What IT Managers Need To Do With Complicated Net Present Values

by drjim on April 4, 2013

Net Present Values can get tricky very quickly…

Net Present Values can get tricky very quickly…
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The good news is that IT managers are often able to quickly wrap their heads around the concept that a dollar (or a euro, or a rand, or a…) in an IT budget that they are given today is more valuable than a dollar that they are given tomorrow. However, things get a bit more trickery when we try to determine the net present value of money that we might get tomorrow…

What To Do When NPVs Get Complicated

The basic idea behind a Net Present Value (NPV) calculation is pretty simple: you want to know how much some money that you’ll be getting in the future is worth today. The future amount is always smaller than the present amount because we assume that if you got it today, you could stick it in a bank and earn interest on it until the time came when you were supposed to get the money in the first place. To come up with these numbers, you can use any one of the very good Net Present Value calculators on the Internet

If you’re dealing with just getting one lump of money in the future, then the calculations are pretty easy. However, as with so many other things in life, things are rarely this simple. Your calculations are going to have to take a number of different events into account.

When it comes to funding a complex IT project, rarely do you get all of the funding that you are asking for upfront. Instead, what the company will do is to provide you with investment funding over time. This means that when you are running the numbers to determine if this project is going to be worth it, you’ll have to account for the value of getting funding at different points in time.

Next, you’re going to have to account for the fact that your IT project is going to generate a revenue stream for the company that will be changing over time. This means in the first few years the revenue stream will probably be negative – you’ll be spending more than you are making. Over time this should change and you’ll start to make more than you are spending.

Finally, at the end of your project something will be done with it. The company may continue to use it, they may sell it off, who knows. In order to determine what the final value of the project that your dream IT team worked on was, you’ll need to come up with a final value for the project.

Even More NPV Complications

When you are calculating an NPV for an IT project you need to be careful. As you collect more and more numbers, your calculations are going to start to look very impressive.

The problem with this is that you need to keep in mind that everything that you are doing is really an estimate. That means that the cash flows that you are basing all of your calculations on are just that: estimates. There will be a great deal of uncertainty surrounding your numbers.

The ultimate result of this will be that when you present your NPV values to the rest of the company, people who don’t want to do the project will have plenty of ways to attack your numbers. Additionally, your senior management is probably going to insist that you play it safe and use the most conservative numbers when you are doing your calculations.

One way to deal with all of this uncertainty is to take the time to create multiple calculations. These can include best case, worst case, and most probable case. By doing this you’ll be ready no matter what anyone asks you during a review of your numbers.

What Does All Of This Mean For You?

Net Present Value (or NPV) is a financial tool that IT managers can use during budgeting and project planning processes to help with their discussions with company management. NPV tells an IT manager what the current value of money that they’ll receive in the future is.

The value of knowing this amount is that it can help in the decision making process. Not all NPV calculations are simple – things such as when funding becomes available can complicate how you go about determining your NPV. When planning an IT project, the use of NPV can help an IT manager make the decision as to if spending IT budget dollars on this project is the best use of limited IT funds.

NPV is a simple financial concept that the rest of the company uses every day. IT managers need to understand what NPV is and how to use it in order to be able to successfully communicate their funding needs and plans with the rest of the company.

– Dr. Jim Anderson
Blue Elephant Consulting –
Your Source For Real World IT Management Skills™

Question For You: Where do you think you should get the interest rate values that you use when calculating your project’s NPV?

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What We’ll Be Talking About Next Time

Being an IT manager is all about knowing a lot about IT stuff, right? Well, no – as an IT manager your real job is to get the most out of your IT team. In order to make this happen you are going to have to have good IT manager skills. The most important of these is to have good supervisory skills. That, of course, leads to the question: just exactly what supervisory skills does an IT manager need to have?

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