Don’t we all want to understand how to deploy our project resources to give the best return? Do you want to track and evidence your project investment decisions? If you’re answering yes to these questions, understanding project return on investment (ROI) could be important for you. Let’s investigate further.
Overview: What is project ROI?
In its purest form, project return on investment (ROI) is a commonly used business metric to help us understand a project’s financial return that can be expected based upon our investment. You may hear it called the project profit ratio, and it is typically quoted as a percentage.
Mathematically, it is expressed as:
((project financial gain or loss – project total cost) / project total cost)) x 100
A negative project ROI indicates a financial loss, a positive project ROI a financial gain. Importantly, project ROI is independent of time period, so care needs to be taken when reviewing and comparing project ROI data and the underpinning assumptions. Two projects both with 20% ROI are potentially very different business decisions when taking into consideration a 1 or 5 year project completion time.
In a classic Six Sigma project that follows a DMAIC approach, we would expect to see project ROI calculations generated in the Define phase or earlier as part of the project charter.
When generating a project ROI calculation, the project team needs a clear and complete understanding of all associated costs and projected financial gain (or loss). To help with this, it’s useful to understand and explore the meaning of tangible benefits and intangible benefits.
Why is project ROI important to understand?
By using project ROI, we have a developed and recognised metric that helps build the business case to invest or proceed.
It helps you decide which projects to invest in
There may be multiple project opportunities to develop products, processes, or services, and clear project ROIs help us develop an investment strategy.
It helps you track project financial health
Project ROI calculations and forecasts are useful tools for evidencing the project financial health during delivery and keeping stakeholders informed.
It helps you allocate your project resources
It’s rare to be allocated infinite resources, so we can be both tactical and strategic with resource deployment if we have well developed and realistic project ROIs.
2 benefits and 1 drawback of project ROI
There are many reasons we might invest resources in a project, and using ROI can be a helpful project selection tool. Let’s explore some benefits and drawbacks of ROI.
1. It’s pretty straightforward to calculate
The mathematical formula for calculation is not too challenging but relies heavily on you doing your due diligence in capturing all costs and a realistic assessment of the project financial gain (or loss).
2. It’s an accepted and well-used project metric
Whether it’s a chemical industry capital project or a marketing team business project, ROI calculations and forecasts are typically used as part of a project’s financial audit and governance.
3. It only tells you about project financial health
Be careful to consider project impacts that may not be included in a standard ROI calculation as they have no directly attributable project cost or financial gain. These can typically be socio-environmental impacts, those intangible benefits that may be as a consequence of your project delivery.
An industry example of project ROI
A global chemical company wanted to expand their lubricant testing portfolio to take advantage of their development in ultra-low-viscosity driveline fluids. A project was initiated to investigate the potential for investment in a new driveline test rig. Due to the size of the investment, a formal project ROI was requested.
The project team analyzed all associated project costs, including lost revenue from service disruption during the build and installation of the new test rig, hiring and training costs for operators, and commissioning and calibration costs. Business gains were assessed with the number of new customers and volumes of tests that could be completed per annum with assumed run rates and test charge rates.
The ROI period was set at five years and included asset depreciation calculations. The project was forecast at a positive ROI at 3 years and 15% @ 5 years, which secured the investment from the executive board and the test rig project was authorized.
3 best practices when thinking about project ROI
When calculating and presenting project ROI values, we should be thorough and transparent. Let’s explore three best practices to consider.
1. Consider your project timing carefully
When we calculate and quote a project ROI, this is typically for the project duration. This could be three years, five years, or maybe a shorter duration, but it always needs to be clearly defined.
2. Capture all of your project costs
For accurate project ROI calculations, we must capture all of the project costs. It sounds simple and obvious, but often, things are missed. Personnel costs are a classic example — it’s much more than the hourly rate!
3. Clarify any non-financial returns
Projects often deliver much more than just financial returns, and it’s important we clarify and capture these. Maybe there is improved employee satisfaction, leading to reduced absenteeism that does not have a direct dollar value assignable — remember those intangible benefits.
Frequently Asked Questions (FAQ) about project ROI
What is a good ROI?
There is no simple answer to this, and it will depend upon your industry sector, appetite for risk, and the maturity of the product or service in question. Typically a range of 5% to 10% is viewed as a good target return.
How can I improve my ROI?
Strong and disciplined project financial control in combination with maximizing your project output whilst maintaining quality targets is a good strategy for a strong ROI.
What does 20% ROI mean?
To achieve an ROI of 20%, a project’s financial gain will be 20% higher than the project cost.
A final thought on project ROI
Initially, the thought of generating project ROI calculations and forecasts may be daunting. However, good financial discipline and a methodical approach to cost and financial gain calculations can help you win project investment utilizing realistic ROI numbers.