Easy to Use Financial Tools for Effective Decision Making

Paul M. DooleyPresidentOptimal Connections, LLCP: (949) 305-3544E: pmdooley@optimalconnections.com W: www.optimalconnections.com

Typical Decision Challenges You May be FacingShould I remain with the status quo, or implement a new Service Management System (SMS)?If I implement a new SMS, which one should I choose? Is it worthwhile for me to implement a Knowledge Management System?Should I invest in Remote Access Tool A, B ..or C?Is it wise for me to consolidate our multiple help desks to a centralized Service Desk, or should we remain decentralized?

AgendaDecision Making ChallengesHow to Use Financial Tools to Help:Cost/Benefit Analysis (CBA)Return on Investment (ROI)Total Cost of Ownership (TCO)7 Steps in Applying the ToolsValuable ResourcesSummary

Someone Once Said Success in life often depends on the choices we make.Take advantage of best practices and available financial tools that can help you make better quality decisionsHow do you make the right choice?

How Do I Know Which Course of Action to Take?Lets see, I could GuessPick one, based on the good old boy networkFocus on the coolest technologyPick the one thats cheapest (up front)Choose the one thats got the most featuresBase my decision on what my management thinks (what consider the users?)

Why Not A More Business Like Course of ActionFollow a best-practice selection processUse a combination of financial tools to improve the quality of your decisionDo the benefits really justify the cost?How long will it take to recover our investment?It the investment really worth it?What is the true total cost over the life of the asset?These tools are not new they have been used for decades by organizations of all kindsApplying them to IT Services is simply good business practice

Whats In It For You?Demonstrate a business approachMinimize risk and costs through informed, higher quality decisionsIncreased credibility with managementBuild stronger Business Cases for proposals A more strategic approach, aligning with business goalsHelp ensure successful business outcomes for customers, through improved service provisioningBe a good steward of investments in IT services

Tools to Improve the Quality of Your Decision MakingThe three tools we will focus on are: Cost/Benefit Analysis (CBA): Weighing costs vs. benefits, and calculating paybackReturn on Investment (ROI): is it worth the investment?Total Cost of Ownership (TCO) what is the total cost of ownership over time?

Using these tools in concert will help you make better quality decisions and build stronger business cases for proposals!

Cost/Benefit Analysis (CBA)OverviewTechnique for deciding whether or not a change is worthwhileAdd up the value of the benefits of a course of action, subtracts associated costs, and come up with an advised decisionCosts: one-time, and on-goingBenefits: usually realized over timeA time factor is built by consideration of a pay back period Key: assign a financial value to both tangible and intangible benefitsPlacing a financial value on intangibles needs to be justifiable

How to Do a Cost/Benefit Analysis (CBA): StepsEstablish a common unit of valuation ($)Identify all of the tangible costsHardware, software, training, documentation, maintenance support, consulting, opportunity costsTotal all of the costsIdentify all of the benefitsTangible benefits (where it is easy to quantify the savings)Intangible benefits (assign values based on estimates, justifiable assumptions)Total the value of benefits in year 1 and beyondDetermine payback time: divide [costs] / [benefits]

Cost/Benefit Analysis (CBA) Consider a ScenarioA support center manager is deciding whether to implement a new computer-based incident management system. His help desk is in start up mode, with mostly new support associates. He is aware that with a more automated incident tracking system he will be able to handle calls more effectively and efficiently, with a higher level of quality and faster delivery.

Cost/Benefit Analysis (CBA) Estimating Costs - ScenarioNew help desk computer equipment: $36,20010 network PCs with software @ $2,450 ea.: $24,5001 server @ $3,500 3 printers @ $1,200 each: $3,600 Cabling & Installation @ $4,600 On-going maintenance costs after 1st yr: $3,930/yrSoftware: $15,000IMS Software, 10 user license @ $15,000 (includes 1st year support)On-going support (Silver): $2,700/yrStaff training costs: $14,800Customer Service Skills - 10 people @ $400 each: $4,000Incident Mgt. System - 12 people @ $900 each: $10,800

Cost/Benefit Analysis (CBA) Estimating CostsOther implementation costs: $48,000Lost time: 40 man days @ $200 / dayLost productivity through disruption: estimate: $20,000 Lost sales through service inefficiency during first months: estimate: $20,000 Total costs (1st year): $114,000 But what are the benefits, and the value of these?And whats the payback time?

Cost/Benefit Analysis (CBA) Estimating BenefitsEstimate the Value of Tangible Benefits:Handle more work with same staff savings: $40,000/yrImproved uptime through prevention - estimate: $20,000/yr Improved efficiency and reliability of call handling - estimate: $50,000/yr Improved service and retention - estimate: $30,000/yr Improved accuracy of information - estimate: $10,000/yr More ability to support sales effort: $30,000/yr Do the Same with Intangible Benefits:Higher employee morale = higher productivityTotal Benefits: $180,000/yearPayback time: $114,000 / $180,000 = 0.63 of a year = approx. 8 months!

