A Case Study
Let's take a very simple project and use it to illustrate some financial principles. Imagine a project with one member of staff delivering a new computer system. Let's call the member of staff "Bob". Bob builds and implements a computer system that automates a manual business process. The automated process is more efficient than the manual process, and therefore the company's costs are reduced (the benefit).
Bob is a high performing, well motivated and skillful chap. He is paid a salary of £250 per day. On average, Bob creates £300 of value each day for the company. He often works longer hours than he is paid, and answers emails in the evenings and at weekends. This means every day the company makes £50 from employing Bob, or a 20% return on investment (ROI).
(£50 / £250) * 100% = 20% ROI
Say that Bob starts the new computer project on 1st January 2013, and finishes the project on 31st January 2013. He completes 22 days of work. As Bob works on the new computer project he is building an asset. After 22 working days the computer project is finished. The new computer system cost the company £5,500 to build (£250 per day * 22 days), and is worth £6,600 (£300 per day * 22 days) given the extra value Bob is adding.
The Good News
Firstly, the company has a new asset. Because it cost £5,500 to build, and is worth £6,600 the company has made a net profit of £1,100 on building the asset itself.
Secondly, the new computer system performs as hoped. By automating a process it saves £50 of labor costs each working day. The new system goes live on 1st February 2013. There are 231 working days remaining in 2013, so during the first year the company saves 231 days * £50 per day = £11,550.
So far, our profit and loss (P&L) and ROI look like this:
Revenue = £6,600 + £11,550 = £18,150
Costs = £5,500
Profit = Revenue - Costs = £18,150 - £5,500 = £12,650
ROI = (Profit / Investment) * 100%
= (£12,650 / £5,500) * 100% = 230%
That is a great result! At the end of 2013 the benefits achieved have paid for the project investment more than twice over.
The Bad News
So far we've only analyzed the visible costs of the project. There are also some hidden costs that need to be added to the calculation to give a complete picture of the project. Unfortunately, Bob had a miserable time delivering the project. There was a lack of sponsorship and he had little or no clear instructions from his sponsor. Also, people who owned the business process were uncooperative. His work effort did not seem to be appreciated.
All of this left Bob feeling disillusioned and demotivated. As a result, his productivity fell during the remainder of 2013. Bob used to work extra hours in the evening and occasionally at the weekend for free. This is how he only cost the company £250 per day, but actually delivered £300 per day of value. Bob decided he was no longer going to give this discretionary effort, so the company lost out by:
231 days * (£250 - £300) = -£11,550
Because Bob had lost faith in the company and his motivation was gone he put in less effort than he was even being paid for. He took sick days more frequently, longer lunch breaks and sometimes arrived late and went home early. Whilst Bob cost the company £250 per day in salary, he was actually delivering £225 of value. This means that the company made a further £25 per day loss.
231 days * (£225 - £250) = -£5775