Financial Analysis of Major Projects

At the simplest level of analysis, you'll want to make sure that the total costs of any major project you undertake are less than the total benefits resulting from the project. You could simply add up the costs, and then add up your expected revenue increases and cost savings over the next few years, and compare the two.

However, if you did that, you'd be ignoring the fact that many of the costs will be incurred at the beginning of the project, while many of the revenues or cost savings will occur later, over a period of months or years.

There are a number of more formal ways to evaluate the costs or benefits that a major purchase or project will bring to your company. The most commonly used are the following:

Each of these methods has its advantages and drawbacks, so generally more than one is used for any given project. And no financial formula, or combination of formulas, should be used to the exclusion of common sense! For example, a project may "fail" your tests under some or all of these methods, but you might decide to go forward with it anyway because of its value as part of your long-range business plan.