The Mysteries of ROI Revealed

  PM Network  

In my May column, I discussed how and why companies should use ROI when deciding to approve individual project investments and in evaluating the relative attractiveness of competing projects. Now I’d like to expand on these thoughts by describing what ROI is and how it can be expressed.

As the term suggests, ROI is an evaluation of the incremental financial benefit a company expects to receive for a given amount of incremental expenditure. The term incremental has considerable significance here. ROI calculations are based entirely upon the economic change (both positive and negative) that would result from approving a particular project.

Incremental financial benefits can assume any number of forms:

• A new revenue stream or increase in an existing one
• Cost savings (lowering current cash outlays, such as spending less on maintenance)
• Cost protection (reduction, elimination or deferral of a future expense)
• Cost avoidance (elimination of an unfavorable future impact such as a fine or lawsuit)

Similarly, incremental expenditures can take on many different forms:

• Costs associated with executing the project n Increases in “steady-state” costs (a jump in headcount or waste, for example)
• New cost expenditures (such as a follow-on service or maintenance obligation)
• Loss in existing revenue streams (as in the…

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