© The Federal Market Group March 2003 3-1 The Business Case — the Proposal, the Estimate, and...

© The Federal Market Group March 2003

3-1

The Business Case — the Proposal, the Estimate, and Cash Flows


2

Discussion Objectives

By the end of this discussion, you will be able to — Understand the purpose of the business case financial

proposal Select the most appropriate estimating method and

technique to determine the cost estimate Determine the impact of cash in-flows and out-flows on

the success of your project or contract


3-3

The Business Case Proposal


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What Is the Business Case Financial Proposal? The business case financial proposal is a document prepared by an organization for the purpose of determining whether or not a proposed business venture should be selected.

Purpose: To set forth the financial and non-financial reasons supporting the proposed venture.

Content: Contains both financial and non-financial data to provide decision makers with relevant, timely, and useful information needed to make the right decision.


5

The Components of the Business Case Financial Proposal Non-financial

Description of the endeavor

Market– or organization–specific business analysis

Customer analysis Competitor analysis Strategic importance of

the proposed effort Key success factors Non-standard terms or

conditions desired by the customer

Financial Financial statements

Income Statement Balance Sheet Cash Flows

Financial Impacts and Timing Revenue Profit Investment Cash flow (in-flow and

out-flow)


6

Non-Financial Business Case Support Data

Project description: high-level description of the effort being proposed and the business reason(s) giving rise to its need

Market– or organization– specific business impacts of the proposed efforts — short-term and long-term Description of the market-place impacts, if the

endeavor is approved or not approved Impact on affiliated organizations, if the endeavor is

approved or not approved Impact on the organization, if the endeavor is

approved or not approved


7

Non-Financial Business Case Support Data (continued)

Customer impacts Historical analysis of recent proposals to this

customer Analysis of the customer business need giving rise

to this proposal Identification of additional opportunities for the

specific customer and other related customers Competition impacts

Analysis of competitor products/services related to the current proposed effort

Historical analysis of recent competitor pricing on similar efforts


8


Strategic importance of proposed effort Market-place considerations affecting pricing

issues on the proposed project Fit with corporate longer–term strategic plan

Key success factors Identification of key assumptions incorporated into

the technical, cost, and management proposals Identification of key risks – downside and upside –

which may affect project profitability Operational buy-in as to performance and schedule

criteria


9


Non-standard terms and conditions desired by the customer Analysis of financial and business operations

impacts if the customer’s non-standard terms and conditions are accepted

Business unit specialist sign-off of non-standard terms/condition analyses


10

The Business Case Financial Proposal

The business case financial contains both financial and business documentation for use in decision-making

The financial form usually is presented as a detailed cost budget with an accompanying income statement, balance sheet, and statement of cash flows Usually budgets are monthly forecasts for the

current and the next year, quarterly for the second through third years, and annual thereafter

The business documentation presents the underlying reasons indicating why the proposal should be accepted and any risks associated with that acceptance


11

Business Case Financial — Cost Budget2002 American Aerospace Companies, Inc.

Business Case Financial Proposal 02-NNNN

Cost Budget - Proposed Expenditure Profile

Rate Jan Feb Mar Apr Oct Nov Dec Total

Direct Materials - 6,000 * 200,000 - - - - 206,000

Material Acquisition 5.00% - 300 * 10,000 - - - - 10,300

Direct Labor

Engineer I 30.00$ 24,000 * 48,000 * 24,000 * - - - - 96,000

Engineer II 45.00$ 9,000 * 18,000 * 9,000 * - - - - 36,000

Manufacturing I 15.00$ - 7,500 * 15,000 30,000 30,000 30,000 15,000 277,500

Manufacturing II 21.00$ - 6,300 * 10,500 21,000 21,000 21,000 10,500 195,300

Engineering Overhead 180.00% 59,400 * 118,800 * 59,400 * - - - - 237,600

Manufacturng Overhead 250.00% - 34,500 * 63,750 127,500 127,500 127,500 63,750 1,182,000

Other Direct Costs

Travel 3,000 * 12,000 * 6,000 * 21,000

Subtotal 95,400 251,400 397,650 178,500 178,500 178,500 89,250 2,261,700

General & Administrative 8.00% 7,632 20,112 31,812 14,280 14,280 14,280 7,140 180,936

