Let’s consider how a business case is used and how business case analysis will add value to your discussions.
In the first post in this series I looked at the importance of using your narrative to add meaning to a business case. In the second we described how successful business cases are able to capture the impact of change in the form of quantified benefits, costs and risks.
Often the financial team control the purse strings in any company. In this role they will analyse the ‘value of change’ and, because they are [often] analytical personality types, these people will expect your numbers support the story. In this context, qualitative descriptions such as “soon”, “very quickly”, “huge gains”, “affordable cost” are of little help without the specific numbers.
Numbers are a vital part of a business case, it is here where business impact is quantified. They mean little in isolation, they require some context to add meaning. In this third post on the subject of business cases we look at some common techniques that can be used to add this context and support the success of your business case.
We will talk about some financial concepts here. Remember, you should not try to be overly smart yourself when there are resources to help you in your company. Speak to your financial controllers and enrol them into your team. Once you have the basic facts at had they will be able to help you to look at the facts as your customers would and offer guidance on how to improve your proposal.
By building scenarios (use cases) this can help you to build a bridge between your story and the numbers, and in the process illustrate the impact on costs, revenues, cash flow and other financial measures. So what are some common ways to do this.
Cash flow and Payback
Cash flow is the schedule of payments in and out over time and is a key part of the business case analysis for most projects.
When a project requires a large investment (either capital or operational) a proportion of the costs will be incurred early in the project. With a delay before the benefits are realised it is important to understand how these funds will be tied up.
To see the cash flow, spread the costs and benefits on a timeline of when you expect them to occur E.g. monthly, annually and the like. Understand that some costs such as project management are likely to be spread over the term of the project and others will be capitalised up-front costs.
For a simple business case it is possible to compare the costs and benefits in a short time period, and if the benefits outweigh the costs you are usually good to go. For more complex procurements however, you need more information as the project is likely to require investment for 3,5, 7 or more years. It is important to know when costs will be incurred, and for how long. Comparing this to when the benefits will start to be realised will highlight the value of the investment over time.
Adding a cumulative net cash flow row (benefits-costs plus prior net cashflow) can be used to demonstrate when the investment will deliver a positive return, or Payback period. (as below)
This scenario shows a payback period of 7 quarters after the start of the project. At this point the project breaks-even.
Why is it important for sales people to understand cash flow?
Principally because of the often sizeable nature of the investment required in your customer to buy your solution. Do their company have the appetite to tie up funds for this period of time? Would the projected benefits make the wait worthwhile?
You should be able to do this yourself as it requires simple analysis only. Armed with this information you can understand the level of funding required to support the project throughout its life and help you to sell the value potential over the life of the project. Particularly the early investment period.
Return on investment, or ROI
ROI is a simple way to assess value in your business case analysis, what you get back relative to what you put in. Again, this is one you can do yourself at a high level.
Return on Investment is a ratio that compares benefits to costs after a given period of time, although be aware it doesn’t take into account the cost of the required investment funds.
The realised ROI (what you actually get) from a project can be impacted over time by uncertainty and for this reason short timescales are usually preferred in the business case analysis performed by many companies.
To calculate the ROI of our project use the following : (benefits-costs)/costs. Our project requires £41k investment and delivers £87k in benefits over the 3 years, this will deliver an ROI of 1.12times the required investment ((87-41)/41)
Why is it important for sales people to understand ROI?
In simple terms selling is about demonstrating value and this is measured at a high level in terms of “will I get more benefit to outweigh my costs”. Armed with the high level ROI information, it is possible to discuss investment returns with a prospect. If you have a good ROI ratio coupled with a short payback period this offers potential for a low risk decision.
Net Present Value (NPV)
Again, the calculation of NPV is one for the finance team to help you with.
Consider your investment proposal for a second. You may be aware that the money you have now is more valuable than any money they you collect in the future years. Why? Because the money you have now can be used to generate more money in the form of investments or even interest from the bank and also the interest rate reduces the buying power of this money. NPV is about calculating the value of an investment with an assumed ‘time value of money’ factored in.
Most organisations would have an assumed value for money related to interest rates and the like. In our example above we used 5%. It is against this result that they will calculate the potential value of a project.
Using Excel it is possible to calculate NPV using the following formula: =NPV(R, Cashflow row) for our example this is =NPV (0.05, g5:05)
If, like in our example, the value returned is negative then this would be perceived to be an unattractive project. Higher positive returns will help to support your case.
Why is it important for sales people to understand NPV?
Companies have an expected threshold for investment returns be that 5%, 10% or 20% investment returns. Asking your prospect about their policy for investment returns will give you the information you need to complete an initial view. With the NPV calculated you will know how much value you offer.
Internal Rate of Return(IRR)
Often this is harder for sales people to calculate as they don’t have access to some of the information required to calculate this. Enrol your finance team to help you with the calculations, although the reason why this is important is worth understanding.
What is IRR? It is the total return of the project over the period of the project. It is expressed as a % return and it is them compared to alternative benchmarks. These benchmarks might include:
- The level of interest available my putting the funds in the bank. If your prospect can earn 10% in the bank and 12.5% or even 14% with you project they may well decide to take a risk adverse approach and not proceed with the procurement.
- The potential return from alternative projects under consideration. If you offer 12% IRR and the alternative offers 17% they may well be preferred.
Why is it important for sales people to understand IRR?
Companies have limited funds and often have multiple projects under evaluation. If they have a tight squeeze on funds they will look towards the projects that offer the best potential return. Do you know enough about the IRR to be able to press your case for investment? Is your project more lucrative than other options? Is your return enough to offset perceived risks?
Using the Analysis
Overall, these pieces of information can help you to engage with you buyer more positively. They will most likely require a business case to gather the internal support required from other stakeholders. If you are able to help them to prepare this case you will strengthen your relationship with them, have the inside track on the decision making and be able to differentiate your proposal for the company.
As with all ratios, these are an excellent guide for sales people providing you have the right information and assumptions. They should be used as a starting point for the conversation rather than an end game in themselves.
Your client will always want to do their own project analysis but seeing a view early will help you to qualify effectively. For example, as per our example the NPV figure would be worrying for any financial controller. If you know this is a negative value early you can pro-actively engage the client to discuss whether this would be acceptable. If not and you can do nothing about it them you really need to consider hard whether the sales campaign is worth the effort.
Would you rather know early or remain in the dark and work through your sales activity only to be thwarted late in the process as financial returns are not strong enough?