Do You Use Financial Accounting To Track Your Projects?
My guess is unless you are in the contracting industry, your answer is yes. My second guess would be – if you have answered yes – you are probably experiencing costs overrun and completion delays. The problem is that Financial Accounting is tied to periodic reporting periods, e.g. monthly, quarterly, and year-end. These periods have little to do with a project’s performance or milestones. You need to use Financial Accounting to report to investors and regulators, however, it will not give you control over the health of your projects nor forecasting tools of any value. For insight into what is going on inside your project and to forecast how well you are doing against budgeted costs, there is no substitute for Earned Value Management (EVM) analysis.
Use of Earned Value Management (EVM) started in the Defense and Aerospace industry because of the multiple factors that can go wrong and bog down performance and on-time completion. Not that “on time and within cost” has become an identifier for that industry. But you can see that this industry was the best crucible to give birth to EVM analysis. The use of EVM has now widely spread to the management of practically any type of project with great results. Almost all disciplined project manager use this method, but some do no properly communicate the tools to the organization in which they work. When there is this lack of communication, frustrations sets between senior management as they watch costs go over budget and delivery dates extended.
EVM integrates project scope, milestones, costs of resources (including staffing), planned budget and actual spending to give you metrics on whether the project is running on schedule or headed for delays and costs overrun. EVM also provides tools to forecast ultimate project costs, and completion date. But perhaps best of all, EVM provides early warning signals when your project is running into trouble.
While this is not meant to be a treatise on the subject, EVM analysis is based on 3 basic elements: Planned Value (PV), Actual Cost (AC), and Earned Value (EV). 1) Planned Value is the planned expenditure from the inception of the project to any point of time, through completion. This value is determined from vendor quotation and the project team before the start of the project. Each task in the project is planned and valued, be it the number of estimated labor hours, equipment, material or software. If you are embarking on a project without having gone through the planning and costing each task, whether done internally or outsourced, you will be running a tremendous risk. 2) Actual Cost is always provided by Financial Accounting. These are all the costs incurred up to this point of time – it is the cost that most people discuss when reviewing the status a project. 3) Earned Value is a measurement of the value achieved in the project at the time of measurement. Each task or procurement in the project has a dollar value which is created at the inception of the project. Adding up values of tasks completed fully or partially gives you the EV at any point of the project life. Your project manager must be intimately familiar with these three elements.
EVM answers the most common Management question “when will the project be completed” better than Financial Accounting. It does this by simply plotting (PV) against (EV). This simple equation produces what is called a schedule variance. A project will likely be completed on time if PV equals EV. A project will experience a delay if PV exceeds EV. A good project manager will dig into the details to find out the root cause for the delay and correct it. Another common question is “How much will this project really cost us?”. To answer this, EVM will take (AC) to date and added to the costs estimated to complete or Estimate to Complete (ETC). The (ETC) can be derived from the subtracting (EV) to date from the project’s budget or (PV). If costs overruns are isolated to only one or two factors, and if they are not likely to recur, this can be a good method to forecast Costs at Completion. If the project is plagued by delays and costs overruns, then EVM will use performance indices derived from PV, EV, and AC and use this weighting into the equation to provide a more accurate Estimate of Cost at Completion.