Cost/Benefit Analysis (CBA) Key Point: Payback TimePayback time is often known as the break even pointTime it takes to recover the cost (sooner the better!)Found graphically by plotting costs and income on a graph of output quantity against $. Break even occurs at the point the two lines cross. Bottom line: Although the estimates of the benefits given by the new system are quite subjective, the IT Director is very likely to approve the proposal, given the short payback time.

Cost/Benefit Analysis (CBA) Key Point: Time Value of $For longer payback times, the time value of money should be factored in!A dollar 5 years from now is not worth the same as it is today!A dollar available now can be invested and earn interest for five years and would be worth more than a dollar in five years When the dollar value of benefits at some time in the future is multiplied by the discounted value of one dollar at that time in the future, the result is the discounted present value of that benefit of the project.The same thing applies to costs future costs have to be brought back to their net present valueNet Present Value: sum of the present value of the benefits less the present value of the costs

Cost/Benefit Analysis (CBA) SummaryCost/Benefit Analysis is a powerful, widely used and relatively easy tool to useDoing it well: include all the costs and all the benefits, and quantify them!Where costs or benefits are realized over time, work out the payback periodInclude time value of moneyIncluding intangible items within the analysis requires you estimate a value for these; supply justifiable valuations for these items.

Return on Investment (ROI)OverviewPurpose: compare the costs of a project (investment), with the value of its resultsAm I getting my expected return?Evaluate one investment vs. anotherROI is expressed as a percentageExample: a 25% annual ROI means that a $100 investment would return $25 in one yearA basic equation for calculating the ROI: ROI = [(Payback - Investment)/Investment)]*100 Investment relates to the amount of resources put in ($, time)Payback is the amount of money earned from your investment

Return on Investment (ROI)ConsiderationsManagers often underestimate the amount of investment requiredHence ROI calculations can be skewedCommon mistake: not factoring in employee time required to implement Resources includes money, as well as human resources or time. Dont under value time!Another mistake: not factoring in the cost of capital a $ today is not worth the same as it will be tomorrow!Present Value (PV) of future costs and benefits needs to be calculated, using your organizations cost of capitalNet Present Value (NPV) is PV of Benefits PV of Costs

How to Calculate Return on Investment (ROI): StepsDetermine the total amount of investment requiredResources financial, people (time), etc.Calculate the amount of returnSavings, revenue & productivity growthIf calculating over time, calculate the Present Value of future costs and returns by your organizations discounted cost of capitalCalculate the ROI by dividing the return by the investment, and multiply by 100 to express as a percentage

Calculating Return on Investment (ROI): ScenarioWhats the 1st yr ROI on our scenario? Givens Total Costs = $114,000Total Benefits: $180,000/yearCalculating ROI for 1st year only (since rapid payback)Applying our ROI formula for the 1st year yields:ROI = [(Payback -Investment)/Investment)]*100ROI = [(180,000 - $114,000) / $114,000 ] * 100ROI = ($66,000 / $114,000) * 100ROI = .578 * 100 = 57.8%CBA showed payback time: $114,000 / $180,000 = 0.63 of a year = approx. 8 months

Return on Investment (ROI) Key PointsROI can be expressed for different time periods: be sure to stipulate your time period!Use a spreadsheet tool to automate the process, ensure accuracy, and compare alternativesRemember one option is always to do nothing. Ensure you calculate this ROI!Be thorough: include all factors All investments required (people, time, money, etc.)Opportunity costs people not able to do their regular job due to being involvedAll returns (savings realized, revenue enhancements, increased productivity, employee and customer satisfaction)

Total Cost of Ownership (TCO): OverviewDefinition: all costs of owning and operating an asset over its expected useful life.TCO ensures that you account for all associated costs over a given time period when you are considering a decision, or assessing one option vs. another Benefits:Accounts for not only the initial investment, but all the other costs associated with further use of the asset.Factors in useful life of assets, usually 3, 5 or 7 years Ensures a comprehensive analysis of long term effects and helps account for hidden costsEnables a total cost comparison of one option vs. another

Total Cost of Ownership (TCO): OverviewChallenges:Does NOT consider benefits of various optionsDoes not factor in the ROI (or value) of one option vs. another only total costs over timeDoes not provide insight into the timing of costs: Product A, which may have a lower acquisition cost and high on-going maintenance costs, is likely to be less attractive than Product B, which may have a higher acquisition cost, but lower ongoing maintenance costs; Yet both may have a similar TCO over the period analyzed!

