One thing I have noticed recently with the economic crisis, is that the the money has stopped flowing. Well not exactly, the requests have just been more scruntinzed than before and more justification has to be given before it is approved. What I have seen then is more of us technical types have problems getting our projects funded because we don't speak MBA very well. Do you know what ROI, NPV, and Break Even Point mean? Management will throw these terms about like we throw atomicity, referential integrity and 3NF and assume everyeone knows what we are talking about.
So, that's the point of the next few articles. In this post, I will explain what they mean. In subsequent posts, I will give a small example of what I did to justify a small software purchase and then show what I am doing to justify the migration to SQL 2008 from SQL 2005.
Return on Investment (ROI) is a traditional financial measure that is used to evaluate the efficiency of an investement. In some cases, it can be used to compare the efficiency of a number of investments. Simply it is calculated by taking the benefit gained dividing by the cost of the investment and expressing that as a percentage.
ROI = (Gain from Investment - Cost of Investment) / Cost of Investment
This popular metric says that if the ROI is negative, the project should not be funded and if alternatives have a higher percentage, they should be chosen over other simialr projects with lower ROI's. Another words, they will choose the one with the highest return. As you can see, this is a fairly simple calculation but the difficulty is in the details. How do you calculate the "
Gain from Investmet" or "
Cost of Investment"? And that is where the manipulation can come into play. One person may add in additional cost or think of other gains that you don't include and that can explain why one person calculates on ROI and another calculates something different for the same project.
Net Present Value (NPV) is an indicator of how much value an investment or project adds to the company. It compares the value of a dollar (or what ever your currency you are working in) today to the value of that same dollar in the future, taking inflation and returns into account. If the NPV of a project is positive, it should be accepted. On the other hand, if it is negative, the project will probably be rejected because the associated cash flow will also be negative and most accounting types do not like that as Cash Flow is the lifeblood of a corporation (especially in tough economic times). To see the actual formula chek out the
Wikipedia explanation.
Break Even Point (BEP) is the point at which cost or expenses equal revenue; there is no net loss or gain, and one has "broken even". Why is this important? From a management perspective, they want to know how long it will take before the project going to cover its costs and to start making money. From there, they can start to see the profitability horizion. Also, with the speed of technological change, you don't want to get too far out on your break even point. For more information please check out the
Wikipedia explanation.
Finally as you start your analysis keep these tips in mind:
- Talk in terms of company benefits. Don't go into detail about how a purchase will save you time and effort. Instead, focus on how it will save the company money. Talk to a few end-users to develop some figures as to how much money you can save.
- Use the right financials and verifiable numbers. Too many requests talk about "payback," when management wants to know about NPV. They want to know this, because NPV helps them maintain cash flow--the lifeblood of the company. Requests that take guesses at the financial value of the proposed purchase often come out with compelling math as to the value of the purchase. Unfortunately, the numbers behind the math don't add up and that jeopardizes the whole proposal--and your credibility.
- Identify, and push, hot buttons. What is most important to your managers and others who will approve or reject your request? While I don’t like acronyms or buzz words, it may help get your project the sight it needs.
- Capitalize on trends. Know what is coming up in your company's operations, offerings, and other areas that may affect your request. To find out, just ask the key people in those areas. For example, you may find out if Project X is coming out with a new version. If so, then think of how the people involved in these things might need and what the benefits of the proposed purchase mean to them. Basically look around the entire company and see where this can benefit more than just you.
- Write tight and in the active voice. In the body of your proposal eliminate the wordiness, repetition, adjectives, and fluff. The more succinct your writing, the more power it has and the more likely folks will read and understand it (they are just as busy as you). Using the active voice increases understanding and retention of the topic and it shows confidence. For more information see http://www.mindconnection.com/library/writing/activevoice.htm
- Eliminate judgment statements. Present the information objectively and you imply the reader is intelligent enough to understand it. Making claims that something is "essential," "imperative," or "a no brainer," and you imply the reader is stupid. You want them on your side...don't alienate them.
- Use the recommended format. If your company doesn't have a standard format, ask someone in accounting who handles these for a couple of funding requests that succeeded, plus suggestions on format. While you're at it, ask for any other advice that might be helpful--what you gain from his/her experience just might surprise you. Be thankful and show your team spirit and you will create a good ally.
- Use an executive summary. This is a one-page cover sheet that provides a "thumbnail" of your proposal. It should tell the purpose, have a paragraph about the benefits, and give the key financial parameters (IRR and NPV). (NOTE: This is dependent on the size of the request. If you are asking for a $1000 piece of software, it may only need to be a paragraph or so.)
Next up is a simple example that I used to get a software request approved for
SQL Trace Analyzer software.