The US dollar is currently at the highest level in seven years against the Japanese Yen and is at a four-year high against major European currencies. This is a reflection of three factors at work: the relative strength of the US economy vice the European and Japanese; Central Banks’ monetary policies; and investment flow, the latest being a derivative of the first two factors. We should expect the strong dollar picture to remain with us through 2015, and possibly beyond, as both Europe and Japan flirt with the risk of renewed recessions and their Central Banks stay the course on near-zero short-term interest rates. While the strengthening US economy is welcome news for all businesses, the strong dollar trend could mean more pain for US exporters. Already US multinationals, such as Proctor and Gamble, have reported results that were negatively impacted by foreign currency weakness. But, it is not only multinationals. Small and medium sized US exporters have also been affected by these currency movements. A small US equipment or agricultural exporter, or technology provider, continuing to invoice in US dollars, is now facing significant price competition from foreign producers of the same products or services. US dollar prices, while remaining relatively unchanged, are fast rising in foreign currency terms. To counter this negative impact, at least partially, smart small business exporters are learning to quote and invoice in foreign currencies; simultaneously covering their currency exposure through their bankers. This, of course, will not eliminate the effect of the strong dollar, but the practice has good benefits for price and competitiveness. When an exporter quotes in dollars, the foreign buyer is figuring into the price the worst exchange rate possible in order to eliminate the risk of a margin squeeze on resale in his country. To be on the safe side, because of continued currency weakness or slow moving inventory, a foreign buyer may mentally add as much as 10% “reserve” on the quoted cost when negotiating. This is a hefty hidden penalty to the US exporter’s price. On the other hand, when the exporter quotes and invoices in the currency of the buyer, he is the taking control of the situation. He is, in essence, speaking his customer’s language, leaving the customer with nothing but to figure out his normal margin for resale. This is being truly customer centric. Meanwhile, the exporter fully covers his exchange risk with his bank at a predetermined rate that is certain to be more advantageous than the one arbitrarily figured by the foreign customer during negotiations. When the invoice matures and payment is made in foreign currency, the bank will deposit dollars in the exporter’s account as if the foreign buyer had done so.
For small and medium US importers, the case of quickly gaining facility with foreign currencies is even more pressing. A strong dollar should reduce costs of goods sold. Because of inertia or the traditional way of doing business many US importers still prefer to pay their foreign suppliers in dollars. They just don’t like to fuss with exchange rates. But some Savvy importers have learned to ask their supplier to invoice them in foreign currencies. In the case of imports from Europe, Latin America or Japan, these importers have realized cost savings ranging from 6% upwards of 30%. Naturally, a foreign supplier is happy to keep invoicing in dollars, and may even promise to hold prices steady long term, but this is simply too much margin to leave on the table. Just as in the case of exports, banks will act as intermediaries at the time of payment and deliver foreign currency to the supplier, taking US dollars from your account. This is done at a pre-negotiated advantageous rate.
Currency movements are difficult to predict, but even at regional and community banks small and medium sized business can find significant expertise that will make this very simple to practice. Advanced foreign currency techniques such as forward hedging and swaps can be made to serve small businesses just as they do for large multinationals. This is a becoming trend in small business finance circles. An international banker friend tells me, he is enjoying intimacy with his small business customers that he had not known before.
Don’t clock-watch your employees. Some managers feel that employees must put in a specific number of hours of work each day in order for the organization to be successful. But, the fact is you have little control over how employees really use their time during their hours at work. If you do not have control over the quality of output, watching the number of hours is of no great benefit. What works better is to provide vision and direction, then ensure that these are well socialized and can be followed by your employees. When you do this, a surprising fact will emerge. You will notice that most employees will push themselves harder; harder than you can ever push them by watching the hours. Of course, there will be stragglers and you should be ready to guide those or weed them out.
When managing hours, you are not getting to the heart and soul of the person. When you allow employees to engage through their heart and soul, great things will happen. Of course, you have to be there to lead and to counsel when an employee or a group hits a dead end. Make clear your objectives, then ask “how do we get there?”” Can we get there in three months instead of six?” Don’t tell them “do it in 3 months, or else!” Be the provocateur in chief, ask questions such as “what if we do this in a totally new way?” This type of outreach to the heart and soul of the employee will collectively energize the whole organization and raise performance to greater heights.
A couple of weeks ago, the Bank of Japan (BoJ) stunned markets worldwide with $96 Billion worth of Shock & Awe in Quantitative Easing (QE). The BoJ is adding Quantitative Easing (QE) to the tune of $80B (yen equivalent) in purchases of domestic securities. Last month, ECB released similar policies. But one outcome is it strengthens the US dollar. Americans have always taken a strong dollar as a matter of pride. So far, the US Dollar has risen by nearly 5% against 10 trading currency peers. But the negative effects of its rise is already felt on corporate earnings. Colgate-Palmolive’ last quarter’s revenue was down 4%, almost mirroring the increase in the value of the dollar, and its net revenue declined by 16%. In its earning report, the company, which generated 80% of it sales from overseas, specifically cited the strong dollar as the reason for the decline. Other US Crown Jewels such as Coca-Cola, Walmart, and IBM are forecasting lower revenue and an impact on earnings in 4th quarter reporting and in 2015. So, with that pride, comes a price.
