguing, the work is relatively risk-free, or they simply grow attached to the projects they propose.

A project-review board doesn’t doom you to a bureaucratic selection process. With documented selection criteria, the steps are pretty simple:

1. Someone proposes a project. Project sponsors or project managers usually prepare proposals to sell the projects to the review board—why the projects are worthwhile, what benefits they provide, and how they fare against the selection criteria.

2. The project-review board evaluates proposals. The board meets regularly to evaluate proposed projects. People who propose projects get a chance to make their pitches, which usually include rigorous Q&A sessions with the board members to clarify ambiguous points. After the presentations, the board discusses the merits of the projects, how the projects fit with the organization’s objectives, as well as any conflicts or issues they see.

3. The board approves or rejects project proposals. The board decides which projects get to move forward and then notifies proposers of the fate of their projects (and, preferably, explains the reasons for these decisions).

The Importance of Business Objectives

Some projects are no-brainers, like the ones needed to satisfy government regulations. For example, American companies that want to stay in business have to conform to the accounting requirements of the Sarbanes-Oxley Act. On the other hand, you can cull projects from your list by picking only the ones that support the organization’s mission and business objectives. If your company dabbles in widgetry, the goal might be getting your tools to market before the competition. But in the healthcare industry, safety trumps speed, because recalling devices already implanted in people is going to hurt the patients and the company’s pocketbook.

Any time you begin to describe a project by saying, “It would be nice…” you may as well stop right there—unless you can link the project to quantifiable business objectives. Here are some common objectives that trigger projects:

• Increase revenue

• Improve profitability

• Increase market share

• Reduce prices to stay competitive

• Reduce costs

• Reduce time to market

• Increase customer satisfaction

• Increase product quality and/or safety

• Reduce waste

• Satisfy regulations

• Increase productivity

Common Selection Criteria

Although some projects get a free pass due to regulatory requirements or because the CEO says so, most have to earn their spot in the project lineup. Because business objectives vary, you need some sort of common denominator for measuring results—which often comes down to money. This section describes the most common financial measures that executives use, and the pros and cons of each. (The box on Surviving Without Selection Criteria explains what you can do if your organization doesn’t have selection criteria.)

Whether you’re trying to increase revenue, reduce costs, or improve product quality, you can usually present a project’s benefits in dollars. The winner is the project that makes the most of the money spent on it. Of course, to calculate financial results, you need numbers; and to get numbers, you have to do some prep work and estimating (Estimating Task Work and Duration). You don’t need a full-blown project plan (Project Planning in a Nutshell) to propose a project, but you do need a rough idea of the project’s potential benefits and costs. That’s why many organizations start with feasibility studies—small efforts specifically for determining whether the project delivers the financial benefits described in the following sections and, therefore, makes sense to pursue.

Note

If some business objectives are way more important than others, you may want to evaluate the projects that support those key objectives first. Then, if you have money and resources left over, you can look at projects in other areas of the business. Risk is another consideration in selecting projects. Suppose a project has mouthwatering financial prospects and heart-stopping risks. Project proposals should include a high-level analysis of risks (Identifying Risks) so the selection committee can make informed decisions.

REALITY CHECK: Surviving Without Selection Criteria

Why should you care about project-selection criteria if you typically learn about projects only when you’re assigned to manage them? What if the selection process is nonexistent, and obtaining resources and support is always a battle? If you know what makes a good project (and have some time and patience), you can turn these trials and tribulations to your advantage.

When executives seem to want everything with equal desperation, it’s up to you to learn what’s really important. Ask managers what their priorities are, and find out what the CEO always inquires about. Listen closely to executives in company meetings.

Once you’ve identified the key business objectives, manage your projects to deliver the results that count. The more often you hit the target, the easier it’ll be to get the resources and help you need. You can’t give everyone everything they want, so focus on the most important objectives.

After you’ve made an impression with a few successful projects, you can pitch a project-selection process to the executive team.

