1.1 Introduction
1.2 Financial Approaches to Measuring Business Value
Description of metric | |
---|---|
Net Present Value (NPV) | NPV is one of the foremost financial key performance indicators (KPIs) used to evaluate large, capital-intensive IT projects. NPV relies on accurate cash flow projections extending over the life of the project, alongside a discount rate which is used to account for the time value of money. Project approval depends on obtaining a positive NPV. IT projects can also be compared with one another using NPV whenever firms need to ration scarce IT capital. |
Return on Investment (ROI) | ROI is an accounting-based ratio that compares total project income to the level of project investment. ROI does not take account of the time value of money, meaning that projects with a longer-term return window would be treated on par with projects that generate equal returns over a shorter time period. Similar to NPV, the accuracy of ROI calculations depends on being able to identify the scale of future cash flows arising from an investment. |
Payback period | The payback period is a simplistic method that calculates the time needed for a project to breakeven (recover its investment costs). In a risk averse firm, managers may gravitate towards IT projects with a shorter payback period. In practice, payback should not be used in isolation but rather alongside other metrics that take account of project risk and that consider the flow of benefits beyond the end of the payback period. |
Internal Rate of Return (IRR) | Given all future cash flows and an upfront investment for an IT project, IRR is the discount rate that would return a value of zero for NPV. IRR can be considered the true rate of return in that it takes account of the time value of money and the flow of value over time. IRR can be benchmarked against desired or minimum rates of return, including the weighted cost of capital. |
Economic Value Added (EVA) | EVA—also called economic profit—is a measure of residual value generated by a project after deducting the cost of invested capital. Since all capital can be allocated to different ends, EVA argues that projects should be assessed an investment cost. This allows for a more equitable comparison if managers are in a position to pick from different IT projects with unique rates of return. |
Total Cost of Ownership (TCO) | TCO captures a multitude of different cost items in a single metric such as the cost of hardware, software, and services, allocated per application, user, department, etc. TCO can also be represented as a cost per period of time. TCO does not take into account the benefit or value to the organisation of using the underlying resource and is, as such, a questionable metric unless accompanied by other metrics such as ROI, NPV or payback period. |
1.2.1 OpEx Measures of IT Business Value
1.3 Beyond Financials: Quantifying Non-financial Aspects of IT Business Value
1.3.1 Scoring
Decision criteria | Weights | Cloud-based solution | On-premise solution | ||
---|---|---|---|---|---|
Grade (−5 to 5) | Score | Grade (−5 to 5) | Score | ||
Enhanced user experience | 15 | 4 | 60 | 4 | 60 |
Risk of user acceptance | 10 | −1 | −10 | −1 | −10 |
Scalability | 20 | 5 | 100 | 2 | 40 |
Failover scenario | 15 | 5 | 75 | 3 | 45 |
Level of access to information | 10 | 5 | 50 | 3 | 30 |
Security infrastructure | 20 | 5 | 100 | 3 | 60 |
Risk of storing data externally | 10 | −3 | −30 | 5 | 50 |
Total | 100 | 345 | 275 |