ROI (return on investment) calculation ability is DOA

What is your strategy for calculating return on investment?

Your Rant: I need to build a case for buying a new piece of equipment. What is the process for doing this?

911 Repair:

Your e-mail reminded me of how a friend of mine used to talk about “Bob dollars.” She was referring to the way I would take the savings I had made when I bought something on sale and treat it like it was real money that I could use on my next purchase. I might not be able to balance my checkbook, but I sure can do complex accounting in my imagination.

And many of us do this same thing at work. We come up with our own calculations about what we need to do a better job. Unfortunately, the only way to get money to spend to do this is to calculate the Return on Investment, or ROI. This is something we all need to be better at, and I’ve included the basics below. For more, check out Karen Berman and Joe Knight’s book, “Financial Intelligence” (HBS, 2006).

What is the initial cash outlay? Now this seems simple enough. What will you have to pay for the product being considered? But it’s often not that simple. In addition to the cost, there may be training fees involved, setup time, etc. So the dollar amount you are searching for is the total cost until this new product creates actual revenue.

What are all the costs involved? There may also be longer-term consequences. For example, will you have to hire new people or increase other operational costs? Again, take the time to examine all of the cost impacts on the organization.

What are the future cash flows? The tendency here is to be too optimistic. As in all things financial, the key is in your assumptions. What assumptions are you making about the revenue that will be created and can you provide real-world examples to back them up? It will be helpful to collect these assumptions, so you can explain them to anyone reviewing your calculations.

How will the investment be evaluated? This is also more complex than many people realize. There are three ways to evaluate an investment: payback, net present value or internal rate of return. The payback method is the simplest; you divide the cost of the investment by the revenue created by it. This will give you the number of years that will be required to pay back the outlay. Net present value acknowledges that money declines in value over time and is a more complicated calculation because it takes this into account. Finally, in the internal-rate-of-return approach, you compare this investment with other possible ways the company could spend the money. Whatever way you go with your calculations, you should be able to tell if the investment is reasonable or not.
Use these strategies, and you’ll move past Bob dollars to getting real money for your important projects.

User strategy:

I was really intimidated by business plans, ROI, etc. Finally, I realized that the only way that I would get what I needed was to learn how to make my case for the resources I needed. Needless to say, it worked. I talked to colleagues, looked at other people’s calculations and learned how to be a stronger advocate for my position. This is not as hard as you may think.

Bob Rosner and Sherrie Campbell author the weekly internationally-syndicated workplace911 column. Bob’s a best-selling author and award-winning journalist who has personally responded to over 50,000 emails. Sherrie’s a relationship expert and award-winning comedian who has offered quick, intuitive and humorous responses to over 30,000 people. He’s been called “Dilbert, with a solution.” She’s the counselor with a kick. Watch our 911 team of consultants, authors, counselors and comedians—namely Bob & Sherrie—tackle the nastiest work wrecks in organizations and via seminars, TV, radio, newspapers, books, web sites and live on workplace911.com.