Business Case Analysis -
What a Project Manager should know: Part 4
In part 3 of this article we looked at what is included in the costing of a Business Case. In this part we unpack the metrics and indicators that should be considered.
Defining Concrete Deliverables or Metrics
Once the analysis of the system / process is complete and the specific benefits have been defined these need to be restated in very specific measurable terms. Headcount reductions should be stated as "Eliminate 500 accounts payable positions from the XYZ facility by October 31, 20XX." A new manufacturing system might have the goal of "Decrease backlog from 90 days to 45 days." while a new financial system might have the deliverable of "Reduce monthly close process from 10 days to 5 days."
These deliverables are the direct outgrowth of the justification for the system.
Rule of Thumb: If the deliverables are defined correctly they should be unambiguous and easily measurable at the completion of the project, unless the rules changed. Very often when a company is in the process of a major transition such as downsizing through retirement incentives, layoffs or mergers or acquisitions it becomes impossible to track even the most clearly articulated goal. In these cases, the best you can do is document the changes that took place and then show on an analytical basis that you would have met your deliverable had the situation stayed stable.
Payback is the number of years it takes to recover your initial investment. Payback assists in evaluating a project’s risk and liquidity. A shorter payback period is desirable because it indicates less risk, higher liquidity and a higher rate of return. The obvious disadvantage of this method is that it is not time adjusted. It assumes that the Rand received tomorrow is of equal value with a Rand received today. Payback is calculated by subtracting the cost against the stream of payments and determining the time frame in which the number reaches zero.
Net Present Value is determined by multiplying a stream of net future cash flows by a discount rate then subtracting the initial investment in the project. This method is one of the most frequently used analytical tools to value a project and it only becomes controversial because of the subject of what discount rate to use.
Rule of Thumb : If the internal rate of return equals or exceeds the required rate, the project will most likely be accepted. The required rate is typically a company's cost of capital, or in an environment of limited resources (all companies I think) it is based on an average of all other competing proposals.
An advantage of the internal rate return is that it considers the time value of money.
The following equations are available within Microsoft Excel
- NPV -- Returns the net present value of an investment based on a series of periodic cash flows and a discount rate.
- IRR -- Returns the internal rate of return for a series of cash flows.
- MIRR - Returns the internal rate of return where positive and negative cash flows are financed at different rates.
- XIRR Returns the internal rate of return for a schedule of cash flows that is not necessarily periodic.
- XNPV Returns the net present value for a schedule of cash flows that is not necessarily periodic.
Probability or risk adjusted rates
Every company has its own approach to adjusting the financial factors they use for risk and uncertainty, though the most common one seems to be to ignore making a specific adjustment. This is not as unreasonable as it sounds since the purpose of the business case financials is to provide a mechanism for comparing between proposals even more than it’s designed to produce an absolute achievable number.
Rule of Thumb : Only use probability or risk adjustment if that is the corporate standard otherwise while your rates might be accurate they will understate your project on a comparative basis.
In the final part of this article we have a look at the importance of communicating the project impact to the wider organisation.
Rules of Thumb Source: Donna Fitzgerald (Donna Fitgerald internet presentation)