Payback Period

Payback period is the time a project takes to earn back what it cost. Consider a project that reduces warranty repairs by $10,000 each month and costs $200,000 to implement. The payback period is the cost of the project divided by the money earned or saved each month:

Payback period = $200,000 / $10,000 per month = 20 months

Payback period has simplicity on its side: The data you need is relatively easy to obtain, and even non-financial types can follow the math. But if you get really finicky about it, payback period has several limitations:

• It assumes enough earnings to pay back the cost. If your company stops selling the product that the warranty-repair project supports, the monthly savings may not continue for the calculated payback period, which ends up costing money.

• It ignores cash flows after the payback period ends. When you compare projects based on their payback periods, projects that generate money early beat out projects that generate more money over a longer period. Consider two projects that each cost $100,000 to complete. Project #1 saves $20,000 each month for 5 months. Project #2 saves $10,000 each month for 24 months. Project #1’s payback period is 5 months compared to Project #2’s 10 months. However, Project #2 saves $240,000, whereas Project #1 saves only $100,000.

• It ignores the time value of money. There’s a price to pay for using money over a period of time. Payback period doesn’t account for the time value of money, because it uses the project cost as a lump sum, regardless of how long the project takes and when you spend the money. The measures explained in the next sections are more accurate when a project spends and receives money over time.

Net Present Value

Net present value (NPV) takes the time value of money into account, so it provides a more accurate picture of financial performance than payback period does. The time value of money is the idea that money isn’t always worth the same amount—money you earn in the future isn’t as valuable as money you earn today. For example, the value of your salary goes down as inflation reduces what each dollar of your paycheck can buy each year. The time value of money is a factor in the NPV measure because you pay a price for using money, like the interest you pay on a home mortgage. The longer you borrow money, the more interest you pay. If you pay for a project with cash on hand, you don’t pay interest. However, organizations want to earn a return on the money they invest, so the project must deliver enough earnings to balance out (or exceed) the price you pay for that money.

NPV starts by combining a project’s income (earnings or savings) and costs into cash flows. (For instance, if you earn $4,000 a month and spend $3,000 on living expenses, then your net cash flow is $1,000.) Then, NPV uses a rate of return to translate the cash flows into a single value in today’s dollars. If NPV is greater than zero, then the project earns more than that rate of return. If NPV is less than zero, then the project’s return is lower. Where does this magical rate of return come from? In most cases, you use the rate of return that your company requires on money it invests. For example, if your company demands a 10 percent return to invest in a project, you use 10 percent in the NPV calculation. If the NPV is greater than zero, then the project passes the company’s investment test. Figure 1-2 shows the NPV of a project that costs $10,000 each month for a year and then earns $15,000 each month for a year after it’s finished.

NPV has two drawbacks. First, it doesn’t tell you the return that the project provides, only whether the project exceeds the rate of return you use. You can compare NPV for several projects and pick the one with the highest value, but executives typically like to see an annual return. One way to overcome this issue is with a profitability index, which is NPV divided by the initial investment. This ratio basically tells you what bang you get for your buck from each project. The higher the profitability index, the better. The second drawback is that NPV is hard to explain to non-financial folks. (Luckily, however, most people whose jobs involve picking projects are well versed in financial measures.)

To avoid frenetic finger work calculating NPV on a handheld calculator, try Microsoft Excel’s XNPV function. You provide the required rate of return, the cash flows the investment delivers, and the dates on which they occur (remember, the value of money changes over time), and Excel does the rest.

Note

If cash flows occur on a regular schedule like once a month, you can use Excel’s NPV function, which doesn’t require dates. This function assumes a regular schedule, and you simply input the rate of return for each time period. If the annual rate is 10 percent and you have monthly cash flows, you enter the rate as 10 percent divided by 12, or 0.833 percent. The NPV function accepts up to 254 values, which is enough for monthly cash flows for more than 10 years.

Figure 1-2. In Excel, the XNPV function interprets negative numbers as money spent—like $120,000 for a project. Positive numbers represent money coming in (as a result of the project’s outcome). If you spend and earn money on the same date, simply enter the net amount (the income minus the expense). Because NPV in this example is greater than zero, the project provides a return greater than the required annual 10 percent return.

