General ROI Questions
What Is ROI? ROI (Return On Investment): Vendors Promise It, Management Demands It, What Is It? Definitions Abound -- You might find these definitions in a finance or economics textbook: A measure of a corporation's profitability, equal to a fiscal year's income divided by common stock and preferred stock equity plus long-term debt. A calculation of the return (earnings) as a percentage of the assets employed (investment). These definitions may be accurate; but, they are not helpful to most people. What Does Return On Investment - ROI Mean? A performance measure used to evaluate the efficiency of an investment or to compare the efficiency of a number of different investments. To calculate ROI, the benefit (return) of an investment is divided by the cost of the investment; the result is expressed as a percentage or a ratio. The return on investment formula:
What Most Decision-Makers Really Want to Know When people ask "What’s the project’s ROI?" what they are really asking is: Is this project worth the money we will spend? Are the returns (benefits) greater than the costs? In other words, they want to know the value of an investment before they decide to spend time and money.
Three Ways People Measure IT’s Value There are many ways to measure a project’s value. Three of the most common financial measures (or metrics) are: Payback Period (PP)
Simply enter what you know (project’s cost and expected financial benefits) and the software automatically calculates Payback. For instance. a
. what would the rate be? (Internal Rate of Return) Now that you know what ROI is. potential rate of return from alternative investments.
Is There Only One ROI Measure? No. This is where FAST ROI saves you time and effort. NPV. and IRR for you. Net Present Value (NPV) – If it is positive.
What is a "Discount Rate"? Similar to ROI. The majority of organizations still consider financial returns as the paramount measure of IT’s benefits. the rate an organization pays for borrowed money (the "cost of capital").financial returns. Payback Period – If it is achieved within the analysis period. NPV. Although the technology and finance journals discuss IT "ROI" as if there is a single number. the better. The most common indicators used are: Payback. the reality is that the term has different meanings in different settings. consider the project for a "go" decision. some organizations only consider financial "returns" while others believe that IT’s benefits include both financial and non.Net Present Value (NPV) Internal Rate of Return (IRR)
Few non-financial professionals really understand what all of these terms mean. In general. consider the project for a "go" decision. discount rate can have several meanings. and 3. consider the project for a "go" decision. There are three common meanings of the term: 1. Here they are translated into plain-English: How quickly does this project pay for itself? (Payback Period) How much is this project worth in today’s money? (Net Present Value) If the financial benefits are restated as an interest rate. the challenge is to do the math. the shorter the payback period. 2. and IRR (see "What is ROI" for plain-English definitions). We’ll try to keep the answer simple.
Are there any general ‘rules-of-thumb" for the metrics? Yes there are: Internal Rate of Return (IRR) – If it is positive.
"hurdle" rate that an IT project must clear before it will be considered before an organization will consider an investment. software) or the "economic life" (the number of years that significant benefits are produced). Major program modifications or hardware upgrades. You might prefer a project costing
. If decision-makers want to see projects with a "fast ROI". then you should consider a 3-year analysis period. IRR provides the same type of information for a project investment. here are a couple of questions to ask yourself.. the analysis period is a number of years post-implementation during which significant benefits will be received. e.. (See the answer to "How is the discount rate used for decision-making?" for an example.) How many years will the benefits of this project last? (E.g. you might decide to set your analysis period at one or two years. If there is no standard..g.g. use it. hardware vs..g. If the IT solution will become obsolete in three years.g. Both the CD and the bond have an associated "interest rate". If your organization has a standard. how long will the product last before significant changes need to be made? (E." Some organizations have standard analysis periods that you must use – these are often based upon a number of factors including the type of investment (e.)
What Does a Negative "Net Present Value" Indicate? A negative value indicates that the financial value of the project is less than its cost. the answers will help you to choose an appropriate analysis period: After implementation.
How Long Should the "Analysis Period" Be for an IT Project? Since projects don’t produce returns until after the project is completed.)
Can You Give Me a Simple Explanation of "Internal Rate of Return"? Think about a bank certificate of deposit (CD) or an interest bearing bond.) Is there a "required payback period"? (E. This interest rate gives you an idea of how hard the money you invest is working. (Note: Some organization’s definition of "analysis period" includes "project implementation. a CD at 4% interest rate or a bond with a 5% "yield to maturity".
rms. the formulas. The reason most professionals buy and use calculators is that it isn’t worth their time – they have other work to do. Besides. you could spend months learning about the metrics. tables.
Can’t I Just Set Up a Spreadsheet to do the Calculations? Certainly you can.htm#Is There Only One ROI Measure?
.000) with a 25% rate of return. why isn’t everyone already doing it?1
http://www. The real question to ask yourself is "Is it worth my time to create a spreadsheet?" If you are a financial whiz. If you are not.000 with a 50% rate of return (IRR) over another project (also costing $100.$100. if it were really so easy. you might only need a few hours or a day or two to do the setup.net/prod_fast_roi_quick_faq. and then hours or days for setup. etc.