Total Costs 103,032 271,512 429,462 192,780 192,780 192,780 96,390 2,442,636

Direct Labor Hours Engineer I 800 1,600 800 - - - - 3,200 Engineer II 200 400 200 - - - - 800 Manufacturing I - 500 1000 2000 2000 2000 1000 18,500 Manufacturing II - 300 500 1000 1000 1000 500 9,300

*Development Costs to be Amortized 95,400 251,400 98,400 - - - - 445,200


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Business Case Financial — Balance Sheet

2002 American Aerospace Companies, Inc.


Proposed Balance Sheet

Dec '01 Jan '02 Feb '02 Mar '02 Apr '02 Oct '02 Nov '02 Dec '02 Jan '03

Assets

Cash - - - - - - - 105,329 306,548

Accounts Receivable - - - - 360,000 360,000 300,000 360,000 -

Inventory

Direct Material - - 6,000 200,000 176,000 44,000 24,000 - -

Material Acquisition - - 300 10,000 8,800 2,200 1,200 - -

Direct Labor - Production - - 13,800 25,500 21,420 24,480 29,580 - -

Overhead - Production - - 34,500 63,750 53,550 61,200 73,950 - -

Direct Labor - Engineering - 33,000 99,000 - - - - - -

Overhead - Engineering - 59,400 178,200 - - - - - -

Other Direct Costs - 3,000 15,000 - - - - - -

Amortizable Development Costs - - - 445,200 391,776 97,944 53,424 - -

Total Inventory - 95,400 346,800 744,450 651,546 229,824 182,154 - -

Total Identifiable Assets - 95,400 346,800 744,450 1,011,546 589,824 482,154 465,329 306,548

Liabilities and EquityWages and Accounts Payable - 46,695 124,949 296,701 70,176 70,176 70,176 35,088 - Income Taxes Payable - (3,434) (12,484) (26,799) 6,643 60,240 87,038 123,693 - Line of Credit - 56,337 249,595 507,305 926,610 230,413 63,193 - Total Liabilities - 99,598 362,060 777,207 1,003,429 360,829 220,407 158,781 - Retained Earnings - (4,198) (15,260) (32,757) 8,117 228,995 261,747 306,548 306,548 Total Equity - (4,198) (15,260) (32,757) 8,117 228,995 261,747 306,548 306,548 Total Liabilities and Equity - 95,400 346,800 744,450 1,011,546 589,824 482,154 465,329 306,548


13

Business Case Financial — Cash Flows

2002 American Aerospace Companies, Inc.


Proposed Statement of Cash Flows - By Month

Jan '02 Feb '02 Mar '02 Apr '02 Oct '02 Nov '02 Dec '02 FY 02

Operating Activities

Net Income (4,198) (11,062) (17,497) 40,874 40,874 32,752 44,801 306,548

Adjustments to reconcile income from

operations to net cash from operations

Changes in assets and liabilities

Accounts receivable - - - (360,000) (60,000) 60,000 (60,000) (360,000)

Inventory (95,400) (251,400) (397,650) 92,904 92,904 47,670 182,154 -

Wages and accounts Payable 46,695 78,254 171,752 (226,525) - - (35,088) 35,088

Income taxes payable (3,434) (9,050) (14,315) 33,442 33,442 26,798 36,655 123,693

Net Cash Flows from Operations (56,337) (193,258) (257,710) (419,305) 107,220 167,220 168,522 105,329

Investing Activities

None

Financing ActivitiesChange in Line of Credit Borrowings 56,337 193,258 257,710 419,305 (107,220) (167,220) (63,193) - Net Cash Flows from Financing Activities 56,337 193,258 257,710 419,305 (107,220) (167,220) (63,193) - Net Increase (Decrease) in Cash - - - - - - 105,329 105,329 Cash at the Beginning of the Period - - - - - - - - Cash at the End of the Period - - - - - - 105,329 105,329


14

Key Points on the Business Case Financial Proposal

Although business case financial presentations may NOT achieve the desired financial results, in some cases non-financial reasons will drive the organization to undertake the endeavor

The success or failure of a business proposition relies on the integrity of the data presented AND the honesty with which the underlying non-financial and financial data is set forth


3-15

The Cost Estimate


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The Role of Costs and Pricing

Your costs are your costs are your costs. Pricing is a business decision. Eliminating activities from pricing consideration does not mean those costs go away – you will pay for those costs out of your profits


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Why Are Estimates Necessary?

