APPROACH: Financial Metrics Defined (con't)
Financial Metrics - Defining the Business Impact (con’t):
- Payback Period (or breakeven) is timeframe it takes for the project to yield a positive cumulative cash flow. It is the point (expressed as the number of months) at which the cumulative project benefits exceed project expenditures to date.
Payback period is a key measurement of risk but does not take into account cash flows after the payback period. It is therefore not a measure of the savings and profitability or even how your investment performs after your benefits equal the initial costs.
- Net Present Value (NPV) represents the cumulative present value of the expected return of a project over a specified period of time minus the initial costs of the project. This dollar figure provides visibility on the actual value of a project, taking into consideration the time value of money - the ongoing benefit of a project in today’s dollars.
A project that will deliver a benefit of $2M a year from now is not the same as getting $2M in today's dollar terms. A dollar today is worth more than $1 tomorrow because inflation will decrease the value of tomorrow’s dollar.
NPV tells you the magnitude of the project and if the project generates a profit and should be undertaken. But, it does not tell you to proceed because it does not tell you when savings will occur. If the calculation is less than 0, the project generates a loss and you shouldn't proceed.
ROI, Payback and NPV should be used in conjunction to understand rate, timing and size of the return.