Helping You Prepare for the Unexpected
                                                                                                               Summer 2012

Ignite Blog

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No More Ugly Babies
One of your star employees has an idea that he thinks is the best thing since sliced bread. He is requesting funding for a new product.  What do you do?  Sign the check?  Say no? 

Some business leaders are inclined to approve the request right there.  No proposal, no idea of the return, no projections, and no risk factored into the request. 

This time, when approached by someone for those valuable investment dollars, you will take a different approach. I've outlined 5 steps that will help you ensure that you are spending money on the pretty baby - not the ugly one!  Let's look at the details.

What You Need to See
When someone has an idea on how to grow the business, you must ask for the following information:
1.  A brief summary of the project
2.  The expected investment
3.  Return on investment
4.  A 5 year profit and loss statement for the business - with and without the project
5.  Cash flow estimate - (this is how you factor in risk)

Now, these 5 items may appear to be a huge request, but in reality, this approach will become your blueprint for all project proposals.  Sure, it might be something new and challenging, but this format will give you a common platform to evaluate all projects.  I've been using this for years for everything from new product introductions, to geographic expansion, to partnerships with distributors and other companies.

Summary
The key to a successful summary is the writer's understanding of the expectations. Your team must understand they need to identity upsides, risks, and the strategic reasons for doing a project.  Help them understand that getting buy-in from you and other leaders requires a few paragraphs regarding the reason for undertaking the program, the potential risks, and the primary assumptions used in the development of the proposal.    

Investment
For some, this isn't always straight forward.  The investment costs must include the actual dollars for materials and capital, and the support costs for the project.  Support costs include items such as sustaining costs (keeps the product going during the course of its life), incremental manpower required to complete the project, and additional operational expenses (royalty payments, sales commissions, and back office support costs).

Return On Investment
Ok - this is more than just incremental revenue.  It is the bottom line number for the profits of the new investment.  It's revenue less the expenses that you incur to get the project done, and any kind of support expenses to execute the new program.  Support expenses include both the true incremental expenses of implementing the program AND the allocation of expenses from other departments to support it.

A simple Return on Investment calculation is dividing the profit by the total investment.  Once you have that number, multiply it by 100%.

5 Year Income Statement
The reason I use 5 years is that most projections are very bullish in the early years.  People requesting money want to show a quick payback.  Ask them to give you 5 years - nothing less.  You also want to understand what the project brings to the business.  To get this data, request an income statement that shows revenue, gross margin, expenses, and profit with and without the project.

Cash Flow Statement
This is probably the most critical aspect of the analysis.  Cash flow is the area that really can't be manipulated.  For many small and midsize businesses, cash flow is king.  You MUST understand the impact of the project on operating cash flow.  Lastly, the cash flow statement will provide the foundation for calculating the net present value of the project.  It's the key area for factoring in risk, too.

I can't stress enough the importance of using these tools.  It's not that complicated, and the data promotes great discussion and interaction among all of your key leaders.  Don't settle for "take my word, this project is going to kick butt."  Have someone do his or her homework, and ask questions.  Understand the risks, the upside, and the financial impact to your business.

Once you get into the routine of performing this exercise, you will probably see a lot more pretty babies than ugly ones.

Net Present Value
There are several ways to evaluate a project with IRR, Payback, and NPV being the most common methods.  For many, NPV is the best method.  NPV shows the actual change in value of the business by doing the project. 

Using NPV provides an opportunity to factor risk into your projects.  Use different rates of 5%, 10%, and 15% for low, medium, and high risk projects, respectively. 

Calculating NPV is easy to do in Excel.  Try it out!  It's much less work than you might think.                
                                 

Want Help in Developing a Project Evaluation Tool?

At Ignite, we have been teaching people how to develop and use this "ugly baby prevention tool."  It's effective, simple and easy to implement.  If you want something that cuts through all the noise in evaluating a project, this is it.
  

Contact us to discuss your needs, and we can give you some ideas on developing a model that suits your business.
  

Send an email to [email protected] for details.