Total Cost of Ownership (TCO): OverviewOther challenges:Only a general formula: calculate the total costs of ownership over the life of the assetNo help for how to value intangible assetsDoes not provide any insight to relative risk of options Companies that rely solely on TCO end up following a strategy that minimizes expenditure rather than maximizes return!Why this tool needs to be combined with CBA and ROI for quality investment decisions!

How to Calculate Total Cost of Ownership: StepsEmploy a spreadsheet tool that meets your needsGather ALL relevant costsAll types: hardware, software, installation, conversionInitial costs and on-going costs over the life of the assetNote: useful life must be the same for comparisons!Which costs should you use? Depends on what the asset is and where it will be usedCosts for most IT investments are usually broken down into direct and indirect costs

How to Calculate Total Cost of Ownership: StepsCompile Direct Costs: chargeable directly to projectHardware & Software capital expenditures for various HW & SWManagement Support time required, maintenance contracts, professional services or outsourcingTechnical Support - support staff time, training time and costs, travel, support contractsImplementation customization, integration), testingCommunication Costs LAN, WAN, leased lines .. And Indirect Costs: not tied directlyEnd user - training, informal support outside recognized IT support channels, local self-supportDowntime - lost productivity due to planned and unplanned network, system, and application unavailability

How to Calculate Total Cost of Ownership: StepsFill in all the dataDirect costsIndirect costsFirst year and re-curing costs over the useful life of the asset (example 3 years).Use the tool to calculate the Total Cost of Ownership over the useful life of the assetOptionally, compare the TCO of this option with that of another option, and the TCO of the status quoDetermine which option has the lowest TCO Here is what our sample nets out to (next slide).

Sample Tool: TCO Calculator, from Info-Tech Research Group3 Year Life-cycle, with upfront and recurring costs

TCO Calculation: Applying to our Scenario How does TCO relate to CBA and ROI? TCO shows long term costs, not cost vs. benefits, or ROITo arrive at a quality decision, we need apply all three tools and account for the time value of money: Assume a 5% required rate of returnCBA payback: $114,000 / $180,000 = approx 8 monthsCosts of $129,860 over 3 yrs discounted to Present Value = $123,676Benefits of $540,000 over 3 yrs discounted to Present Value = $514,287ROI: 57.8% for 1st year, however 3 years ROI is much greater:NPV of 3 yr Benefits vs. Costs: $514,287 - $123,676 = $390,611$390,611 / $123,676 = 3.158 * 100 = 315% ROI over 3 yrs! Bottom line: rapid payback of initial investment, and high ROI over the life of the asset, with acceptable TCO. GO for it!

Applying the Tools: a Best Practice Selection ProcessStep 1: Form a team, project and do a needs analysisStep 2: Prepare a Requirements DefinitionStep 3: Go through a diligent selection process to evaluate proposalsStep 4: Arrive at short list of suppliersStep 5: Apply the financial tools we discussed to build a business case for the best decisionStep 6: Make the decision and negotiateStep 7: Implement and track your results

Step 1: Form a Team and Do a Needs AnalysisForm a cross-functional teamAppoint a project lead, and develop a project plan with milestones, resources and time framesConduct kick off meeting to define and prioritize needsSet expectations, and communicate!Do a Needs Analysis: allows you to analyze the situation to see whether the technology is truly needed immediately. May includeSurveys, interviews and observations to gather detailed inputReviews of past metrics performance, customer, employeeEstablish a baseline (KPIs) for later comparisonConsider best practices for the area, as well as industry analystsSource: HDI SCM

Step 2: Prepare a Requirements DefinitionDocument all requirements for the proposed system or toolBackgroundCustomer end-user requirementsCurrent support processesDesired features and functionsOther: usability, scalability, portability, or complianceCategorize requirements, and list priorities (must have, nice to have, optional/plus)Weight requirements, use numbers to quantifyFactor in optional additional information: Special requirements from key stakeholdersAvailable budget allowancesAnticipated volume of transactions for scalabilityNumber and type of support staff requiredSource: HDI SCM

Step 3: Conduct a Diligent Selection ProcessIdentify vendors/suppliers who potentially can meet your needsSend a RFP out to target suppliers, gather responsesUse a checklist to process responsesConsiderations during the process:Investigate quality of vendor technical supportReview demonstrations by selected vendorsIf you opt for a trial, for testing consider:Conformance testing to requirementsLoad testingEnd-user testing

Communications notify stakeholders in advance of changes in the works, and keep them informed!Source: HDI SCM

Step 4: Arrive at the Short List of SuppliersSchedule interviews for the short list of vendorsConsiderations:Use a script to guide the interviewsInclude your team in the demonstrationsDetermine if you can get trial or pilot use Visit vendor customer sites, explore service quality, check on industry reputationAlso check the company depending on the investment, sometimes the company you are dealing with is also an important consideration!Based on the proposals returned in answer to your Requirements Documents, which products/service providers most closely fulfill your needs?