Estimates provide — The basis for deciding if a project/contract should be

authorized to proceed The baseline by which project/contract expenditures

can be measured, tracked and controlled The management tool by which a project/contract

manager can evaluate project decisions


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Types of Estimates

Order of magnitude Precision: +75%/-25% Normally used for quick estimates, without much

research Preliminary (budgetary)

Precision: +25%/-10% Used for strategic plans, also referred to as the top-

down estimate Definitive (detailed engineering)

Precision: +10%/-5% Used for contract proposals or modifications, also

known as the bottoms-up estimate


19

Estimating Best Practices

Practical estimates are — Based upon historical fact Consistent with corporate strategic plans Prepared based upon a consistently applied

methodology (optimally through the use of templates) Realistic, since they are based upon likely conditions Based upon documented assumptions related to the

project staff, the technical work to be performed, and working conditions likely to be found

Team-based Identified as to date and time of preparation Incorporate risk factors


20

Cost Estimating Methods

Cost estimating methods may rely on any of the following methods — Detailed engineering Analogy Parametric techniques


21

Cost Estimation Process Approach

Determine project requirements

Develop the WBS

Identify project resources

Develop initial schedule based upon resources

Prepare initial estimate based upon resources and schedule

Adjust schedule and resources based upon proposed contract

Re-estimate the project based upon the adjustments

PERFORM RISK MANAGEMENT ACTIVITIES

Contract AwardBaseline the schedule and estimate with stakeholders


22

Detailed Engineering Estimate

A detailed engineering estimate will incorporate the following elements into the proposal Identification of the work to be done The timing at which the work must be done Identification of the human resources who will perform

the work and the level of effort required (hours, days, weeks, or months)

The direct cost of the human resources Identification of materials and subcontract The direct cost of non-human resources


23

Detailed Engineering Estimate (continued)

Identification of other direct costs to be incurred in support of the effort and the timing of such costs

The amounts of indirect costs to be applied to estimated direct costs

Adjustment of the estimate for identified risks Identification of profit to be proposed, subject to the

existence or non-existence of competition


24

Analogy

Analogy is an estimating method which uses a past project which is similar to the current proposed effort

Obtain the statistical and cost data for the past project Determine the differences between the prior effort and

the current proposed effort in the areas of Technology Complexity Miniaturization Quantity Inflation


25

Analogy (continued)

For each identified difference, provide a technical assessment as to the percentage change that would be applied to the prior data

Quantity adjustments are the second last factor to be addressed and inflation factors are the final factor to be addressed.

Non-cost data can be affected by all factors, except inflation


26

Analogy Example

Three years ago, we performed a project which required 8,000 labor hours which had a fully loaded labor rate of $75 per hour for 100 units. We have been asked to perform the project again this year for 120 units.

Finance has indicated that the inflation rate for each of the last 3 years has averaged 3.5%.

Engineering has made the following technical assessment Technical changes would have reduced the effort by

10% Miniaturization impacts would have increased the effort

by 3%


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Analogy Example (continued)

Analogy ExampleAdjustment Hours Rate Cost

Original Project 8,000 75.00$ 600,000.00$ Adjustment Technical Changes -10.00% (800) Miniaturization Impacts 5.00% 400 Subtotal 7,600

Quantity Adjustment1 20.00% 1,520

Inflation Adjustment2 10.87% 8.15 9,120 83.15$ 758,328.00$

1Quantity adjustment: (New qty - old qty)/Old qty = (120-100)/100

2Inflation adjustment: This is a future value problem. The compounded inflation factor for 3.5% for three years is 10.87%. Calculated as [=ROUND((1+.035)^3,2)-1]. If Finance had a fully loaded rate, that rate would have been used instead of the calculated rate.


