Project Profitability
 

When we recently reset our clocks back to standard time, we were constantly reminded to change and test the batteries in our smoke alarms and carbon monoxide detectors. Hope everyone has done that!  With Black Friday approaching, we feel that another seasonal “Must Do” is in order – Assess your projects’ profitability!
 

The day after Thanksgiving is when retail stores, purportedly, go from being in the red (financially bad) to being in the black (financially good); hence, Black Friday. Our projects operate in a very similar manner. When we launch a project, we spend money on things such as project personnel, equipment, software, consultants, travel, vendors, etc. Our project, then, is ‘in the red,’ and will be in the red until the project’s financial benefits ‘repay’ the sum of the project investment costs. This, in a sense, is our project’s Black Friday, and in the business world we call this payback period.
 

A picture is worth a thousand words:


Payback occurs when a project’s negative cash flows turn to positive ones. The payback period is calculated once our project’s cash flow model has been constructed. The cash flow model forecasts future cash flow streams that our projects are expected to deliver.

 

As business and project professionals, we must not be intimidated by the numbers, but must understand and embrace them, primarily Return on Investment (ROI), to accurately represent and manage our project investments.  

Basic ROI is just one component in the ROI evaluation. Let’s dive into the four key measurements of the “ROI Umbrella” when analyzing and evaluating our project investments.

Net Present Value (NPV)

NPV is one of the most important, if not the most important, financial measurement used when evaluating projects. NPV calculates the amount of money, in today’s dollars (or Euros, Yen, etc.), that a project is expected to make for a company. This calculation does not deal in percentages, abstract numbers or ambiguous terms; it states, in hard cash, how much money a business will make or lose as a result of a project. If the NPV is positive, the company will make money, if it is negative the company will lose money, and if it is 0, the company will neither make nor lose money, but will cover the total costs of the project and break even. NPV is paramount in determining the attractiveness and viability of projects and has become a standard measurement tool for many organizations in the project selection process.

Internal Rate of Return (IRR)

The IRR, expressed as a percentage, is the yearly rate at which an organization expects to recover its investment in a project. It is the annual compound interest rate that can be gained from the money that was invested in the project. The IRR determines whether a project’s yearly rate of return exceeds the interest rate that a company is paying on the money that was borrowed to fund the project (the borrowing rate). If the borrowing rate is 12%, and the IRR is 10% -- that is not good; but if the IRR is 14% -- that is good.

Payback period

As mentioned, the payback period is the period of time required for a project’s financial benefits to ‘repay’ the sum of the project investment costs. The payback period shows how rapidly, or how slowly, a project returns the initial investment back to the company. For this reason, it is often called the ‘time-to-money’ period.

Basic Return on Investment (ROI)

Basic ROI is appealing to most business professionals because it seems fairly straight-forward. Well it is straight-forward, but unfortunately, too straight forward to be the sole indicator of a project’s financial viability or attractiveness. In fact, we need to be careful with lending too much credence to this financial measurement, for there are inherent flaws in it when dealing with long-term projects, multiple cash flows, depreciable assets and taxes. But it does offer a comparison of the overall project financial benefits to the overall costs, which is beneficial. For this reason, ROI should be included in the evaluation of projects.

In determining and evaluating all of these ROI measurements, we can gain a better understanding, acquire deeper insight and determine the financial strength and viability of project investments with confidence.

Check out our popular 1-day workshop (8 PDUs) to learn how you and your organization can become more business-savvy and financially-oriented when navigating the complexities of your project investments.
https://reschgroup.com/training/project-roi-cash-flow-modeling/

For more information on how we can assist you with your most challenging projects, visit us at www.reschgroup.com or give us a call at 1-201-803-4653.

Cheers to profitable project investments!