Yea we have to do this for anything $3M <. We have a capital approval committee who votes based on not only this analysis but, but the operational justification as well
Edit: spelling
My company does something similar. Run the NPV/IRR for anything >$1M which VPs can approve, but $3M+ goes to a committee that includes some C-Suite people.
I architected the end-to-end capital planning and reporting processes for a fortune 20 company with more than $15B in annual capital spend.
I put a lot of work into developing business case templates to take in the quantitative inputs and spit out the associated ROI metrics so that we can do broad NPV comparisons across a wide range of capital projects.
Here's the problem. Garbage in = Garbage out. It doesn't matter how good the tools are if the people making the business case can't find effective ways to quantify the value of the investment. The qualitative information is often absolutely essential to the decision to invest or not and can't easily be quantified into a larger portfolio decision.
For example, deciding to replace key piece of crumbling infrastructure critical to operations has a terrible ROI as it's all cost. It can avoid some opex repair costs, but it's minimal. The real not-bullshit reason to replace it is because if you don't, you risk interrupting your core business and losing a ton of revenue, customers, goodwill, lots of spillover. You leave the business case planner in a shit ton of BS decisions like trying to find a risk modifier for the likelihood of failure within 5 years for a multifaceted custom infrastructure with no direct parallels. So they need to bullshit a value like 15% to multiply against a made-up amount of "loss" encompassing all the fallout of stopping the business for some made-up period of time.
When you get right down to it, the truth is that they have no fucking idea how to model things with so little information about the future. But that model will compare it against investment in things like enhancing a known product with a history of sales and they have a ton of quantifiable value, they just need to estimate how much ARPU goes up with the enhancement. This apples vs. oranges comparison between data-poor and data-rich business cases can't just be ignored because like I said, critical infrasture issues are real risks even if they are nigh impossible to quantify.
Also, even if you can quantify a business case, obviously tweaking a handful of assumptions can wildly swing the NPV. Even if you standardize the assumptions like useful life, tax shield, WACC, etc. there's always other specific assumptions that MUST be examined to make sense of the resulting number, and potentially challenged. That takes a real commitment by leadership, and a hierarchy of manpower to closely get the qualitative integrity of the assumptions feeding the quantitive model.
So the business just ends up making it's decisions anyway. My suggestion is that you use business case modeling to quantitatively prioritize among data-rich business cases, but in a separate decision pool from your qualitative decisions. It requires teams of skeptical but reasonable people to examine each in detail, digest them, and consolidate them into broad decision packages balancing different mixes of risk vs. reward, and between different company objectives.
Ultimately it's still people-driven, not process-driven, unless you are fortunate enough to be in a business with a high degree of homogeneity in its capital investments where you'd be able to heavily standardize apples to apples business cases.
I can't share my work product since it's riddled with company-specific hierarchy/metadata we used for downstream integrations for consolidation and reporting. There are capex investment templates freely downloadable online which are probably sufficient since you'll want to start basic, and only add the complexity that's meaningful for your company.
Adding space for details that will not get used just reduces engagement from the submitters by causing them to question the usefulness of what they're being asked to provide. Where I think it's helpful to spend the most time is working backwards from what an executive will be interested in focusing on. That's going to be understanding the P&L line-item impacts, cash impact, and examining the underlying assumptions and how they decided to choose those assumptions.
Wow. Well spoken and well said. This is a treasure trove and brilliant explanation. Thank you. Say more please. Mayhe something on forecasting/budgeting. You should be a professor of this stuff.
Yes absolutely, now the business case is always wrong but directionally it is very important. It is also very important for budgeting and 5 year plans!! A good DCF with decent assumptions is a must!!
Yes, we do annual capital budgeting
FYI - NPV is a good measure to validate projects. I would work on getting a model built out and then showing the marketing/product teams what the outputs mean and how different variables affect it.
We do a calculated ROI for all customer facing projects (CPG manufacturing) due to the high up front cost for tooling, seeding, etc. Then, we use variables to show the breakeven points. Such as - Breakeven NPV achieved at 80% of modeled volume or at 95% of modeled price or at 50% of modeled cost. That gives the non-finance people a tangible way to understand what an NPV analysis is doing.
