Net Present Value: NPV

Now, let's say that in the phone example, you are borrowing money at 6% to fund the extra spend. What profit do you make over time, using a cost of money, and turning this into a - value? - a sort of increase in shareholders worth. This is Net Present Value, a monetary profit in today's terms, comparing costs out, savings in, and the annual cost of money.

Discounted cash flow: DCF

Any investment gives rise to a stream of future expected cash flows, both in and out. Cash flows out unevenly when you pay the bills for hardware, software, training, consultancy, maintenance etc. In effect, cash flows in when the expected benefits materialise and your FD will want to see your cash-flow projections. DCF converts all of these to an equivalent amount of present-day money (or present value) by discounting future cash flow.

Identifying and quantifying the benefits

Of course, key to this approach is your ability to identify the benefits and quantify them (no matter how downstream or remote from you they may seem) and the point in time at which the benefits start to appear. Look for the impact on others � how will the proposed system affect purchasing or invoicing, for example. How much can you defer and reduce the buying of materials because you are making fewer prototypes? What is the cost reduction impact of getting your new products to market earlier? How much can you save on product recall or in-service modifications because you can project a reduction in the number of post design changes? You will also need to get a handle on ALL the associated costs: system hardware, software, training, implementation, consultancy and the point in time when these costs occur. Get anything wrong and your case may well fail. Err on the conservative side. It is better to underestimate and overachieve.

A simple example

So, now that you know all three measures, if you could actually identify and quantify all the solution benefits, you can deliver a full ROI based business case to support your technical proposal. Let's see this in action!

A CAD manager proposes to spend £250,000 on a complete CAD/CAE/CAM solution. The CAD manager has shown that benefits will accrue from reduced product development time, reduced stockholding, and better buying margins. The benefits total £18k per month, but the supplier would charge an extra £2k per month to deliver those benefits. Over a 36 month review period and a 10% cost of money - is this a good deal? Who can possibly tell unless we look at the three key economic measures?

It's now plain to see this makes sense and the technical decision is now supported by the financial language that business people understand.

How to do it

So how can you determine the ROI? There are a number of ways:

Employ a consultant
Using a consultant with specific capabilities in this area tends to be very expensive. Costs can run into tens of thousands of pounds. If included in the system costs, these could drastically weaken the projected ROI. You may also find that consultants make frequent use of benchmarking information derived from previous similar commissions rather than individual analysis, potentially lessening the accuracy of the projection. In any event, they are unlikely to be as expert as you in understanding the situation in your company.

Do it yourself
Sometimes, being a technical expert is a bad thing. You may miss the most obvious savings, especially those experienced downstream and in other departments, because your own expertise tends to make you look at the purely technical issues. For example, you may look at the technicalities associated with providing access to the system from the shop floor and neglect the savings that come from the associated elimination of costly specially printed route cards. The approach tends to rely on DIY spreadsheets, ideal if you are au fait with discounted cash flows, hurdle rates, discount rates etc. You'd also need to spend lots of time creating and presenting the final report.

Ask your vendor or reseller for help
Of course, some would say that it's up to the vendor or reseller to cost justify their solution. However, they may lack the commercial and industrial knowledge of your business and there is an issue of credibility, 'they would show a god ROI, wouldn't they! However, it is reasonable in my opinion to get some level of help from the vendor or reseller. As a minimum, this ought to be based on a realistic appreciation of what their solution can do, what it has already achieved for others plus an ability to help you as a trusted advisor.

Use a commercially-available software tool
There are numerous software tools available, mainly Excel based, mainly for specific circumstances, and often offered as a hook into consultancy services. In fact, there are very few easy-to-use generic tools that have the required authority, flexibility, presentation and that can prompt you to identify and evaluate the full benefits of the solution you are seeking to acquire. We will look at some of these next time.

Next time: structure and content of a typical ROI-based business case How you can lay out the business case so that the FD can see and trust the vital ROI information of NPV, IRR, PP and DCF.

John Marchant is Consulting Editor of MCAD Magazine and senior partner in the skilstream partnership, case study and return-on-investment specialists.