OK, so we need to talk about Financial Appraisal. I’ve just finished a series of 4 blog posts on financial appraisal methods for projects. Here they are for reference:
I’ve also written about financial and non-financial methods for project selection in an earlier blog.
Reasons to Ignore the Financial Appraisal Figures
So if you’ve read those blogs, and have an awareness of these four methods, here are some good reasons to ignore the results. Yes, the financial appraisal methods are just that; Financial methods, and they pay no attention to the many other factors that should be considered when selecting a project.
Reasons to Ignore a Good Project
Here are some reasons that a project with a good financial return might still get rejected:
- Companies need cash to run projects. No matter how good the potential project returns, without spare cash to invest, the project cannot happen. Even if the company has spare cash, then investing in a project is just one option. The cash could be used to ‘buy-out’ another company or enter a partnership.
- Projects need resources. If the company does not have, or cannot obtain the correct resources with the correct skills, then the project cannot happen. Resources can be expanded to include materials, equipment, and space. Without these, the project cannot happen.
- Projects may not be run if they are too risky. An organisation needs a balanced portfolio of projects, some easy, some more risky. If the project is too risky, and unbalances that portfolio, then the project will not be approved, regardless of financial benefits.
- Timescales may not allow the successful completion of the project. A project with excellent returns may need to be completed by a certain date, and if the schedule does not allow for that, then the project may get rejected.
Reasons to Accept a Project with Poor Returns
Projects with apparently poor returns may still get accepted for the following valid reasons:
- The organisation may have idle resources, or future forecasts of under-capacity. These resources will need work, and keeping them busy with a project that breaks even can be a consideration.
- A project may be accepted to develop skills. Even if the project is not ‘the best’ financially, the project may help the company develop into new areas by developing new skills that can be exploited on future projects.
- Similar to the previous reason, the organisation may want to break into a new technology. A project can help develop skills in that technology for future exploitation.
- Projects may be run as loss leaders. There may be the benefit of future potential work from a customer. Accepting to run a project with poor returns in order to work with a new customer is very acceptable, but remember that there is no guarantee of future business with that customer.
Projects provide employment for staff, and offer opportunities for individual and company development.
Project Financial Appraisal
All of these project finance techniques are shown in this video playlist: In particular, the following video highlights these issues.
Despite the financial calculations, projects may still get accepted or rejected for other reasons.
Financial Appraisal is just one element of project selection. Other considerations such as resources, risks, budget, cash-flow, and scheduling need to be considered int he final decision.