Calculating Return on Investment
When planning for new projects or programs, we often hear senior management and executives asking about Return on Investment (ROI). Return on Investment is a very general term that can mean many different things. Often it seems to mean “How long will it be before we earn back what we have invested, and how much more will we earn than we invested?”
When we analyze that definition of ROI, we can see that it leaves out crucial questions: What is the source of the funding to do the project, working capital or debt? What is the cost of raising that capital? What is the length and timing of the cash outflow? When will the cash inflow begin, in what amounts and frequency, and how long will it last? What effects will the cash flow have on company finances? Finally, how risky is the project?
In order to calculate the effects of a project in order to improve financial returns, we must know what the costs of the project will be, as well as the projected benefits to revenue. Let us assume that the cost of the project includes software: Supply chain and accounts receivable tools that will cost $500,000, while implementation costs for software will be an additional $750,000. Reengineering the supply chain and accounts receivable processes is estimated to cost another $1,500,000 for consulting assistance. In addition, the cost of Marvelous Food's employee work on the project will be about $450,000, for an estimated project total of $3,250,000. It is estimated ...