Many people say that agile improves your bottom line. Whether you are a business executive, or an agile project manager, you need to understand what ‘profit’ means and how agile can boost it whilst lowering overall risk. For these things to happen, you need to restructure your budgeting practices around agile projects and you must also be able to recognise value and report it accurately. In essence, you increase value by reshaping your cash flows through the bringing forward of future revenues and the deferring of future expenses which is achieved by prioritising your stories and delivering them incrementally. This blog post outlines the value of agile, and how to make it work for you.
Profit is Just a Matter of Opinion!
At first glance, profitability would seem to be what is left after you’ve subtracted costs and expenses from your revenues. Things get more complicated when you are working on more than one thing at a time, and have to account for indirect costs. For example, let’s compare two imaginary projects – project A and project B. Project A has direct costs of €500,000, and project B €800,000. The projects share indirect costs of €1,000,000 (for facilities, software licenses, project management office staff and services). The total cost for each project is based on its direct costs, and on the way the indirect costs are divided up. Imagine there are two ways to divide the indirect costs: based either on the project’s use of facilities and services, or on team size. Therefore, if project A consumes twice as much facilities and services as project B, then it will be apportioned €670,000 of the indirect costs. The total project costs will then be €1,220,000 for project A and €1,130,000 for project B. If, however, project B has twice as many people as project A, then it will attract €670,000 of the indirect costs, making the overall costs €880,000 for project A and €1,470,000 for project B. Strange though it may seem, the apportionment method is what determines costs; profit is therefore a matter of accounting opinion. It’s important to remember this when you’re trying to justify the use of agile on projects using profitability-based metrics, such as return on investment (ROI).
What’s The Value of Money?
The timing of cash flows is central to the value of a project. Would you rather have €0.91 today or €1 a year from now? Well, if you could invest the €0.91 at 10% per annum it would be worth approximately €1 in one year (since 1.0 = 0.91 x 1.1). In other words, €1 in the future is the same as €0.91 today if it’s discounted at 10% (or as financial people like to say, the net present value, NPV, of €1 discounted at 10% is €0.91). Therefore, you can only answer the question once you know what rate of return you can reasonably expect. If it’s more than 10%, invest the €0.91; if it is less then take the money now!
Whatever the expected rate of return, avoid delaying future revenues as they erode the value of projects. If you had to wait two years for your €1, for example, its value (when discounted at 10%) would drop to approximately €0.83!
Common causes of delays to projects include;
- Writing full up-front specifications before starting development
- Waiting until the product is finished before testing
- Delivering the final product only when everything else is completed.
How Do You Value Agile?
Agile will improve your organisation’s the bottom line in two ways:
- It will help to prioritise products based on the customer’s view of value
- Its incremental delivery method will ensure that products get to market and generate revenues earlier.
Only when combined, will Agile prevent a situation where the customer is waiting for high-value deliverables while you’re still developing lower-value ones. You’ll also be able to reshape the cash flows of the project by bringing forward future revenues and deferring future expenses. This will push up the net present value of the project, ensuring it contributes more to the organisation.
Indeed, whichever financial metrics you use, this fundamental agile dynamic improves profitability by increasing the net contribution of agile projects to the overall organisation. However, don’t forget to discount cash flows to present-day values, as it is important to report and communicate value correctly within the organisation.
Show Me The Money!
Incremental is as incremental does. Align the funding of agile projects with their cash flows. Budgeting should be a cyclical process that encompasses planning, appraisal, funding, development, and delivery. You should release funds based on assessments validated in the marketplace. In practical terms, assess the products delivered by each increment in terms of their value (e.g. anticipated revenues and expenses). This, in turn, provides the basis for getting the necessary funds. From then on, you should always implement and review projects before you start production. Expectations will be tested and learning will flourish; you can then feed the knowledge gained back into the agile budgeting process.
What Are My Options?
The handling of risk is an important feature of agile project management. Alongside the rigorous practices of agile risk management, it is also important, from a financial point of view, to seek feedback. This will provide valuable market information, which you can then use in project planning and solution delivery. You should assess all the real options regularly to determine whether to continue with the project. As with lean thinking, the goal is to avoid waste; if it becomes clear that a project is not achieving its objectives, it may be time to change direction. You could invest efforts elsewhere, for example, or even stop work on the project altogether.
Anyone who works with agile project finances must understand what profit means and how to appraise agile projects in a manner that makes clear the benefits they deliver. The TSO publication, Valuing Agile: The Financial Management of Agile Projects explores the fundamental dynamics of agile finances in detail, and illustrates them using practical examples. It explains in simple language how value is accounted for, and reported. Agile budgeting, capital and operational expenses, and the management of financial risk are also covered in detail. Valuing Agile provides a thorough and comprehensive overview of everything that an agile project manager, scrum master, product owner, or business executive needs to know. Be sure of one thing, though: your agile projects can deliver value – you just have ensure your chief financial officer understands it!