Assuming you got through the rough stuff of defining costs and benefits, the analysis should be simple. What you want to know is if the benefits of the project will exceed the costs, and by how much. Since costs and benefits may be spread over long periods of time, Present Values of these amounts are also usually calculated to compare the amounts in “today’s” dollars.
When I did my first Cost-Benefit Analysis for a major project, I had to work with a spreadsheet expert to do these calculations; now you can probably download something for free or a nominal fee that will do basic and advanced calculations. The key things these tools need is the cost and benefit dollar values, and the length of time of the analysis. The latter is usually defined by accounting standards at your company, and the most popular time periods used are three years and five years, often based around your company’s depreciation procedures/periods.
Given that, you can usually get calculations like:
• Break-Even Point, the point in time when the benefits realized exceed the project cost
• Various rate of return and yield values, like IRR.
These calculations may be used to determine if a project passes a funding hurdle; it’s not enough that a project makes money, it has to make more than investing the equivalent dollars of the project cost in securities or other investments.
After all this is done, a project can now proceed into the gating process to see if it has enough expected value to warrant its being initiated and carried out. Of course, if your analysis has determined already that the project does not have positive return or does not surpass the hurdle rate, you can stop now and move onto the next project idea. Determining that a project is not good for the business is just as valuable as finding those projects that are good for the business. Resources should not be wasted.
And that's it for now, comments welcome.
2 comments:
Dave, Excel has an Npv function in it these days.
There you go.
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