Overview of analysis techniques

- Many business investment analysis exercises take literally months of effort, and they usually result in sophisticated spreadsheets or financial models being developed. Now, in order to produce reliable outputs, work of this depth is usually unavoidable, but it can actually be fun doing this. Well, sometimes. In my experience, reams of numbers and data isn't what decision makers want. What they do want is a concise summary of the financial analysis that's presented in a way that enables them to make decisions with confidence. Now, I find that the most effective way to do this is to have the financials presented in an industry standard manner rather than being unique to your organization. Industry standard measures allows easy comparison with other organizations, and it also helps to manage your stakeholders' expectations. A suitably trained financial analyst will be your best friend here. So, you're probably wondering what are the more common business investment metrics that can help make these critical business decisions? Now, I should add that what we are about to cover is just a brief overview. Later on in this course, we'll step through a case study to help explore these concepts further. Okay, the first and easiest to understand technique is a cost-benefit analysis, sometimes called benefit-cost analysis. This is where the total costs are compared with the total financial benefits with the outputs usually expressed as a ratio. In this example over five years, the total benefits of $37.5 million divided by the total costs of roughly 25.6 million, giving us a benefit-to-cost ratio of 1.46. The next metric we can produce is something called a net present value or just NPV. This is where we discount future year's dollars to the present day using something called a discount rate. In this example, we're discounting using a rate of 7.9%, giving us an NPV of roughly $4.79 million. Now, the last metric we can utilize, and one I see most commonly used, is the return on investment, usually shortened to just ROI. To calculate the ROI, we simply divide the net financial benefits by the total cost of investment. In this example, the net benefits of $11.9 million are divided by the total costs of 25.6 million, giving us an ROI of 46%. Now, there are a whole host of other metrics out there that you may wish to use, but these ones are the most commonly used in the industry to help make investment decisions. So, if you are a decision maker and don't have these powerful metrics at your fingertips, I strongly suggest you talk with your financial analyst to help pull this picture together because insight such as this will likely have a huge bearing on the decision you ultimately make.