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Parametric Estimating

Parametric estimating is an estimation method which utilizes either a physical or performance characteristic as the basis for the estimate

The characteristic chosen should be the one which is most responsible for the cost of the item or the service

Parametric estimates are developed through mathematic models, known as cost estimating relationships (CERs). Knowing the value of the characteristic can provide insight into the value of the item


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Parametric Estimating (continued)

Examples of parametric estimates Road construction is driven primarily by the number of

lane miles New home construction is driven by square footage Software cost has two examples —

Most recent: Function point Early 1990’s: Lines of code


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Resource Utilization and Planning

Resources who are available for use on the project affect project estimates in either one or two ways — Productivity Availability

Productivity addresses the amount of work which can be provided over time and is often a function of knowledge and/or experience of the resource — Lower productivity results in longer activity durations Higher productivity results in shorter activity durations

Availability addresses the impact on the elapsed time over which an activity must be performed, since no work can be accomplished during periods of non-availability.


31

Estimating Tools — Averages

Many estimates rely on the use of averages Arithmetic mean Median Mode

Best practices — Calculate averages, since the outcome and comparison of those averages might be useful in determining an estimate


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Regression Analysis

Regression analysis is used to estimate effort or costs by identifying a relationship between two variables, one of which is independent

Knowledge of the relationship of the variables, one of which is an independent variable, enables the projection as to the value of the dependent variable

The mathematical method,known as the method of the least squares, is easily computed using Excel tools.


33

Regression Analysis — Example

Data

1993 $18,500

1994 19,000

1995 19,500

1996 20,400

1997 20,800

1998 21,300

1999 21,800

2000 22,500

2001 23,000

2002 ?

24,00024,000

23,50023,500

23,00023,000

22,50022,500

22,00022,000

21,50021,500

21,00021,000

20,50020,500

20,00020,000

19,50019,500

19,00019,000

18,50018,500

93 94 95 96 97 98 99 00 01 0293 94 95 96 97 98 99 00 01 02


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Example Using Regression in Excel

Year X Y In Excel: Select Tools, then Data

1993 -4 18500 A drop down menu will appear, scroll down and select Regression1994 -3 19000 A pop-up menu will appear1995 -2 19500 Insert the range for the dependent variable (Y) (dotted range)1996 -1 20400 Insert the range for the independent variable (X) (solid range)1997 0 208001998 1 21300 Substitute the values in the equation Y = a+bx1999 2 21800 where: Y = Answer2000 3 22500 a = Intercept 20755.5562001 4 23000 b = X Variable 1 566.666672002 5 ? x = the X value for 2002 5

SUMMARY OUTPUT Y = 20755.556 + (566.6667 x 5)Y = 23,589 , or 23,600

Regression StatisticsMultiple R 0.998045R Square 0.9960938Adjusted R Square 0.9955357Standard Error 103.8925Observations 9

ANOVAdf SS MS F Significance F

Regression 1 19266666.67 19266667 1785 1.08581E-09Residual 7 75555.55556 10793.651Total 8 19342222.22

Coefficients Standard Error t Stat P-value Lower 95% Upper 95%Lower 95.0%Upper 95.0%Intercept 20755.556 34.63083211 599.33748 9.507E-18 20673.66671 20837.444 20673.667 20837.444X Variable 1 566.66667 13.4124636 42.24926 1.086E-09 534.9512526 598.38208 534.95125 598.38208


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The Use of “Fudge” Factors

Realistic estimates is one of the most problematic issues facing project managers around the world

Project costs are often over-estimated due to the following reasons: “My manager always cuts 15% out of my

estimates.” “I want to make sure that I can stay within my

estimate, so I will add 20% to my best estimate.” The result: Estimates which are overstated.


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Normal Estimating Methods by Type of Cost Material

Vendor estimate Analogy Parametric

Direct Labor Bottoms up (labor effort x

labor rate) Analogy (effort and rates)

Subcontract Effort Vendor estimate Analogy

Other Direct Costs Travel (bottoms up by

travel component) Overhead and General & Administrative (G&A) Annual overhead estimate

prorated to labor or material base used in contract

Annual G&A estimate prorated to total costs used in contract

Normally prepared by financial organization


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Ensuring a Valid Estimate — Best Practices

Review the solicitation to determine if the proposal meets the requirements

Document all constraints and assumptions Understand both your organization’s AND your

customer’s ground rules Document the sources of the cost data Ensure compliance of the estimating methodology with

the ground rules Always compare your estimate with other established

data – a sanity check Consider the impacts of risk in the estimate


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Key Points Related to Cost Estimates

