Three Ways to Factor Risk into the Decision to Fund a Project
SERIES ARTICLE
By Fernando Santiago
Ontario, Canada
Would you fund a project with your own money without factoring risk into the calculation of financial returns? Likely not. This three-part series of articles presents concrete and simple ways to incorporate risk into the evaluation of a project investment: delivery risk related to time and cost, benefit and business risk, and finally delivery and benefit risks combined, the dreaded acid test.
The calculation of financial value in a project, benefits minus investment, should also factor the time value of money and risk. Most project proposals or business cases include some form of financial indicators; Internal Rate of Return and/or Net Present Value (NPV), which both consider the time value of money. However, when it comes to risk when included in the business case, it is usually presented as additional or supporting information, and not factored into the calculation of financials of the proposed project. At best, the decision is made on a most-likely scenario of benefits and investments. Sadly, in most cases, these most likely scenarios are really sunny-day or optimistic scenarios. Have you ever seen a business case presented for consideration that is weak?
There are two reasons that explain why business cases are, for the most part, optimistic:
- Investments are underestimated because it is done at an early state and proponents simply don’t know enough of the project to properly assess the cost. In addition, assumptions are generally positive: things are going to work well, integrate easily, resources will be available, etc.
- Assumptions on benefits are confident and optimistic, otherwise, the project would not be proposed in the first place. Phrases like “slam dunk” and “no brainer” are frequent. Let’s just do it!
The two bullet points above have one thing in common: uncertainty, which is why factoring risk is so important. This article presents three ways to incorporate risk:
- Factor delivery risk into the calculation of time and cost for delivery
- Factor benefit risk into the calculation of benefits
- Factor both, delivery and benefit risk, the acid test
This article will show you how to factor delivery risk. The next two installments of this article will cover benefit risk, as well as how to consider business risk, and the combination of both delivery and benefit risk.
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Editor’s note: This three-part series is by Fernando Santiago, co-author of the book The Outcome-Based Organization and Managing Director of P3M Solutions, a Canadian corporation specialized in benefits realization management that provides consulting and training in project, program, and portfolio management (P3M). See his profile at the end of this article.
How to cite this paper: Author Santiago, F. (2020). Three Ways to Factor Risk into the Decision to Fund a Project – Part I: Delivery Risk. PM World Journal, Vol. IX, Issue VIII, August. Available online at https://pmworldlibrary.net/wp-content/uploads/2020/08/pmwj96-Aug2020-Santiago-factoring-risk-in-project-funding-part-1-2.pdf
About the Author
Fernando Santiago
Ontario, Canada
Fernando Santiago, PMP has been a pioneer and innovator on the topic of benefits realization management for more than ten years. He is co-author of the book The Outcome-Driven Organization, as well as several white papers and articles, presentations and webinars. He has also developed original tools and a software application for benefits realizations management. He has worked in financial institutions, energy and technology companies, as well as educational and professional institutions in North America, South America, Asia and Europe. Fernando is a practitioner, consultant and trainer. He is an international public speaker and invited professor at the MBA level. Based in Ontario, Canada, Fernando can be contacted at fsantiago@p3msolutions.org