Step 5: Apply the Financial Tools in CombinationApply the Financials Tools to this short list of solutions:Cost/Benefit Analysis (CBA)Return on Investment (ROI)Total Cost of Ownership (TCO)Considerations:Net tangible and intangibles to a common financial metric (usually $)Account for the time value of moneyWhich provides the best cost to benefits ratio?Which provides the best return for the money?Which provides the lowest total cost of ownership over the life of the investment?Bottom line: which is the best decision?

Step 6: Document the Business Case for the DecisionAll three tools should be used together to help assess which action is best to take!Document your Business Case based on the result of the selection process, and the output of the financial tools Include exec summary, goals & objectives, supporting evidence: CBA, ROI and TCO of alternatives, with recommendationsReview with your management and gain their supportNegotiate with preferred vendor to arrive at final feature set, with pricing and delivery terms

Step 7: Implement the Decision and Track ResultsKey: follow best-practice project mgt. practicesQualified project leadCommitted, cross-functional teamSolid project plan with milestones, assigned and budgeted resources, and time framesCommunicate effectively: across the team, and to affected stakeholdersPrioritize early, easy wins!Drive the project, accomplish the milestones, and report on the benefitsCompare the results to your baseline(s), and report results. Celebrate success with your team!

Summary: Using the Financial Tools Together Help YouUse a business approach to decision makingMinimize risk and costs through informed, higher quality decision makingIncrease credibility with managementBuild stronger Business Cases for proposals to management, increases chances for approvalAlign with business goals, and support the vision and mission of the businessEnsure successful business outcomes for customers, through effective and efficient service provisioningBe a good steward of investments in IT services

Valuable Resources to Take Advantage Of!Handout: CBA TemplateCalculating Cost/BenefitMind Tools CBA Tool: www.mindtools.comCalculating ROIGuidelines: www.silberperformance.comTips: eHow.comOnline Tutorial - ZDnet.com: http://news.zdnet.com/2422-13569_22-153325.htmlROI Calculator: www.solutionmatrix.com Calculating TCOInfo-Tech Free TCO & ROI Calculator: www.infotech.com

Happy Decision Making!.. Any questions?Thank you for attending this session. Please fill out a session evaluation form.Paul M. DooleyPresidentOptimal Connections, LLCP: (949) 305-3544E: pmdooley@optimalconnections.com W: www.optimalconnections.com

Welcome the audience

Mention the title of the presentation (for the recorder)

Introduce yourself

Say examples of DECISIONS I typically need to make

Review the Agenda what we going to cover

Decision Making ChallengesHow to Use Financial Tools to Help:Cost/Benefit Analysis (CBA)Return on Investment (ROI)Total Cost of Ownership (TCO)7 Steps in Applying the ToolsValuable ResourcesSummary

Say:

Doesnt success in life typically DEPEND on the wisdom of the choices we make?

Wise choices = faster, less cost, greater benefits, successPoor choices = slower, higher costs, few if any benefits, little success or failureGuessthis is like shooting in the dark little chance of hitting the mark

Pick one, based on the god old boy networkChoose because your friends advise youBut they may know nothing of the issues involved!

Focus on the coolest technologyCoolest is not necessarily the best choice. May be TOO expensive for the return delivered. May involve too much RISK.

Pick the one thats cheapest (up front)Least expensive initially is not necessarily the cheapest over the long run!

Choose the one thats got the most features (many of which may not match ours)Features are great, but what features are most important to your organizations, and potential users?

Base my decision on what my management thinks (what there are users?)Base your requirements on the needs of the key stakeholdersYes, management is a party but not the only one! Consider the needs of all key stakeholders when defining your requirements

Follow a best-practice selection processUse a combination of financial tools to help answer the following questions and improve the quality of your decisionDo the benefits really justify the cost?How long will it take to recover our investment?It the investment really worth it?What is the true total cost over the life of the asset?

These tools are not new they have been used for decades by businesses of all kinds, and are considered good business practice!