Weak GDP growth forecasts, recently released by the IMF, suggest probabilities are significant that one or more Eurozone countries could slip back into recession in 2015. The IMF predicted that the combined Eurozone GDP growth will come in at a meager 0.8% in 2014 and 1.3% in 2015; compared with 2.2% and 3.1% for the US. Stimulus measures undertaken, so far, by the European Central Bank (ECB) have not worked. The recent rise in the dollar exchange signals hope for Germany, regarded as the economic engine for Europe.
The Euro / US Dollar exchange has fallen to $1.26, and if the ECB pursues Quantitative Easing (QE) similar to the US Fed’s, the Euro could fall to $1.15 according to Allan Sinai, Chief Economist with Decision Economics. A Further rise in the value of the dollar would help all European economies and would particularly be a boon to Germany because its economy is export focused. The flip side of the coin is that US exporters will likely suffer. A drop in the value of the Euro from $1.35, where it had mostly hovered for the last couple of years, to $1.15 means a potential margin squeeze of nearly 15% for US exporters. Goods and services priced in US dollar will become 15% more expensive vs. European competitors’. This is big for large US exporters such as Boeing where the competition with Airbus for new orders is high. For US companies with international operations the problem does not end there. Foreign revenues will translate into fewer dollars on the income statement, therefore negatively impacting bottom lines. Naturally, large US companies with foreign operations enter into currency hedging contracts to mitigate these swings in currencies, but none enter into contracts to hedge 100% of the risk as this theoretically is the antithesis of being hedged. Middle Market and small US companies may not have sophisticated Treasuries or bankers to deal with all this – some will find international sales particularly challenging in 2015 and possible beyond.
On the other hand, the rising dollar will favor US importers and manufactures that use imported components in their final products. What Europe, and Japan, are hoping will happen is that the US – their largest Trading Partner – will import more of their production thereby creating jobs and putting back on track their economies.
To get its economies back on track, Europe will need more than a cheaper currency. Most recently, the Head of the IMF, Christine Lagarde, has been dropping suggestions everywhere that European governments add fiscal stimulus to the monetary stimulus already in place. This can come in the form of public investment in infrastructure projects, and tax reforms that will put more Euros in people’s pockets. In fact, Lagarde would like to also see the US undertake similar measures just to ensure that the economies across the pond are growing simultaneously. But with US public debt nearing $18 Trillion, and the election cycle underway, her call is unlikely to get any traction.
The world’s economies have limped along since the 2009 financial crisis. Although the US appears to be pulling ahead, Europe remains at risk. A cheap Euro is only part of the answer. The fiscal reforms being recommended by Lagarde are essential for Europe and governments there should heed her.
So many conservative politicians, I won’t name names, have been on the Feds’ case (Federal Reserve Bank), accusing it of a libertine attitude and a penchant for accommodative monetary policies which will lead, they claim, to the mother of all inflations. They are fundamentally wrong in their economic wager! So far, inflation has not materialized and the sky is not falling. After six long years of easy money policy by the Feds, US Core Inflation rate as of the June report is just 1.9% year over year, and has averaged 1.72% over the first 5 months of the year. The risk of disinflation is not yet off the table. Further evidence of disinflation risk is coming from our major trading partners: UK, the Eurozone, and China, where Core Inflation rates are 1.6% and 0.8%, and 1.7% respectively. So concerned about disinflation is the European Central Bank (ECB), that its President Mario Draghi initiated a negative interest rate policy in June, where banks must pay for leaving money on deposit with the Central Bank – it usually works the other way around! Still not satisfied, Draghi announced last week that the ECB will give banks as much as $1 Trillion in cheap money, if the banks commit to aggressively lending the money.
