Decision Inventory Tool: how to make a better trade-off?
Updated: Mar 13, 2019
By Xixi Chen
We all make trade-offs. But what is a trade-off? A trade-off is when you have to sacrifice some opportunities or choices to gain increased benefits by another opportunity or choice. In the financial world, there are also many trade-offs need to be evaluated by financial executives and project managers.
How to manage budget in a reasonable way is always the ultimate goal for project managers and financial executives. In Pharmaceuticals for example, pre-clinical and clinical trials are scheduled based on science and patient cycles. Failure in a phase typically means no additional expense is needed for this project. Success indicates the project may move to the next phase, which requires additional funding for the year. Financial organizations are faced with aligning a deterministic budget with a collection of technically risky projects with uncertain outcomes.
Difficulties beyond the scheduling of budgets include
1) In years when more projects succeed than expected, how is the tradeoff made if increasing the budget is not an option?
2) If more projects fail than previously expected, is there another project waiting for those freed up fund?
3) In either of the two cases above, what is the impact on next year’s financial requirement?
In this article we will introduce a budget managing tool, Decision Inventory Tool that we developed to help companies managing annual budgets.
Decision Inventory Tool Preview
Figure 1: Decision Inventory Dashboard Snapshot
As seen in Figure 1, each bar stands for a project in a project portfolio, and all projects are ordered sequentially by decision points of the projects. The values on top of the bars represent project values. The project statuses are shown by bar color. The red dotted line represents the total budget amount for the 2018 fiscal year. And the blue solid line stands for the expected cumulative spend for all projects that have decision points in 2018. Users can graphically see how expected cumulative spend changes over time and meets up with the total budget.
The example below was created for a hypothetical pharmaceutical company, but they could be applied to a variety of other industries. The R&D department has a rich discussion about the value, risk, timing and cost of every significant R&D project. But the testing process takes place on its own schedule, which is not necessarily quarterly or annual. We will examine three scenarios at different dates to show how the Decision Inventory Tool would make budget discussions easier and timelier for decision makers.
Figure 2: Decision Inventory Dashboard at Start of 2018
Time Snapshot 1 (see Figure 2)
o Date: January 1st, 2018
o Motivation: Creating project inventory for current fiscal year
All project names are fictitious
No decisions have been made yet, so the Expected Cumulative Spend is currently under the total budget
Figure 3: Decision Inventory Dashboard May 2018
Time Snapshot 2 (see Figure 3)
o Date: May 31st, 2018
o Motivation: Making decisions for all projects with decision points before May 31st
All decisions have been made for projects with decision points before May 31st
Current Expected Cumulative Spend just meets up with the total budget
o Insights / Conclusions
Normally, projects with higher project value would also request higher out of pocket spend, but for exceptional projects, we need to take project length and project possibility of success into consideration to make more logic funding decisions. And that’s how the Decision Inventory Tool visually helps users manage projects and budgets throughout the fiscal year.
We can expect that later in the year, we would have to make some trade-offs between projects to remain under budget. This is because funding all remaining projects would exceed the total budget.
The 1st and 4th projects were stopped because their trial experiments failed.
Figure 4: Decision Inventory Dashboard October 2018
Time snapshot 3 (see Figure 4)
o Date: October 17th, 2018
Making decisions for all projects with decision points before Oct 17th
Utilizing total budget and optimizing portfolio value for the current fiscal year
All decisions have been made for projects with decision points before Oct 17th
We see the tradeoff between risk and the project value of projects
o Project Comparison Example: Scorpio (July) vs Saturn (December)
Both projects have a project value of 24, but the Saturn project requires a much lower budget in 2018. In other words, Saturn contributes more to the current year portfolio value than Scorpio
Under the current year budget constraint, it is wise to put a hold on Scorpio in order to budget for Saturn, which has a decision point in December
It is always necessary to track the projects’ decision made during the year and optimize portfolio value under certain budget constraints
The Decision Inventory Tool offers an easy view for decision makers on tradeoffs between projects’ risk and project values
Making tradeoffs between portfolio risk and portfolio value is always a difficult task for project managers and financial executives. All project managers want to achieve the highest profit with relatively low risk. The Decision Inventory Tool visualizes budget changes in a time scale, and help people manage projects with or without decision points throughout the fiscal year with more logic.