Demonstrate a business approach to decision makingBecause you are speaking the language of business management

Minimize risk and costs through informed, higher quality decision makingTaking a systematic approach to selection technology will ensure the needs of all key stakeholders are considered, increasing your chances for successApplying financial tools like CBA, TCO and ROI will help ensure that your recommendation will have the best cost/benefit ratio, lowest total cost of ownership over the life of the investment, and best ROI

Enjoy increased credibility with managementYour management will be impressed with your business like approach, and you will likely have greater attention paid to your proposals

Build a stronger Business Case for proposals to management, increases chances for approvalBase your proposals on a sound financial footingGain traction with managementIncrease your chances for approval on critical projects

A more strategic approach, aligning with business goalsThis is a more strategic approach, in alignment with ITIL best practicesYou will naturally take a look at higher level business goals and strategies, and be more consistent and supportive of the vision and mission of the enterprise

Help ensure successful business outcomes for customers, through effective and efficient service provisioningThe investments you make systems, tools, applications will be more effective and efficient in meeting business and customer needs, hence improving your provision of services

Be a good steward of investments in IT servicesITIL Financial Management dictates that we need to be good stewards of the $ invested IT. Using financial tools helps ensure we are such wise stewards.

Go over the 3 key tools we are going to talk about:

Cost/Benefit Analysis (CBA): Weighing costs vs. benefits, and calculating paybackReturn on Investment (ROI): is it worth the investment?Total Cost of Ownership (TCO) what is the total cost of ownership over time?

Cost Benefit Analysis or cba is a relatively* simple and widely used technique for deciding whether to make a change. As its name suggests, you simply add up the value of the benefits of a course of action, and subtract the costs associated with it.

Background:Cost-Benefit Analysis (CBA) estimates and totals up the equivalent money value of the benefits and costs to the community of projects to establish whether they are worthwhile. These projects may be dams and highways or can be training programs and health care systems. The idea of this economic accounting originated with Jules Dupuit, a French engineer whose 1848 article is still worth reading. The British economist, Alfred Marshall, formulated some of the formal concepts that are at the foundation of CBA. But the practical development of CBA came as a result of the impetus provided by the Federal Navigation Act of 1936. This act required that the U.S. Corps of Engineers carry out projects for the improvement of the waterway system when the total benefits of a project to whomsoever they accrue exceed the costs of that project. Thus, the Corps of Engineers had create systematic methods for measuring such benefits and costs. The engineers of the Corps did this without much, if any, assistance from the economics profession. It wasn't until about twenty years later in the 1950's that economists tried to provide a rigorous, consistent set of methods for measuring benefits and costs and deciding whether a project is worthwhile. Some technical issues of CBA have not been wholly resolved even now but the fundamental presented in the following are well established.

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Costs are either one-off, or may be ongoing. Benefits are most often received over time.

We build this effect of time into our analysis by calculating a payback period. This is the time it takes for the benefits of a change to repay its costs. Many companies look for payback on projects over a specified period of time e.g. three years.

Objective: assign a financial value to both tangible and intangible benefitsPlacing a financial value on intangibles needs to be justifiable

Tangibles: easy to calculateReduction in labor costs (fewer headcount needed)Higher productivity = more work with same amount of staff

IntangiblesBenefits, but not easily quantifiableNeed to make assumptions, justify benefits in $ financial termsExample: More satisfied employees does this improve productivity?

Establish a common unit of measurement

In order to reach a conclusion as to the desirability of a project all aspects of the project, positive and negative, must be expressed in terms of a common unit; i.e., there must be a "bottom line." The most convenient common unit is money. This means that all benefits and costs of a project should be measured in terms of their equivalent money value. A program may provide benefits which are not directly expressed in terms of dollars but there is some amount of money the recipients of the benefits would consider just as good as the project's benefits. For example, a project may provide for the elderly in an area a free monthly visit to a doctor. The value of that benefit to an elderly recipient is the minimum amount of money that that recipient would take instead of the medical care. This could be less than the market value of the medical care provided. It is assumed that more esoteric benefits such as from preserving open space or historic sites have a finite equivalent money value to the public.

Identify all of the tangible costsThis is easy - hardware, software, training, documentation, maintenance support, consulting, other costsOpportunity costsMissed work while engaging in this choiceInterruptionsCost of doing CBA!

Total all of the costs

Identify all of the benefitsTangible benefits (where it is easy to quantify the savings)Intangible benefits (assign values based on acceptable estimates, justifiable assumptions)

Total the value of benefits in year 1 and beyond

Determine payback time: divide [costs] / [benefits]

Example: A support center manager is deciding whether to implement a new incident management system. His department has been in set-up mode, with mostly new support associates. He is aware that with a more automated incident tracking system he will be able to handle calls more effectively and efficiently, with a higherlevel of quality and faster delivery.

