Updated: Jun 27
Business growth consists of investing in your business as well as business development through time and seeing a growth in customer, revenue, staff, and business processes systems as well as acquiring equipment, moving locations, or expanding your business worldwide.
In this introductory article, we going to discuss the present value of an investment in a product line. You may want to purchase a product line or machinery or business books which are considered an investment in your business growth as well.
We will discuss two methods that can give you an indication of the length of time to repay an investment in years and the others give you the benefit of investing. The Payback method gives you the number of years you have to repay an investment in a product line or machinery, However, the Present Value method gives you the benefit of the investment meaning if it is worthwhile to invest in a said product line or not and the potential ROI(Return on Investment) you can get over a period of time let say a 5 years period.
We have developed a Payback Calculator that you can use for free on our website. Cleo one of our business tool calculators helps calculate the payback years of an investment in a product line. All you need to put in Cleo is your invested amount and your cash flow for a year, the product you invested in and press calculate.
It will return the number of years you have to repay your investment before you see a profit based on your yearly cash flow. You can use Cleo yearly if you have an increased cash flow in the next years. Or if you are asked in your post to use the Payback Method to determine when the investment gives you ROI at what year. Cleo will return zero years if your cash flow exceed your investment value.
Determining if your project is worthwhile
To determine if your project is worthwhile or your investment in a product line or machinery will generate a profitable position in the future, the cost and benefits are used to determine whether your investment is economically viable and feasible.
In order to do this, you have two methods that you can use the Payback methods as discussed above and the Present Value. We will demonstrate below how to use the Present value method with an example using our Marketing Playbook The Core Asset of Marketing Revealed.
Let say you decide to purchase 100 copies to give to staff and yourself the business owner for their personal growth and yours in business and marketing and apply knowledge and skills learned in their jobs and you the business owner toward the vision of the business by changing existing marketing practices. Each Marketing Playbook cost £566.82 and you want to know your return on investment within 5 years with a 10% increase factor over 4 years and a 15% discount factor in year 5.
The Present Value formula is: x(1+r/100)n = benefit at year n (n is exponental)
The Present value method is to ascertain if an investment is worthwhile in a product line or machinery. In order to receive a return if you have a discount factor or increment factor the formula is for a discount factor 1/(1+ r/100)n, however, if it is an increment factor the formula is 1*(1 + r/100)n
So for our example: 100*566.82 = £56,682 (your investment in our playbook)
Present Value of the £56,682 initial investment benefit at year 1 is calculated this way with a 10% increment is:
Present value = 56,682*(1+10/100)1
= 62,350 benefit in year 1
Present value = 56,682*(1+10/100)2
= 68,585 benefit in year 2
Present value = 56,682*(1+10/100)3
= 75,443 benefit in year 3
Present value = 56,682*(1+10/100)4
=82,988 benefit in year 4
Present value =56,682/(1+15/100)5
= 28,180 benefit in year 5
Note the sharp decline in benefit in year 5 has it includes the 15% discount factor. However, you can see a steady increase in benefits for the last 4 years, therefore, it is considered a worthwhile investment because if you total the benefits result over 5 years it is £318,448 over 5 years and it exceeds your initial investment by £261,766 (ROI) which is the potential profit you will see in year 5 using our Marketing Playbook by applying the right methods and techniques as well as using the templates included in your marketing and developing sustainable business systems that you can re-use to grow your business exponential by applying what you learn regularly and your constant effort, determination, strong desire seeing this profit position through.
However, the decline in profitability in years 5 suggests that you have stopped using the Playbook information, and the right techniques and methods or become complacent and your business start seen a sharp decline in profitability.
If you want to use the Present Value of an investment method in a product line or machinery you will always have the discount factor(ie decline in percentage ie: 5% or 10% or 15% per year) because a product declined in value over time.
However, you will still have a profit and a nice return on investment before the product become obsolete (ie: computer) or out of style, or discontinued. It is always recommended to use in your business the Present Value methods before making a major investment in a product line or machinery to see if it will be beneficial for you to invest, therefore a worthwhile investment.
Once you determine that it worthwhile investing in the say product line and determine how much you will sell it and total the selling prices for years you can use the Payback method to determine the number of years you will need to repay the investment and see a profit emerging out of your initial investment. The formula is initial investment /by yearly cashflow
So let say you bought £40000 worth of computer and your yearly cash flow is £25000
You will calculate your Payback years this way £40000/25000 = 1.6 your payback period is 1yrs 6 months before you see a return on investment.
You can use the Payback Method over 5 years too in a table your initial investment does not change but your yearly cash flow should steadily increase yearly so if you do a projection of income over 5 years (yrs 1, 2. 3. 4. 5) you can use the Payback method on each year and you will see which years you can exceed your initial investment and the next year profit, therefore, return on investment.
