Before any project makes it into the approved portfolio of projects it must go through a rigorous project selection process. The project selection process starts with all potential projects having to go through a rigorous, repeatable and appropriate selection process.
There are a few exceptions. In the normal course of business there may be some emergency or legislative compliance works that must be done that meet none of the following criteria. There are also projects that are supported by someone with enough political power to shortcut a good selection process. A high percentage of these ones end in failure though.
The project selection process is usually captured in a business case prepared for a project. The business case provides a robust way for an organization to assess the merits of each project it might do, and make decisions in a standardized and transparent way. If an organization is not using a business case it is probably allowing politically motivated or pet projects, to be done. These projects have a much higher chance of project failure so think carefully before agreeing to manage one.
The business case should contain the following information:
- A description of the issue or opportunity that has arisen
- A description of why this project is needed
- How will the project solve the issues or opportunities
- What are all the potential ways to address or solve the issue (include an assessment of the ‘do nothing’ approach)
- What is the recommended solution, outputs and expected outcomes
- How does the recommended solution address the issues or opportunities
- What is the timing of the project
- A description of known risks to the project
- A calculation of the financial and/or non-financial returns to the organization
It is not uncommon for a project manager to be given the project after it has passed through this process. In a perfect world, the project manager would be involved in this process in some way. However, in the absence of a perfect world, if you find yourself receiving a project to manage, make sure you ask if it has been through the project selection or business case process. Perhaps think twice about accepting a project that hasn’t been through the process as the chances of project success are less than one that has been through the process.
The following diagram shows the process that projects can go through from being part of all potential projects through to being included as part of the approved portfolio of projects.
We begin this process with a list of all the potential projects that we could do or that have been suggested to us. The first step that any project must go through is to check whether it helps the company achieve its strategic goals. If it doesn’t, then the company shouldn’t support it. It won’t advance the organization, and the organization likely lacks the core competencies to complete the work. If you don’t have a defined strategy you can instead use this filter to assess whether you have the necessary skills to complete the work or whether you’re just tempted by the chance to make a quick dollar. Resist this temptation! You will not have the necessary ability or motivation to do justice to the project and it’s a sure fire way to increase the chance of project failure.
Once you have ensured that all potential projects meet your organization’s strategies goals, skills, and abilities, the next step is to consider whether the project meets any pre-determined financial filters. The process of justifying a project from a financial point of view is important for two reasons.
The first is to ensure that the investment you are making will provide a satisfactory return. Does your organization have a requirement for a certain level of financial return? If it does, you need to ensure that all projects meet this. If a project doesn’t meet strict financial criteria, it must meet some other strategic imperative, such as generating future work or contributing to charity. However, you cannot do these projects forever or you will go out of business fast.
The second reason is that you need to keep in mind that it isn’t the client financing the project. Your organization will pay wages and salaries, materials, and any other costs until the client pays the first invoices sent out. This means that you need to know how this project is going to affect your company financially.
There are many ways to assess the financial viability of a project and it is not uncommon to require that a project be assessed against several financial metrics. Here are six of the most commonly used financial assessment tools. The first three are relatively easy to use and set up, while the second three are a little more difficult (i.e. you are going to need a software spreadsheet to do the calculations); however, the results tend to be a little more thorough.
- Payback period is a nice easy one to use. It is simply a calculation of how long it takes to earn back the investment you’ve made. You decide on an appropriate time period, and if the project earns back the investment within that time period it’s good. If it takes longer than that time period to earn back the money invested then it’s not a good idea.
- Profit margin is also one of the more popular ones as it is nice and simple. The company sets a required profit margin to be made on all projects and simply doesn’t do any projects which fail to make that profit margin. Margins are identified across industries so it’s probably best to check with your accountant to set this.
- Opportunity costs also need to be considered. If you decide to do this project, what other projects are you not able to do? If the value of other projects is higher than this particular project you may wish to reconsider which ones you do.
- Present Value is the value in today’s dollars of money in the future. Which would you rather have – $10000 today or $12000 in two years’ time? That process you just went through to make your decision meant calculating the present value of $12000 in today’s money. If the $12000 is worth less than $10000 in today’s money then you would take the $10000 today. If however you felt, or calculated, that you would rather have the $12000 in two years’ time then it is worth more than $10000 today.
