Budget Management in R&D Projects

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Finance is a broad term describing the management of money and other valuables, which can be easily converted into cash to achieve economic objectives of the given organization. The usual structure of the financial department in large, mature pharmaceutical company includes Tax Group (scope: tax declarations & optimization, transfer pricing), Accounting (scope: external reporting, financial data management), Corporate Finance (scope: treasury & capital markets, M&A, investor relations), Controlling (scope: internal reporting, budgeting & planning, business valuation), plus potentially additional groups.

project budget is the total sum of money allocated for the particular purpose of the project for a given period. The goal of budget management is to control project costs within the approved budget and deliver the expected project goals. In the pharmaceutical industry, Project Manager (PM) is responsible for achieving the project goals within the given budget frame. Program Leader (PgL) is accountable for staying within program budget. The controlling group has a leading role in supporting the PM & PgL in Cost Management of R&D projects and programs and help them to achieve financial goals. Controlling supports relevant R&D related financial aspects with a special focus on R&D projects and R&D functional lines (e.g. CMC, clinical operation, clinical, biostatistics, etc.). They prepare financial management reports, management decisions, and investment statements. Controlling usually leads R&D planning and forecasting processes.

Since every biopharmaceutical company is a unique entity, there will be differences in their financial & operational structures, and roles & responsibilities. Every pharma will also implement distinct IT systems, financial terminology, and timing of the R&D planning, forecasting & tracking processes.

For the purpose of this article, we can assume that every project in average pharma organization goes through several financial processes during each fiscal year:

  • Operational Planning (frequency: 1/year): usually 1 to 3-year budget for the R&D particular project to perform all essential activities needed to reach the next decision point according to the project plan. Compiled by PM and the team. Project costs are usually compared to benchmark industry costs and approved by R&D governance body.
  • Tracking of Project Actual Costs (ongoing activity, 1/month): ‘actuals’ booked expenditures of a project to date as captured in the financial systems. Should be reviewed by PM and the team on a regular basis.
  • Quarterly Forecast (performed three times/year): estimate on the expected overall costs to be spent in the current year for the project (including accruals), including all known deviations.  While Operational Planning provides financial framework for business activities for a given period (e.g. year), changes may occur throughout the year requiring budget adjustments. Forecasts capture those changes and modifications to support overall budget management of a given project. Forecasts are prepared by PM and teams, with controller supervision.
  • Year End Accruals (performed at year end): expected costs for activities conducted in the current year that cannot be invoiced in time but have to be anticipated. One of the most challenging and work intense financial processes. Usually compiled by Controlling with a support of functional lines and PMs.
  • Reporting of Budget Deviations (ongoing activity): most common consequence of unexpected delays or strategy changes; those are tracked by PMs and functions and require additional R&D governance committee(s) approvals.

Depending on the particular organization, estimates are prepared for both indirect (or internal) and direct (or external) costs, or just the latter. Direct costs are expenses that a company can easily connect to a given “cost object,” which may be a product, department or project. This includes items such as software, equipment, or raw materials. If your company develops a medical device software and needs specific pre-generated assets such as purchased frameworks or development applications, those are direct costs. Other expenses falling into the ‘direct costs’ category could be the cost of external services, goods that can be directly charged to a specific project, e.g. external costs of clinical studies (CRO), samples and supplies, legal fees, advertising, project-specific consultants, etc.  Indirect costs go beyond the expenses associated with creating a particular product to include the price of maintaining the entire company. These overhead costs are the ones left over after direct costs have been computed, and are sometimes referred to as the “real” costs of doing business (read more here). Examples of indirect costs that cannot or will not be allocated directly to projects are costs of personnel, IT, training & literature, travel, a cost of congresses and seminars, etc.

Pharma industry seems to recognize the importance of above processes but also struggle with the accuracy and effectiveness of the budgetary planning and forecasting. Many companies plan too conservatively, and this results in securing too much money for their programs. At the other end, some companies are too optimistic in planning and end up in critical need of additional funding. Both situations have a negative impact on the ability of the organization to fund other R&D opportunities. Underspending is perceived even more negatively by investors (bad planning=missed opportunities).

The key reasons for this insufficiency are limited expertise and availability of appropriately qualified personnel, use of outdated financial systems, tools, and processes. All of those factors contribute to lengthy and inefficient budget estimates within the organizations. Per ClearTrial survey (now Oracle), in 2011, 57% of the companies relied on Excel spreadsheets, with only 21% of respondents highly confident in their budget forecasts.

Many companies develop their software in-house, tailor off-the-shelf programs, utilize benchmarking databases. All of those solutions are not perfect and usually do not work very well. Those budget tools are pretty inadequate as investments, considering how expensive drug development is. The industry use of outdated financial approaches for budgeting and forecasting puts it 10 to 15 years behind other sectors. But the status quo slowly evolves. Public companies apply tighter scrutiny on the budgets, and successively, the tolerance of variance in budgets within those organizations came down. Any fluctuations in the budget forecasts, comparing to initial estimate, drive attention of the senior leadership and financial auditors. This is certainly not in the interest of the responsible project leader and affected organization.

The large pharma is usually equipped better to perform the budget planning and forecasting comparing to the small- to mid-sized rivals. I will use here a simple example of the study budget planning. Generally, smaller pharma organizations develop an initial trial budget using per patient costs for a historical study or vendor bids. Those organizations often lack the internal forecasting capability, and thus they are unable to quickly, precisely and accurately re-forecast trial cost when changes occur. As a result, they deal with increased probability of financial risks and issues. How the pharma companies can avoid those risks? Simply; by relying on external expert vendors who offer various financial planning and forecasting systems. Those systems use industry intelligence and benchmarking data to forecast budgets accurately and quickly. Yet, many smaller companies prefer to stick to old and inefficient ways of managing the project funds. Why? They may not see a quick return on such investment and thus prefer to allocate the money elsewhere. Also, a new financial system can be a real hassle to implement mid-project or program.

Two additional factors have to be considered for better budget management. Companies striving to stay on top of a project budget, have to partner efficiently with their vendors for budget reconciliation, alignment, and transparency. Also, finance and project & functional team members should be trained on the financial processes and systems and go through internal cross-education.

Many pharmaceutical organizations still need to address budget management gaps to ensure that no capital is wasted. It can be achieved through implementing relevant cross-functional education and training, financial IT systems, tools, and processes.

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