Project Portfolio Management - Projects Must Contribute A Positive Cash Flow

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My last two articles talked about some of the strategies needed for PPM to be effective

. In this article, I'd like to discuss the third strategy: contribute to a positive cash flow.

1.Be aligned with the firm's strategy and goals

2.Be consistent with the firm's values and culture

3.Contribute (directly or indirectly) to a positive cash flow for the enterprise.

4.Effectively use the firm's resources - both people and resources

5.Not only provide for current contributions to the firm's health but must help to position the firm for future success.

Contribute (Directly or Indirectly) to a Positive Cash Flow for the Enterprise

In finance, there's a term called Net Present Value or NPV that is often used to determine whether or not a project will be profitable. NPV is defined as "the present value of a project or an investment decision determined by summing the discounted incoming and outgoing future cash flows resulting from the decision." In other words, take all of the revenues and costs of the project and assign a dollar value in today's market.

Wikipedia gives a good example of how it works: Let's suppose that a corporation must decide whether to introduce a new product line. The new product will have startup costs, operational costs, and incoming cash flows over six years. This project will have an immediate (t=0) cash outflow of $100,000 (which might include machinery, and employee training costs). Other cash outflows for years 1-6 are expected to be $5,000 per year. Cash inflows are expected to be $30,000 each for years 1-6. All cash flows are after-tax, and there are no cash flows expected after year 6. The required rate of return is 10%. The present value (PV) can be calculated for each year.

Here are the results of the present value (PV) calculations:

Year 0 (today) = -$100,000

Year 1 = $22,727

Year 2 = $20,661

Year 3 = $18,783

Year 4 = $17,075

Year 5 = $15,523

Year 6 = $14,112

NPV = $8,881.52

*Note: If you want to do the calculations yourself, Excel has a nice formula to quickly calculate NPV. In this example, the required return is 10% and each year for six years the company will earn $25,000 ($30,000 - $5,000).

Here's the Excel formula:

=NPV(0.10,25000,25000,25000,25000,25000,25000) - 100000

The sum of all these present values is the net present value, which equals $8,881.52. Since the NPV is greater than zero, it would be better to invest in the project than to do nothing, and the corporation should invest in this project if there is no mutually exclusive alternative with a higher NPV. If the NPV were less than zero then this project should not be pursued.

When looked at from a Project Portfolio Management point of view, it's not all about whether the project will create positive cash flow for the company. Itss about selecting the best projects for the company.

To illustrate, let's suppose that a company can pursue one of two different projects - Project A has an NPV of $10,500 and Project B has an NPV of $9,000. Both have a positive NPV and so both would be profitable for the company. Unfortunately, the company only has the resources to complete one project. Which project should the company choose?

At first glance, it appears that the answer is obvious - select Project A. But does Project A meet the other PPM criteria for selection? Does the project align with a firm's strategy and goals? Is it consistent with the firm's values and culture? Will it effectively utilize the firm's resources? Will it help the company in the future?

After carefully analyzing the two projects, you may decide to go with Project B because it aligned better with corporate objectives. Or maybe Project A is the better choice since it will bring in more profits. The decision may be different for each organization. The point is that NPV and consequently cash flow, should not be the deciding factor when choosing one project over another. The ultimate decision should be based on a complete evaluation of the project, taking all five aspects of PPM into consideration.

by: Jessie L. Warner

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