Determining if a project is not worthwhile
An investment is not considered worthwhile if its project cost exceeds the present value. Which brings us to introduce the cost of a project and how to conduct a cost-benefit analysis composed of two steps: Producing the estimates of costs and benefits, and to determine whether the project is worthwhile once these costs are ascertained.
How to produce costs-benefits analysis
The goal is to compose a list of what is needed to implement the system and a list of the new system's benefits.
Bear in mind that a cost-benefit analysis is never straightforward because of both tangible and intangible items.
Tangible items are those which direct value can be counted straight away (e.g. purchase of equipment, time spend by people developing a program, insurance cost, or the cost of borrowing money). They are often associated with computer system development including the following:
Equipment costs for the new system. Including developer costs as well as items such as accommodation costs and furniture are included here.
Personal costs. These include staff needed to develop the new system and the one who will run the system when established. The staff needed maybe Analyst, Designers, and the Developer will be needed to build the system. This also includes any costs incurred to train system users.
Material costs. These include stationery, manual production, and other documentation costs.
Conversion costs. The costs of designing new forms and procedures and of the possible running of the existing systems and the new systems are included here.
Training costs. These costs include both training the users of the new system and any training required for developers who may be required to use the new technologies.
Other costs. Sometimes consultants(Marketing & Business) cost is included here together with management overheads, secretarial support (admin), and travel budgets. Any training costs for users of the new system can be included here.
However, the value of your intangible item cannot be precise and are mostly made of subjective judgment as an example: how can you save by completing a project early or providing new information to decision-maker? note that a considerable back and forth argument can occur before an agreement is reached on such intangible costs.
The sum value of the costs of items needed to run the project is known as the cost of the system. The sum value of the savings made is known as the benefit of the new system. Once you agreed on the costs and benefits, you can evaluate whether the project is economically viable.
The cost estimates are used to set your project budget, therefore it recommended to divide into the project phases which will give you an idea of when funds and staff will be needed. Therefore estimated cost need to be calculated carefully and devoid of ommissions from the estimates that necessitate a request for more funding because you have forgotten to mentioned something.
The benefits of a project evaluation can range from tangible and intangible. The tangible benefits are benefits that can be measured in actual currency terms. Meaning reduced production costs through the introduction of new technologies or reduces processing costs through the use of computers.
Less tangible benefits can include increased sales through changes and improvement to the ordering systems(ie: online sales) or a wider market through better distribution of Marketing Data(Analytic). Measurements of these benefits are not direct but base on estimates of what could happen when a new ordering or marketing system is introduced (The Core Asset of Marketing Revealed - Marketing Playbook). Your management must be convinced that the estimates are accurate if they are to accept your evaluation.
If you just started your business or growing your existing small business it is good to incorporate in your Business Plan and Marketing Plan the latter information provided in this introductory article.
Intangible benefits cannot be measured as an example, what is the benefit of better decision making through computer support or the benefit of maintaining a good business image?
Business Processes Improvement
Developing new ways of doing business can be viewed as a project as well as it is common to improve existing operations to reduce costs and improve throughput. You can use the throughput formula to gauge your efficiency and it can be calculated in two ways.
The general formula is I=RxT meaning I for inventory R for rate and T for the time where the rate is the throughput. However, if you solve R you would get R=I/T instead. You can see it is a versatile formula as you can whether find the value of I or the value of R.
To calculate your stock value and sales rate of your stock depending on the time it takes to sell the stock doing this can help you improve your selling technique and methods and updating your existing marketing of the product by trying market testing and A/B slipt test and see which one improve the sale of the said product if you find the strategy that works systemized it.
Most businesses can have an old information system at the present time often consisting of many systems that were written in the past and still in use because they work and these methods and technologies where tested and proven to works. (You can find these legacy systems in our Marketing Playbook The Core Asset of Marketing Revealed). These systems tend to support one business unit and are called Legacy Systems.
It is common for modern organisations and small businesses to incorporate Legacy Systems to improve their supply chains, sales, and internal production processes. It is often referred to as business process re-engineering. This pertains to the organisation as a whole, business processes, and integration of existing systems(social media platform or CRM) to support the organisation wider business processes.
There are two alternative ways to re-engineer processes, one way is to make adjustments to existing processes and the other is to adopt a strategy to use standards processes or blueprints. (found in our Playbooks The Core Asset Of Marketing Revealed and The Core Asset of Marketing Revealed Startup Kit) We also have written an extension to the Playbooks for online application the Prospect to Client Systemised