Benefits:Tripling of mail shot capacity: estimate: $40,000 / yearAbility to sustain telesales campaigns: estimate: $20,000 / year Improved efficiency and reliability of follow-up: estimate: $50,000 / year Improved customer service and retention: estimate: $30,000 / year Improved accuracy of customer information: estimate: $10,000 / year More ability to manage sales effort: $30,000 / year Total Benefit: $180,000/year Payback time: $114,000 / $180,000 = 0.63 of a year = approx. 8 monthsHis financial cost/benefit analysis is shown below:Costs: New computer equipment:10 network-ready PCs with supporting software @ $2,450 each1 server @ $3,500 3 printers @ $1,200 each Cabling & Installation @ $4,600 Sales Support Software @ $15,000 Training costs:Computer introduction - 8 people @ $400 eachKeyboard skills - 8 people @ $400 each Sales Support System - 12 people @ $700 each Other costs:Lost time: 40 man days @ $200 / dayLost sales through disruption: estimate: $20,000 Lost sales through inefficiency during first months: estimate: $20,000 Total cost: $57,000 Other implementation costs: $48,000Lost time: 40 man days @ $200 / dayInternal project costs to implement the system

Lost productivity through disruption: estimate: $20,000 Due to other work deferred or delayed

Lost sales through service inefficiency during first months: estimate: $20,000 Estimate of impact to sales due to lower service level delivery

Tangible Benefits:Handle more work with same staff savings: $40,000 / yearImproved average resolution time means more incidents with the same level of staff can avoid paying overtime, saving $40,000/year

Improved uptime through prevention - estimate: $20,000 / year End users experience less down time, meaning higher productivity and cost savings

Improved efficiency and reliability of call handling - estimate: $50,000 / year Fewer lost calls, better management end-to-endFewer calls outstanding, lower backlogLess time working on the backlog, higher customer productivity due to fewer longer term issues outstanding

Improved service and retention - estimate: $30,000 / year Improved service levels means customers realizing value of services, more willing to pay, stay

Improved accuracy of information - estimate: $10,000 / year No longer need to spend time correcting incident logs, following up on errors time savings

More ability to support the sales effort: $30,000 / year Customer support center can not only handle internal calls now, but more effectively support the sales effort as well

Intangible Benefits:Higher employee morale, resulting in higher productivity>> We are not quantifying this in this example, but one could make assumptions based on industry practices

Total Benefits: $180,000/yearPayback time: $114,000 / $180,000 = 0.63 of a year = approx. 8 monthsTip: The payback time is often known as the break even point. Sometimes this is more important than the overall benefit a project can deliver, for example because the organization has had to borrow to fund a new piece of machinery. The break even point can be found graphically by plotting costs and income on a graph of output quantity against $.

Break even occurs at the point the two lines cross. Inevitably the estimates of the benefit given by the new system are quite subjective.

Despite this, the Director is very likely to introduce it, given the short payback time.

Note: Not only do the benefits and costs of a project have to be expressed in terms of equivalent money value, but they have to be expressed in terms of dollars of a particular time. This is not just due to the differences in the value of dollars at different times because of inflation. A dollar available five years from now is not as good as a dollar available now. This is because a dollar available now can be invested and earn interest for five years and would be worth more than a dollar in five years. If the interest rate is r then a dollar invested for t years will grow to be (1+r)t.Therefore the amount of money that would have to be deposited now so that it would grow to be one dollar t years in the future is (1+r)-t. This called the discounted value or present value of a dollar available t years in the future. When the dollar value of benefits at some time in the future is multiplied by the discounted value of one dollar at that time in the future the result is discounted present value of that benefit of the project.The same thing applies to costs. The net benefit of the projects is just the sum of the present value of the benefits less the present value of the costs. The choice of the appropriate interest rate to use for the discounting is a separate issue that will be treated later in this paper.

Key points: Cost/Benefit Analysis is a powerful, widely used and relatively easy tool for deciding whether to make a change.To use the tool, firstly work out how much the change will cost to make. Then calculate the benefit you will from it.Where costs or benefits are paid or received over time, work out the time it will take for the benefits to repay the costs.Cost/Benefit Analysis can be carried out using only financial costs and financial benefits. You may, however, decide to include intangible items within the analysis. As you must estimate a value for these, this inevitably brings an element of subjectivity into the process.

Purpose: compare the costs of a project (investment), with the value of its resultsTo determine if the result is worth the costAlso used to evaluate the value of one investment vs. another

ROI is expressed as a percentageExample: a 25% annual ROI means that a $100 investment would return $25 in one year (net investment = $125)

A basic equation for calculating the ROI: ROI = [(Payback - Investment)/Investment)]*100

Investment relates to the amount of resources put into generating the given payback (time, money, etc). Your payback is the total amount of money earned from your investment (savings, increased revenue generating capability).