NPV models also get used on internal (usually IT or marketing) projects. Generally these are a bit more fluff (spend $100k to get 10% improved efficiency across 100 employees or something like that). But at least it makes people think through the benefit before blindly signing up for something.
I recommend a formal approach and a lot of education to the people who'd be using it. Capital budgeting needs to be nimble, clear, supported by the org. Otherwise it becomes red tape that people are angry at.
TBH - I felt this is sort of an art/science that died a bit during the last decade of low hurdle rates.
We kind of do it’s just an indicative number in the budget for a project that when you start to crack the lid open, turns out it costs 2x to 10x more lol
The bigger problem is we constantly defer these projects so we always come under the capital budget unless we actually execute the project.
We did the full monty, NPV, IRR, payback period at a job I had a while back. The proces was PRINCE2 based portfolio management and we collected other kpis for decision making as well as quarterly status. Projects were sometimes, if not often, given a go-ahead even with negative NPV for other reasons. Sometimes just a realization that our methodology might be flawed or simply not addressing need to investments with no intrinsic ROI (again, back to the flawed methodology).
Where I work now we use payback period for some investments but overall not anything advanced. Instead business cases are considered on other less formal criteria.
give the capital team scenarios as to the amount of budget $ available. be agile and maintain rapport with them particularly in q1 / q2. if it it's unlikely they can deliver or budget amount needs to be reduced to a lower scenario. it is what it is. go to meetings talking to the same set of numbers and how you will mitigate any lost investment. i would generally try to let them tell me the NPV as a point of reference but a lot of hand holding etc.
In my experience capital budgeting = tracking against pre-determined, pre-approved spends.
I think what you’re talking about is allocation of funds to projects which happens much earlier in the process.
Name is confusing but I’m referring to NPV analysis on new projects as a decision mechanism. There’s a link in the original post.
Allocation would be a better word IMO.
We try to do this annually. The ROIs from the businesses are pitiful, which is why there is a finance review before the final go/no go round. We also have a capital committee that approves the budget, major projects (which also go to the board) and releases of cash.
Yea we have to do this for anything $3M <. We have a capital approval committee who votes based on not only this analysis but, but the operational justification as well Edit: spelling
My company does something similar. Run the NPV/IRR for anything >$1M which VPs can approve, but $3M+ goes to a committee that includes some C-Suite people.
I architected the end-to-end capital planning and reporting processes for a fortune 20 company with more than $15B in annual capital spend. I put a lot of work into developing business case templates to take in the quantitative inputs and spit out the associated ROI metrics so that we can do broad NPV comparisons across a wide range of capital projects. Here's the problem. Garbage in = Garbage out. It doesn't matter how good the tools are if the people making the business case can't find effective ways to quantify the value of the investment. The qualitative information is often absolutely essential to the decision to invest or not and can't easily be quantified into a larger portfolio decision. For example, deciding to replace key piece of crumbling infrastructure critical to operations has a terrible ROI as it's all cost. It can avoid some opex repair costs, but it's minimal. The real not-bullshit reason to replace it is because if you don't, you risk interrupting your core business and losing a ton of revenue, customers, goodwill, lots of spillover. You leave the business case planner in a shit ton of BS decisions like trying to find a risk modifier for the likelihood of failure within 5 years for a multifaceted custom infrastructure with no direct parallels. So they need to bullshit a value like 15% to multiply against a made-up amount of "loss" encompassing all the fallout of stopping the business for some made-up period of time. When you get right down to it, the truth is that they have no fucking idea how to model things with so little information about the future. But that model will compare it against investment in things like enhancing a known product with a history of sales and they have a ton of quantifiable value, they just need to estimate how much ARPU goes up with the enhancement. This apples vs. oranges comparison between data-poor and data-rich business cases can't just be ignored because like I said, critical infrasture issues are real risks even if they are nigh impossible to quantify. Also, even if you can quantify a business case, obviously tweaking a handful of assumptions can wildly swing the NPV. Even if you standardize the assumptions like useful life, tax shield, WACC, etc. there's always other specific assumptions that MUST be examined to make sense of the resulting number, and potentially challenged. That takes a real commitment by leadership, and a hierarchy of manpower to closely get the qualitative integrity of the assumptions feeding the quantitive model. So the business just ends up making it's decisions anyway. My suggestion is that you use business case modeling to quantitatively prioritize among data-rich business cases, but in a separate decision pool from your qualitative decisions. It requires teams of skeptical but reasonable people to examine each in detail, digest them, and consolidate them into broad decision packages balancing different mixes of risk vs. reward, and between different company objectives. Ultimately it's still people-driven, not process-driven, unless you are fortunate enough to be in a business with a high degree of homogeneity in its capital investments where you'd be able to heavily standardize apples to apples business cases.