Back home, the US Feds has the same problem. Despite its asset purchases and long term easy money policy, loan growth at commercial banks remains weak, except for auto loans. This is not only due to tougher credit underwriting standards by commercial banks, but more so because companies are unable to commit investments unless they are convinced the economy is growing. This is precisely why predictions of hyperinflation, as some conservative have gone apoplectic proclaiming, have not materialized and are unlikely to materialize. The process of money creation goes like this. First, the Central Bank (the Federal Reserve in the US) creates money through easing of reserve requirements, or by purchasing financial assets from commercial banks (as the Feds have done through Quantitative Easing (QE)). These actions by the Feds create additional capacity to lend at the commercial banks. The commercial banks, in turn, use the additional capacity to make loans to companies and individuals in expectation of profits. This last step is necessary to increase a country’s money supply, and for any inflation to happen because of that increase. And, it is this last step in the process which is not taking place here or in our trading partners’ economies. So, while economic policy hawks are correct that the Federal Reserve’s monetary policy is too easy, they are not looking at the full picture.
Last week, Etihad Airways inaugurated its non-stop flight from Los Angeles to Abu Dhabi; flight time 16h 25m. Los Angeles mayor, Eric Garcetti, UAE Ambassador to Washington Yusef Al Otaiba, and US Ambassador to the UAE Michael Corbin attended the celebration aptly named “Air Bridge to Los Angeles”. This is not a story about an airline. This is a story about a country that is possibly the Florence of the Middle East.
Not since the Italian City State of Florence, which attracted talent clusters in banking, art, and sciences in the likes of the Medicis, Michelangelo, and Leonardo di Vinci, and led the European Renaissance, has history witnessed a similar magnetic attraction. The UAE, born out of a federation of small Arabian Gulf States less than half a century ago, stands today as a beacon of thought leadership in a region that we normally associate with conflict. In the face of many doubters, the UAE, in its short 40+ years history, has attracted some of the best and brightest talents in the world. Yes, the country has some oil wealth, but this is not its biggest factor of success. To illustrate the point, the UAE produces 2.8 million barrels per day (mbd) and has a population size of about 9 million people. Compare this to Libya, which produces 1.8mbd and has a population size of about 6 million people. Then look at where the two countries are on all other benchmarks! The reason for the UAE success is its free thinking light government. The prestigious Swiss-based Institute for Management Development (IMD) agrees. IMD ranks the UAE as No.1 for having the lightest government in the world. In term of overall international competitiveness, IMD ranks the UAE 8th. That is ahead of countries like UK(16th), Ireland(18th), and France(27th).
I said that this is not an article about Etihad Airways. However, I think using airliners is helpful because, on one level, air traffic is an important benchmark used by economists and business analysts to gauge business potential and economic progress. Economists and business analysts prefer to season their judgment with the test of time and trend analysis. So, I will indulge them.
My business activities with the UAE began in the early eighties and continue to today. In 1985, I was living in Dubai. It was the year that Emirates Air was established, as the first flag carrier in the UAE. At the time, I held a fairly high position in Corporate Lending with Citigroup (it was a different style bank then). Emirates Air had entered into discussions with Boeing to establish a nascent fleet. Naturally, Citigroup, along with the US Export-Import Bank, became interested in financing the transaction. I do recall the discussions we had in the Bank’s credit committee; a number of members were hesitant to extend credit. The question was: with so many world-class airlines (British Air, Air France, KLM, Indonesian, Cathay Pacific, Japan Airlines – you name it) landing and taking off from the Dubai and Abu Dhabi airports, how can Emirates compete and survive? Foolish thinking! Today, Emirates ranks in the top 10 airlines in terms of passenger miles flown, and the third largest in terms of freight ton/miles. The number of jobs that both Emirates and Etihad airlines provided in this country over the years is just astounding. Only last November, the two airlines put a combined order with Boeing totaling $102 billion – you do the math!
The point is Etihad, Emirates, and other successful businesses could not have made it in a vacuum. The UAE, because of its business-friendly environment, and easy access to large markets such as India is today’s best platform for international expansion. If you are the decision maker in your company on where to locate a foreign subsidiary, think UAE: the Florence of the Middle East.