IMPROPER CALCULATIONS BY MANY SMALL BUSINESS OWNERS

The business owner often misunderstands the actual amount of investment into a business. As a result, true ROI calculations for most small businesses are skewed. Most small business owners make their mistake in this most necessary calculation, because they do not properly value their own time. Please note that when I previously defined "investment", I stated that it relates to the "amount of resources put into generating the payback." Indeed, "resources" includes cash money. But, it also includes "human resources" or "time". If most small business owners would value their hours at the minimum wage, and calculate their time into the investment equation, they would soon realize that their small business is running in the red! Some small business owners will finally run ROI calculations including the human resources, and suddenly realize that they could make more money working a job. If the small business owner has been running their business for a really long time, struggling to make ends meet, they might see this calculation and close their doors once and for all.

Explain discounting money by the future value of money

Explain ROI on our Scenario

57%ROI can be expressed for different time periods: one year, one month, one week, one day. For example, if a $100 investment returns $150 after one month, then the ROI would be 50 percent monthly ($50 profit divided by $100 investment = 0.50, or 50 percent).

Calculators and computer spreadsheet programs can be very useful in calculating ROI. Refer to their instruction manuals for more information.

When comparing ROI for different investment opportunities, be sure all fees and expenses have been included to ensure a fair comparison. Some ROI quotes do not include fees and expenses and can therefore be misleading.

Use a spreadsheet tool to help automate the process, ensure accuracy, and compare alternatives

Remember one option is always to do nothing. Ensure you calculate this ROI!

Be thorough: include all factors All investments required (people, time, money, etc.).Include opportunity costs people not able to do their regular job due to being involved in a projectInclude all returns (savings realized, revenue enhancements, increased productivity, employee and customer satisfaction)

ASK: Ever puzzled about which option has the lowest overall total cost of ownership over the life of the investment? TCO is about calculating what is the TOTAL costs of the item one item, or a set of alternatives.

So you can identify WHICH option is the lowest cost over the life of the asset

Note: Cheapest option up front may be the most costly over the life of the investment

Key points:

TCO does not factor in:Value of benefits vs. costsROI of the investment, or competing alternativesThe time of the costs whether early, mid-life, or later incurred

Timing of costs may affect decision making

No specific formula for all scenarios

No guidance for:Valuing intangiblesRisk assessment of options

Adopting TCO as sole strategy amounts to minimize cost rather than maximizing return

What you want is to do BOTH minimize cost, while maximizing benefits and return on investment

No single accepted formula for calculating TCO, but many spreadsheet templates available. Here we are using a sample tool from Tech Research Group

Step 1: use a tool

Step 2: Make sure you gather ALL costs

Main idea: consider ALL relevant costs when considering an investmentAll types: hardware, software, installation, conversion costs, services, maintenance/support, training, documentation, supplies, utilities, updates/upgrades, disposal costs, etc.Initial price and on-going (recurring) costs over the projected useful life of the assetNote: useful life must be the same for comparisons!

Which costs should you use? Depends on what the asset is and where it will be used

Costs for most IT investments are usually broken down into direct and indirect categories

Costs for most IT investments are usually broken down into direct and indirect categories Direct Costs: those directly attributable to the assetHardware & Software - capital expenditures for servers, client computers, peripherals, network components, and software.Management Support - costs associated with network, system and storage management, including labor staffing, maintenance contracts, and professional services or outsourcing feesSupport - support staff labor costs, training labor and fees, travel, support contracts and management overheadImplementation - development costs (customization and integration), testing, training, and consultingCommunication Fees - inter-computer communication expenses for leased lines, remote access, and allocated WAN expensesIndirect Costs:End user - cost of formal end-user training, casual learning, informal support outside recognized IT support channels, self-development of applications, and local file maintenanceDowntime - lost productivity due to planned and unplanned network, system, and application unavailability

Indirect vs. Direct Costs

Direct costs are those for activities or services that benefit specific projects, e.g., salaries for project staff and materials required for a particular project. Because these activities are easily traced to projects, their costs are usually charged to projects on an item-by-item basis.

Indirect costs are those for activities or services that benefit more than one project. Their precise benefits to a specific project are often difficult or impossible to trace. For example, it may be difficult to determine precisely how the activities of the director of an organization benefit a specific project.

It is possible to justify the handling of almost any kind of cost as either direct or indirect. Labor costs, for example, can be indirect, as in the case of maintenance personnel and executive officers; or they can be direct, as in the case of project staff members. Similarly, materials such as miscellaneous supplies purchased in bulk -- pencils, pens, paper -- are typically handled as indirect costs, while materials required for specific projects are charged as direct costs.

ExamplesCosts usually charged directly Project staff Consultants Project supplies Publications Travel

Costs either charged directly or allocated indirectly Telephone charges Computer use Project clerical personnel Postage and printing Miscellaneous office supplies

Costs usually allocated indirectly Utilities Rent Audit and legal Administrative staff Equipment rental

Step 3: fill in the data

Step 4: Calculate TCO over the life of the asset

Step 5: if comparing, all must have same useful life

Step 6: which has the lowest CO?