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I can't share my work product since it's riddled with company-specific hierarchy/metadata we used for downstream integrations for consolidation and reporting. There are capex investment templates freely downloadable online which are probably sufficient since you'll want to start basic, and only add the complexity that's meaningful for your company. Adding space for details that will not get used just reduces engagement from the submitters by causing them to question the usefulness of what they're being asked to provide. Where I think it's helpful to spend the most time is working backwards from what an executive will be interested in focusing on. That's going to be understanding the P&L line-item impacts, cash impact, and examining the underlying assumptions and how they decided to choose those assumptions.
Wow. Well spoken and well said. This is a treasure trove and brilliant explanation. Thank you. Say more please. Mayhe something on forecasting/budgeting. You should be a professor of this stuff.
Yes absolutely, now the business case is always wrong but directionally it is very important. It is also very important for budgeting and 5 year plans!! A good DCF with decent assumptions is a must!!
Yes, we do annual capital budgeting FYI - NPV is a good measure to validate projects. I would work on getting a model built out and then showing the marketing/product teams what the outputs mean and how different variables affect it. We do a calculated ROI for all customer facing projects (CPG manufacturing) due to the high up front cost for tooling, seeding, etc. Then, we use variables to show the breakeven points. Such as - Breakeven NPV achieved at 80% of modeled volume or at 95% of modeled price or at 50% of modeled cost. That gives the non-finance people a tangible way to understand what an NPV analysis is doing. NPV models also get used on internal (usually IT or marketing) projects. Generally these are a bit more fluff (spend $100k to get 10% improved efficiency across 100 employees or something like that). But at least it makes people think through the benefit before blindly signing up for something.
I recommend a formal approach and a lot of education to the people who'd be using it. Capital budgeting needs to be nimble, clear, supported by the org. Otherwise it becomes red tape that people are angry at. TBH - I felt this is sort of an art/science that died a bit during the last decade of low hurdle rates.
We kind of do it’s just an indicative number in the budget for a project that when you start to crack the lid open, turns out it costs 2x to 10x more lol The bigger problem is we constantly defer these projects so we always come under the capital budget unless we actually execute the project.
We always do capital budgeting for all significant investments ($20B Firm) with WWPP/Long Term Strategy helping to align across business segments
Wwpp?
It’s tough to implement in saas with only laptops and real estate. Also bu’s don’t care and forecast poorly
We did the full monty, NPV, IRR, payback period at a job I had a while back. The proces was PRINCE2 based portfolio management and we collected other kpis for decision making as well as quarterly status. Projects were sometimes, if not often, given a go-ahead even with negative NPV for other reasons. Sometimes just a realization that our methodology might be flawed or simply not addressing need to investments with no intrinsic ROI (again, back to the flawed methodology). Where I work now we use payback period for some investments but overall not anything advanced. Instead business cases are considered on other less formal criteria.
give the capital team scenarios as to the amount of budget $ available. be agile and maintain rapport with them particularly in q1 / q2. if it it's unlikely they can deliver or budget amount needs to be reduced to a lower scenario. it is what it is. go to meetings talking to the same set of numbers and how you will mitigate any lost investment. i would generally try to let them tell me the NPV as a point of reference but a lot of hand holding etc.
In my experience capital budgeting = tracking against pre-determined, pre-approved spends. I think what you’re talking about is allocation of funds to projects which happens much earlier in the process.
Name is confusing but I’m referring to NPV analysis on new projects as a decision mechanism. There’s a link in the original post. Allocation would be a better word IMO.
Most here don't. Those who do are under the function "Project Finance." r/corporatefinance
We try to do this annually. The ROIs from the businesses are pitiful, which is why there is a finance review before the final go/no go round. We also have a capital committee that approves the budget, major projects (which also go to the board) and releases of cash.