Recently, I was asked to calculate the ROI of an internal project at work, and after I ran the numbers, I discovered that not only was the project incredibly financially sound, but the value of being a technical person who can do these sorts of things is remarkable.
In this section, I’ll start off with some basic terminology and give you a basic rundown of how ROI calculations work and what they’re useful for. This is something that anyone with a technical inclination can easily pick up, and is the sort of knowledge that can improve a career, make work less stressful, and can help you make a case for why a project is a good (or bad) idea.
ROI: Return on Investment is a calculation of how much a business or individual stands to profit (or save) by engaging in a particular activity. ROI is expressed as a percentage above the initial investment; a 4% ROI means that an outlay of $1 has an income (or saving) of $1.04, 4 percent higher than the initial outlay.
IRR: Internal Rate of Return is a similar measure to ROI, but is calculated differently. Rather than looking at pure return on investment, IRR focuses more on a concept called the Time Value of Money. TVM is based on the idea that a dollar today, because of its investment power, has more value than a dollar a year from now.
Hurdle Rate: In many organizations, a project must be able to “clear” a certain IRR (or occasionally ROI) rate to be considered viable. A hurdle rate is often set on a per-division or company-wide basis. A common example is 10% hurdle rate, meaning that a project must have a 10% return in order to be considered for approval.
Fortunately, calculations for ROI are pretty simple:
(INCOME - SPEND)/SPEND
For example, if we can get $125 by
($125-$100)/$100 = $25/100 = .25 = 25%
This means we have a 25% ROI on this investment. Pretty simple, but it’s important to keep in mind that this simple ROI calculation may fall apart when looking across a longer period of time, which is where IRR comes in.