Costs are costs are costs, but pricing is a business decision Three estimating types often used in today’s business

include (in the order of precision from lowest to highest) Order of magnitude Preliminary Detailed

The most frequently used methods in completing estimates are: Detailed engineering Parametric estimating Analogy


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Key Points Related to Cost Estimates (continued)

Estimates are often based upon averages – where ever possible averages should be calculated to provide insight as to possible activity outcomes

Productivity and availability affect the duration of activities, but only productivity has a direct effect on the costs


3-40

Cash Flows


3-41

CASH IS KING!CASH IS KING!


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Costs Incurred — Reality Check

Typically, costs must be incurred before revenues are collected to offset the cash expended Direct Labor costs – outflows every payroll period Direct Material and Subcontract costs – outflows within

30-45 days of receipt (dependent on bi-lateral agreement)

Other Direct Costs – outflows within 15-30 days of receipt (dependent on bi-lateral agreement)

Overhead and G&A costs (except depreciation) – outflows in the same fashion as their related direct labor, direct material, or subcontract costs

Depreciation is a non-cash expense – original investment (carried on the balance sheet) required the cash outlay


43

Cost Incurred — Reality Check

Between the time the cost is incurred and the payment is made, the liability is either recorded in Accounts Payable (for non-internal labor related costs) or in Wages Payable (for internal labor costs). These liabilities are reduced when payment is made.

Directly associated costs of the endeavor (direct material, direct labor, subcontracts, and other direct costs, and all related overhead costs – excluding G&A – are transferred to inventory (balance sheet account), until the sale is recorded

Unless there is internal funding provided by the organization or financing provided by the customer, the endeavor will not even get off the ground because cash is required to pay the bills within a reasonable amount of time!


44

Balance Sheet Impacts on Cash Flows

When a sale is generated to the customer, revenue is recognized (sales), inventory is reduced (by charging cost of sales), and the amount of the invoice is recorded as Accounts Receivable (an asset on the balance sheet). How long will the customer take before generating

the payment? Will the length of time taken by the customer be less than the amount of time before the costs which make up that invoice are due to be paid?

Inventory which represents costs directly associated with the endeavor cannot be relieved until revenue is recognized


45

Balance Sheet Impacts on Cash Flows (continued)

Balances in the inventory and accounts receivable accounts represent investments by the organization in the contract effort – the quicker the customer pays for the effort, the quicker those investments can be converted into cash, which will permit continued operations. If internal funding is not available, then customer financing may be an attractive alternative: Advance payments – payments received prior to

the start of work Progress payments – payments received based

upon the expenditure of costs Milestone payments – payments received based

upon the completion of pre-defined objectives


46

Balance Sheet Impacts on Cash Flows (continued)

Some projects require investments in fixed assets, which are depreciated over the estimated useful life of the asset. As these investments are depreciated, the costs are recovered as part of the overhead cost recovered in the sales price. Customers rarely pay for these costs directly. In order to generate payment for these assets

earlier than the time over which they are depreciated, projects must generate a profit (the excess of project revenues over project costs) to permit early payment or the organization must fund the acquisition through internal funding or borrowing.


47

Key Points on Cash In-Flows

Maximizing the receipt of cash before completing work Advance payments Progress payments Milestone payments

Insisting on payment within 30 days of completing work Minimizing terms which require payment with

conditions after delivery, unless compensation for the time value of money is incorporated into the price Acceptance tests after delivery Long payment terms (more than 30 days)


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Key Points on Cash In-Flows (continued)

Use of electronic funds transfers Billing more than once a month (mid-month or every

other week) Advance payments on larger orders C.O.D. payments for customers with records of

payment delinquencies Timely deposit of cash receipts Offer of discounts for early payment


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Key Points on Cash Out-Flows

Use of charge accounts, as long as payment is made by the due date

Use of checking accounts with out-of-area banks Do not pay invoices before the scheduled due dates Negotiate contract terms which delay the timing of

payments to subcontractors

© The Federal Market Group March 2003 3-1 The Business Case — the Proposal, the Estimate, and...

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