ROI Analysis

Overview

Calculate and analyze return on investment for projects, purchases, and decisions

Steps

Step 1: Define the investment clearly

Establish exactly what is being evaluated:

1. Describe the investment or purchase in detail
2. Define scope and boundaries (what’s included, what’s not)
3. Specify the time horizon for evaluation
4. Identify decision criteria and stakeholders
5. List alternatives to compare against (including “do nothing”)

Step 2: Identify and quantify all costs

Enumerate every cost associated with the investment:

1. List direct costs (purchase, implementation, training, licensing)
2. Identify indirect costs (productivity loss, integration, maintenance)
3. Uncover hidden costs (change management, technical debt, exit costs)
4. Include opportunity cost of capital
5. Create year-by-year cost projection
6. Document assumptions for each cost estimate

Step 3: Identify and quantify all benefits

Enumerate and monetize all benefits:

1. List hard benefits (revenue increase, cost reduction, time savings)
2. Quantify each hard benefit using appropriate formulas
3. Identify soft benefits (morale, competitive advantage, risk reduction)
4. Estimate soft benefits where reasonable, or note qualitatively
5. Create year-by-year benefit projection
6. Document all assumptions and calculation methods

Step 4: Project cash flows

Build period-by-period cash flow model:

1. Create timeline matching evaluation period
2. Place costs in appropriate periods
3. Place benefits in appropriate periods
4. Calculate net cash flow for each period
5. Account for ramp-up time (benefits may not start immediately)
6. Validate timing assumptions

Step 5: Calculate ROI metrics

Calculate appropriate metrics for the investment:

1. Calculate simple ROI (total gain / total cost)
2. Calculate payback period (when cumulative cash flow turns positive)
3. Calculate NPV using appropriate discount rate
4. Calculate IRR (rate that makes NPV = 0)
5. Select primary metric based on context and stakeholder preferences
6. Document calculation method and discount rate rationale

Step 6: Perform sensitivity analysis

Test robustness of ROI to assumption changes:

1. Identify key assumptions (most uncertain or most impactful)
2. Vary each assumption by +/- 10-20%
3. Recalculate ROI for each variation
4. Create best/base/worst case scenarios
5. Calculate breakeven points for critical variables
6. Identify which assumptions ROI is most sensitive to

Step 7: Make recommendation

Synthesize analysis into clear recommendation:

1. Compare ROI metrics to investment criteria
2. Compare to alternatives (including “do nothing”)
3. Consider sensitivity results and risks
4. Factor in strategic fit and soft benefits
5. Formulate clear recommendation with rationale
6. Document conditions and assumptions

When to Use

• Evaluating whether to make a significant investment or purchase
• Comparing multiple project or investment options
• Justifying expenditure to stakeholders or leadership
• Performing post-investment evaluation to measure actual returns
• Assessing technology purchases or upgrades
• Evaluating hiring decisions or headcount increases
• Analyzing make vs buy decisions
• Prioritizing a portfolio of potential investments

Verification

• All costs are included (direct, indirect, hidden, opportunity)
• Benefits are realistic and assumptions are documented
• Cash flow timing is appropriate (benefits don’t start too soon)
• Discount rate is appropriate for risk level
• Sensitivity analysis covers key assumptions
• Recommendation is clear and actionable

Input: $ARGUMENTS

Apply this procedure to the input provided.