You have identified several issues within your operations. You feel that if fixed, your company will benefit greatly by eliminating these issues; how do you now go about soliciting senior management for funding approval to pay for the solution that you feel will solve the issues you have identified?
All senior management will bias their decision to fund a project based on a financial analysis of the opportunity. In other words, “is there a ROI or Return on the Investment?” Understanding how to present a financial analysis to senior management therefore is very important. You might be thinking “I don’t have the proper training in financial analysis to present a solid case for funding my project.” This is where Setpoint can help; we have developed an online ROI calculator (Return On Investment) to assist you in putting together a high level financial summary that will ultimately be required by your Sr. Management, to fund your potential project.
You may not be a financial wizard; but, everything you do can be quantified in monetary terms. Here is a road map that you can follow in your quest to gather this information. It all begins with your company’s pain or in the discovery of “what do you have to much of or not enough of?“ For instance, you have too much scrap, too much labor, not enough equipment utilization, not enough throughput, or you can ask yourself what are the current issues facing your business, whether it is management dictated or issues that you have identified yourself. Start by listing all of the issues you have identified, then prioritize each of them by importance to solve, and assign each one a monetary value. You could say your scrap rate is 5% and that equates to 25,000 parts per month. If each part scrapped costs $.50, you just valued the scrap being produced at $12,500/month. Do this same analysis with each of your issues.
Once you have established what all of the issues are, you can then make a correlation between what your current business situation looks like now, and then you need to decide what you want it to be once all the issues are solved. You may not be able to solve all of the issues you identified right away but start with those issues that pose the largest potential gain for your company if solved. For example, if you currently have 10 operators and you believe you can get it down to 6, or if your throughput is 60 ppm and you believe you can get it up to 90 ppm, there will be a benefit to your company that can be calculated if you can indeed achieve this level of improvement or change. After making it through your list of pains and you have quantified what it is now and what you would like it to be, that the differences will now need to be converted into a monetary value to get your annual benefit. If the improvements are related to a project with a specific time frame, you can multiply the annual benefits x the number of years the benefits should be realized. Below is an example project to give you an idea of how to complete this analysis.
Now that you have your annual benefit calculated, you will need to know your estimated cost of your project, the number of years your new equipment will be used and your annual minimum interest rate or what interest rate you need in order to make the investment, sometimes this is referred to as the hurdle rate. For our example we will assume the cost of the solutions or the new equipment is $4.5 million. We have determined that will use this new equipment for 5 years and the minimum interest rate is 7%. With your annual benefit calculated, an estimate of the cost, years in production and interest rate, it’s time to go to our ROI calculator and plug in the numbers to find out if your project is worth pursuing. Below is a screenshot of our ROI calculator for the above example project.
From our inputs we are given three important numbers that will sell your CFO on your project; the Net Present Value (NPV), Payback – in years, and Internal Rate of Return (IRR). We will briefly explain each number and why it is important. Because a dollar earned in the future won’t be worth as much as one earned today, the NPV method provides a value for your project in today’s dollars minus the initial cost of the project. When interpreting the NPV, if the number is greater than zero, it should be accepted. For our example project, our NPV came back at $17,349,952.14; compared to the investment of $4.5 million this project should be an easy sell.
The payback method is the simplest way to evaluate the return of a project; basically, it tells you how many years it will take to get the return on your money or investment. For this method, the payback period must be shorter than the life of the project. In our example, we are estimating an equipment life of five years and our payback period is under one year (0.84 years), you should definitely feel confident in presenting this project to senior management. We find that most companies require an ROI period to be less than or equal to 2 years. Some very aggressive companies actually won’t invest in capital equipment unless the ROI is one year or less.
The final metric shown in the ROI calculator is IRR, which calculates the actual return provided by the projected cash flows. The IRR can then be compared with the company’s hurdle rate. When considering the IRR of your project you want it to be greater than your company’s hurdle rate, otherwise the project doesn’t make sense financially. In our example, the IRR was calculated at 115.84%, which is greater than the 7% hurdle rate, making this project a good one to pursue.
Next time you have identified some issues in your operations and need funds for a project to correct these issues, remember to calculate the ROI to see if pursuing the project makes sense before spending a bunch of time and effort on something that will not ultimately get funded for lack of an acceptable ROI. As long as your return is positive you will have the financial evidence and confidence to present your project to senior management and sell them on your project.