Return on Investment: Measuring Value Creation

ROI.BLOGOrganizations have a responsibility to use their resources in the most impactful manner. In an environment of competition for limited resources, getting approval and funding for a project can be a challenge, and so it should be. Only the most strategic value-creating projects are likely to warrant approval and funding. How can you approach your next project in a way that is most likely to get your key decision-maker’s attention? 

Project proposals are sometimes presented to decision-makers based on the intrinsic benefits that will be derived from the project. For example, “This project will save time or make things easier.” While these benefits may be real, project proposals need to relate to a specific business need, i.e., a problem to be solved or an opportunity to be seized, that is of importance to the organization. 

Specifically, you must show how the project will positively impact the organization’s financials, customers, operational effectiveness, and/or employee performance and development. A project proposal might show how it will increase revenue, lower costs, increase market share, improve efficiency, reduce waste, or improve employee performance. The project proposal needs to clearly show not just why the project is important and how it will be implemented but also what the quantifiable impact will be.

Return on Investment (ROI) is a commonly used tool to quantify the projected net value that will be created by the project relative to the project’s costs. ROI calculations allow decision-makers, who must allocate resources, to compare the value creation of one project to another. If enough value is created, the project may be approved and funded. 

To calculate ROI, divide the net value created (return) by the underlying cost (investment) to create that value. Here is the formula: 

Return on Investment (ROI) = (Net Benefit / Total Cost) x 100

Net Benefit = Total Benefit – Total Cost

To calculate ROI, first all of the project’s benefits and costs have to be converted into dollars. Direct and indirect quantifiable costs can include: upfront project evaluation, implementation, licenses, materials, training, compensation and benefits, administration, evaluation, and transition costs. When the project’s projected benefits and costs cannot be quantified, they may still be important and can be identified separately from the ROI calculation. Second, identify the key organizational performance measurements that the project impacts and quantify the degree of improvement to determine the amount of value (in dollars) that will be created. 

Internal and external project data can be accessed and evaluated through finance and accounting, impacted departments, subject matter experts, internal and external databases, and benchmarking.

Other ROI calculations can also be considered that provide a fuller financial picture such as:

Break-Even Point (for projects that impact the volume of units sold) answers the questions: “What volume of units must be sold so that the cumulative profits generated equal the project’s costs?” or “How many additional units have to be sold to generate enough profit to pay for the project?”

Payback Period (for projects where gains are realized over time) answers the questions: “At what point in time do cumulative cash inflows from increased profits or savings (return) equal cash outflows (investment)?” or “At what point in time is the investment recovered?”

Net Present Value (takes into account the time value of money) answers the question, “How much are the future costs (investment) and benefits (return) worth in today’s dollars?”

Internal Rate of Return (measures a project’s degree of attractiveness) answers the question, “What is the minimum required rate of return that a project must yield in order for the project to be considered?”  

Partner with finance and accounting, management, and subject-matter experts to determine appropriate assumptions and work through these calculations.

When approaching projects, think like a business owner. If it were your money, would you spend it on this project? Quantifying the actual dollar impact that a project will have on a key organizational performance measure helps decision-makers make informed decisions. From a workforce management perspective, relating human capital investments to the organization’s strategic and economic priorities makes a stronger case for a project proposal. ROI calculations can help you quantify the degree of value creation and organizational impact.