This topic contains 8 replies, has 7 voices, and was last updated by Frank Herrera 1 year, 4 months ago.
Hi — seems like during this tough economic time, my company has become a real stickler for showing ROI on any improvement project we start. I know how to calculate traditional ROI, and within that, I know how to calculate the cost-component fairly well — but my challenge is figuring out the “return” component (or the value the project will potentially give us in the long-run). Some projects are pretty easy, but some are complex so I was wondering if anyone could share some methods that work for them.
There was an article on ROI posted on the website a few weeks ago and should be easy to find. I do share your interest in finding new ways for costing — might have to dig deeper.
Want to know the calculation? Read wikipedia post on this with easy calculation method. http://en.wikipedia.org/wiki/Rate_of_return#Further_reading
@Sebs1977 – I’m guessing the problem is not in calculating improved output, or even throughput, but rather labor savings. This is always tricky, as you don’t save anything until there are fewer feet coming in the door. Thus, labor savings that reduce less than one FTE are not “hard” savings. And then, even those that do reduce more than one FTE are not actualized savings until that FTE is no longer allocated to the activity (preference is to find new value adding activities, but sometimes it is just reduction of headcount).
I’d advise you to work with your financial folks. They aren’t going to just accept a model for savings from someone who’s not familiar with the corporate standards but there’s NOTHING wrong with presenting a potential model.
@Sebs1977 Get hold of some information on Activity Based Costing (ABC). It will help you understand how to build cost models for your projects. If you take a strong run at building your own model and then take it to your finance people like Chris suggested you will be amazed at how much better you understand your business.
Just my opinion.
Finance experts today are more interested in IRR (Internal Rate of Return) than simple ROI. IRR includes NPV (Net Present Value) in the calculation. This allows comparison of investment in the proposed project to other potential investments. If you aren’t a finance expert do not try to do these calculations yourself. You can easily find the formulas and do the calculations but you’ll be torn to bits when you present them unless there “hard” savings. Assumptions such as the benefit of improved quality or reduced cycle time will not suffice if your management doesn’t embrace these same assumptions.
Don’t go for overkill. The best ideas are those which can be explained to a layman. If you know the business, the risks to the business and the process, try to articulate the ROI best as you can in the manner you understand. Once the concept is clear, the financial wizards can present in any which way, they desire.
Did you experiment with the long term net present value of the cash flows indicated in your roi calculations. Calculate the internal rate or return and compare it with your NPV and that should give you something solid to work with.