Every day, situations arise at companies when we have to make decisions on smaller or bigger investments, or have to work on such decisions. The general problem is that the personal bias or convictions of the person making the decision or the owner are too influential in the investment decision. Investment calculations are not usually simple, they require effort, and so they are frequently omitted and the decisions are made without them.
Quick evaluation of investments – can this be done professionally?
Yes, it can, but we have to clarify some principles and find appropriate practical solutions. Then we have to keep to the set path.
- investment calculations should be the starting point of any investment decision
- select the appropriate calculation method for each investment category
- make more thorough and quicker decisions with the new method
There are two main groups in terms of the methods applied for investment calculations: static and dynamic methods. With the static methods, we can focus on costs (cost comparison is important here), profits, profitability and depreciation. With the dynamic methods, the value of capital, annuity calculations and possibly the internal rate of return can be important.
In this case, we compare the costs of two or more processes or projects. Generally speaking we have a process, and we already know what kind of result it will produce; then we choose an alternative process for it, which at the very least has to reach the same result in terms of output, and ideally at a lower cost.
The disadvantage of the cost comparison is that it does not take the project’s capital investment requirements and potential yields into account, we can only define the annual costs once, so they remain unchanged. Additionally, we cannot record the changes in value occurring during the project, so we have to work with averages.
One great advantage though is that this is one of the simplest calculation methods. Determining costs is still the simplest task, and defining the value of future benefits does not complicate our lives either.
When is it worth applying the cost comparison method?
- for initial investments, when we know what the required performance is and we can achieve it with several alternatives
- for supplementary investments, when we want to achieve a specific increase in turnover, and we can choose from several investments
- for replacement or rationalising investments, when we replace some of our manufacturing capacity, so only costs can be compared
When is the cost comparison method not enough?
If the investment focuses on two assets with very similar performances (in terms of both technical parameters and the initial acquisition value), then the annual costs due in the following period have to be taken into account during the investment.
If we see there is a difference in performance between the investment options, we have to switch to defining item costs.
However, this latter alternative is only useful as long as the investment with the greater utilisation level enables a lower item cost with unchanged quality. If the quality changes in the meantime, the performance will also change, and then we have to examine the results too, so the profit comparison method will be the right option instead of cost comparison.