Point out 3 year lifecycleSame tool used

Numbers

Point out:

- costs experienced at different times

- lowest TCODCF method Discounted Cash Flow DCF method Discounted Cash Flow (DCF) is what someone is willing to pay today in order to receive the anticipated cash flow in future years. DCF means converting future earnings to today's money. The future cash flows must be discounted in order to express their present values in order to properly determine the value of a company or project under consideration as a whole. The DCF for an investment is calculated by estimating the cash you will have to pay out and the cash you think you will receive back. The times that you expect to receive the payments must also be estimated. Each cash transaction must then be discounted by the opportunity cost of capital over the time between now and when you will pay or receive the cash. For example, if inflation is 6%, the value of your money would halve every 12 years. If you are expecting an asset to give you an income of $30.000 a year in 12 years time, that income stream would be worth $15.000 today if inflation was 6% for the period. We have just discounted the cash flow of $30.000: it's only worth $15.000 to you at this moment.

The DCF method is an approach to valuation, whereby projected future cashflows are "discounted" at an interest rate (also called: "rate of return"), that reflects the perceived riskiness of the cashflows. The discount rate reflects two things: 1. the time value of money (investors would rather have cash immediately than having to wait and must therefore be compensated by paying for the delay) 2. a risk premium that reflects the extra return investors demand because they want to be compensated for the risk that the cash flow might not materialize after all. History: Discounted cash flow was first formally articulated in John Burr Williams' 1938 text 'The Theory of Investment Value' after the market crash of 1929 and before auditing and pubic accounting were mandated by the SEC. As a result of the crash, investors were wary of relying on reported income, or indeed, any measures of value besides cash. Throughout the 1980s and 1990s, the value of cash and physical assets became steadily less well correlated with the total value of the company (as determined by the stock market). By some estimates, tangible assets dropped to less than one-fifth of corporate value (intangible assets such as customer relationships, patents, proprietary business models, channels, etc. comprising the remaining four-fifths).

WHY follow a structured selection process?

Systematic process preferred to undisciplined methodMinimize riskEnsure chances for successObtain buy-in from key stakeholdersEnsure solution matches real needs now and in the futureEnsure selection is the BEST choice Best ROIBest cost/benefits rationLowest TCO

Key Steps:

Step 1: Form a team, project and do a needs analysisStep 2: Prepare a Requirements DefinitionStep 3: Go through a diligent selection process to evaluate proposalsStep 4: Arrive at short list of suppliersStep 5: Apply the financial tools we discussed to build a business case for the best decisionStep 6: Make the decision and negotiateStep 7: Implement and track your results

Step 1: Form a cross-functional team from the various areas affected

Appoint a project lead; develop a project plan with milestones, resources and target time framesConduct kick off meeting to define and prioritize needsSet expectations accurately, and communicate on-going!Needs Analysis: allows you to analyze existing data to see whether the technology is truly needed immediately. May includeSurveys and observations to gather detailed inputReviews of past metrics performance, customer, employeeInterviews end-users and those affected (critical!)Establish a baseline (KPIs) for later comparisonConsider best practices for the area, as well as industry analysts

Step 2: prepare a requirements definition

Document ALL requirementsCategorize and prioritizeWeight requirementsFactor in other information

Step 3: Conduct a diligent selection process

Identify potential vendorsSend RFPUse a checklist to process responsesConsiderationsSupportTrials

Communications keep people apprised

Step 4: arrive at a short list of vendors

Schedule interviewsConsiderations:Use a scriptInclude a teamDetermine if trials are available

Visit vendor sites, your selected customersCheck the companyWeight in contenders

Step 5: Apply the financial tools in conjunction

CBAROITCO

Step 6: Document the business case

Document your caseEmploy all 3 toolsFormat properlyNegotiate final terms

Step 7: Implement and track results, communicate as you go!

Follow best practice project mgt.Prioritize early, easy winsDrive it, report progressCommunicate as you go

Summarize and restate key points:

Use a business approach to decision makingMinimize risk and costs through informed, higher quality decision makingIncrease credibility with managementBuild stronger Business Cases for proposals to management, increases chances for approvalAlign with business goals, and support the vision and mission of the businessEnsure successful business outcomes for customers, through effective and efficient service provisioningBe a good steward of investments in IT services

Review sources of info

Calculating Cost/BenefitMind Tools CBA Tool: www.mindtools.comCalculating ROIGuidelines: www.silberperformance.comTips: eHow.comOnline Tutorial - ZDnet.com: http://news.zdnet.com/2422-13569_22-153325.htmlROI Calculator: www.solutionmatrix.com Calculating TCOInfo-Tech Free TCO & ROI Calculator: www.infotech.com

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