- Net present value (NPV) is the value in today’s dollars of all future cash flows for a defined period of time. In some projects you are spending money now to make money in the future. You want to assess what that future money is worth in today’s dollars. To do this you take your cash flows, in and out, over a predetermined period of time and apply a discount rate to them. The discount rate is usually linked to the level of required return that you, your shareholders or your accountant has determined is needed to keep the organization profitable.
If the NPV is positive, it means that the money you are investing today will generate future cash flows that are earning the required amount of return. A negative NPV means that the future cash flows are worth less than what you are investing in today’s dollars and the project may not be worth doing. NPV calculations between two projects can often be used to select which is the more appealing project; a rough rule of thumb is that the project with the higher NPV is the better one to do.
To calculate NPV simply add up all the Present Value calculations for the expected income and then subtract this present value from the initial spend.
For example, if you project had an initial spend of $100000 in the first year (remember that this is a negative number), and was supposed to generate income of $30000 in the second year, $35000 in the third year, $37000 in the fourth year, and $39000 in the fifth year with a discount or interest rate of 10% the Net Present Value of your project would be $10634.52.
- Return on investment (ROI) is a similar concept to the profit margin discussed above; it just has a little more accountant-speak around it. The profit margin generally refers to the net profit made after costs, tax and depreciation have been removed from the equation. Return on investment can mean the gross financial return on the investment, expressed a percentage of the investment made. Once again, you, your shareholders or your accountant should determine what an appropriate level of required ROI is.
- Internal rate of return (IRR) is perhaps the most difficult to calculate but arguably gives the most accurate financial assessment of a particular investment a project. It is the annualized and compounded interest rate that the investment will return. So you need to know the time period, the return on investment and how to calculate the compounding effect over that time period. Obviously, a good IRR will be at a minimum more than what you can get by putting your money in the bank.
As you can see, there are both simple and sophisticated ways to assess the financial performance of any project you are going to do. It is up to you to decide what the most appropriate means of doing this is. Don’t get into the habit of simply going ahead with a project simply because you think, or feel, it will make money. If you don’t do a thorough and appropriate financial analysis of your projects there is a great chance they will lose money and eventually you will go out of business.
Additionally, making sure you have completed a robust financial justification process ensures that you organization has approved investment of its money and will pay the bills. Remember that often you or your organization has to outlay quite a bit of money before the first invoices are generated and paid. So having a robust financial assessment process means less risk to you and your money.
In addition to financial criteria, there are several non-financial criteria that can be used to justify proceeding, or not proceeding, with a project. Typical non-financial criteria include market share, putting in place barriers to market entry, reducing reliance on suppliers and to provide for community development or support.
Health, social services, not-for-profit organizations, wildlife conservation projects and even the Olympic Games are all examples of organizations having non-financial criteria to help in their decision making process about which projects they undertake.
It is your decision what mix of financial and non-financial criteria you use in your project selection method. The more professional the criteria are, the greater the chance of project success.
It may be that you have a few projects that make it through the selection process and all pass with flying colours. However, it may be that you don’t have resources to do them all, or need to rank them somehow to determine which ones are the most important to you. This is the process of prioritizing your projects. To start with you need to decide which metrics are important to you in choosing between them.
The criteria for ranking them are highly subjective. Most organizations will place a greater emphasis on financial return. But there are other metrics to use, such as reputation, difficulty, future growth, repeat business and market share. You may also want to give each of your selected assessment criteria a different weighting so you can place a different emphasis on different elements.
At the end of this process you want to have a documented list of all the projects you are doing ranked by order of importance to the company that everyone can see. It also helps when new projects join the list to put them in their correct position according to the professional assessment criteria you have developed. Doing this correctly will help you allocate time, energy and resources to the most important projects.
The following diagram shows an example of a weighted attribute project selection process showing the areas being considered as important when prioritizing projects, the score each project gets for each area, the weighting given to each area and the total score showing that Project C has the top priority despite Project B having the greatest financial return.
Weighted Attribute Project Selection