Here’s how to use the XNPV function:

1. In an Excel workbook, fill in one cell with the annual rate of return you want to use, and then enter the cash flows and dates in two of the workbook columns, as shown in Figure 1-2.

   The dates and cash flows don’t have to be side by side, but you can read the workbook more easily if they are.

2. Select a blank cell where you want to insert the function (like cell B28 in Figure 1-2), and then click the Formulas tab. On the left side of the ribbon, click Insert Function.

   The Insert Function dialog box opens with the “Search for a function” box selected.

3. In the “Search for a function” box, type XNPV, and then click Go.

   In the “Select a function” list, Excel displays and chooses the XNPV function. It also lists related financial functions.

   Tip

   You can also locate the XNPV function and its siblings in the “Or select a category” box by choosing Financial and then picking the financial function you want.

4. Click OK to insert the function into the cell, and then fill in the boxes for the function’s arguments.

   In addition to adding the function to the cell, Excel opens the Function Arguments dialog box, shown in Figure 1-3, which presents the function’s three arguments with hints and feedback.

5. Click OK to complete the function and close the dialog box.

Tip

If you’re an old hand at Excel functions, you can type the entire function into a cell: Select the cell and then type =XNPV(, and Excel shows you the arguments it requires. You can select a cell for the first argument, type a comma, and then select the cells for the next argument.

Figure 1-3. To fill in an argument, click a box, such as Rate. Then, in the worksheet, click the cell (or cells) that contain the input. For example, for Values, you can drag over all the cells that contain the cash flows (in Figure 1-2, that’s cells C3-C26).

Internal Rate of Return

A project’s internal rate of return (IRR) tells you the annual return it delivers, taking into account the time value of money. IRR is like the annual percentage yield (APY) you earn on a savings account, which includes the compounded interest you earn during the year. If your project delivers an IRR greater than the return your company requires, you’re golden.

Just like NPV, IRR depends on when cash flows in or out. For example, money you spend up front drags the IRR down more than money you spend later on. Likewise, if a project brings money in early, the IRR is higher than if the income arrives later.

Like payback period and NPV, IRR has its drawbacks. The big one is that it can give the wrong answer in some situations! It works like a charm when you have money going out for a while (negative numbers) and then the rest of the cash flows are money coming in. However, if the series of cash flows switches between positive and negative numbers, several rates of return can produce a zero NPV, so, mathematically, there are several correct answers. If you calculate IRR in Excel, the program stops as soon as it gets an answer. But if you run the function again, you might get a different result.

Another issue arises if you borrow money for your project. In that situation, the first cash flow is positive (money coming in) and the later cash flows are negative (money flowing out to pay project costs). Because of that, you have to switch the way you evaluate IRR: In such situations, you (counterintuitively) want to reject a project if its IRR is greater than your company’s required rate of return and accept a project if its IRR is less than the required rate of return.

Excel’s XIRR function calculates IRR based on cash flows and the dates on which they occur, as shown in Figure 1-4. The steps for inserting the XIRR function into a worksheet are similar to those for XNPV in the previous section. (For the mathematicians in the audience, IRR doesn’t have a formula of its own. The way you calculate IRR by hand is by running the NPV calculation with different rates of return until the answer is zero—that return is the IRR.)

Note

If the XIRR function doesn’t find an answer after 100 tries, it displays the #NUM error in the cell. You also see the #NUM error if your series of cash flows doesn’t include at least one positive and one negative cash flow.

Figure 1-4. In this example, the project costs $10,000 per month for the first 12 months. Then, once the project outcome is reached, it earns $15,000 per month for the next 12 months. The resulting IRR is 50%.

Note

XIRR includes a third argument called “guess,” which is the first return you use in the search for the IRR. If you leave the guess argument blank, Excel uses 10%. Depending on whether the resulting NPV is positive or negative, the XIRR function tries a different value until NPV equals zero.