Project Management can include many financial terms. These terms are most relevant to project selection methods, and in particular the economic model, which is the most popular approach to project selection. As a project manager, it will help you be more confident in selecting the right project. These financial terms will allow you to calculate the cost, profit, and other important aspects of the projects that will be initiated. These financial terms refer to project finance, as defined in PMP training. We will be reviewing six of these financial terms in this article.
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Let’s now define these six financial terms, and show them using examples.
Financial Terms in Project Management #1: Economic value Added, EVA
The Economic value added is the first financial term. It’s also abbreviated as EVA. EVA refers to whether the project’s return on investment is greater than its costs.
Let’s take an example to illustrate this important financial term. If the project is costing $100,000 and the company receives benefits worth $120,000, then the economic benefit for this project will be $20,000.
EVA refers to the added value that a project creates for its shareholders, above the cost of the project. This added value could be either intangible or financial assets.
A marketing campaign can increase brand awareness for your company. It might not bring in revenue directly, but it could increase brand value. It will therefore be considered an economic value added.
Financial Terms in Project Management #2 – Opportunity Cost
The opportunity cost is a key financial term that is associated with project selection. The opportunity cost is when a project is chosen over another.
An organization might have multiple projects they can start. There are constraints to projects such as time, budget, and resource constraints. Some projects are chosen over others.
Let’s say that there are two projects that your management is looking at initiating in your company.
Project A’s net present value is $200,000, while Project B’s net present value is $150,000. Both projects can be started because they both have positive Net Present Values. Project A, which will bring in a higher net present value, is more feasible if it’s not chosen.
If Project A is chosen, the opportunity cost to select Project A will be $150,000. Selecting Project A will result in Project B not being initiated, and thus the $150,000 net present value that would have been gained by Project B will not be realized.
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Sunk costs are also a financial term. These are the expended costs. Sunk costs are all money that has been spent in the project up to this point. If the project has cost $100,000, it is considered a sunk expense.
When deciding whether to continue a project in trouble, it is important not to ignore sunk costs. Because it is money that has already been spent.
For example, the project could have cost $200,000 when it was originally planned to spend $100,000 for the work that has been completed. This is a significant difference. This could be a problem for senior management.