Investment appraisal techniques
Investment is a key part of building your business. New assets such as machinery can boost productivity, cut costs and give you a competitive edge. Investments in product development, research and development, expertise and new markets can open up exciting growth opportunities. At the same time, you need to avoid overstretching limited financial resources or restricting your ability to pursue other options. Deciding where to focus your investment is an essential part of making the most of your potential. Even a project that is not designed to generate a profit should be subjected to investment appraisal to identify the best way to achieve its aims. Financial aspects of investment appraisal
Different appraisal techniques let you assess the effects an investment will have on your cash flow. You can compare the expected return to the cost of funding and to the returns offered by other potential investments. Your assessment should consider all the financial consequences of an investment. For example, buying more expensive machinery might be worthwhile if it is more efficient and uses cheaper supplies. As well as the financial impact, your calculations should also consider any indirect effects. Identifying these soft benefits is often as important as the financial evaluation and may help your decision-making. Soft benefits could be:
Greater flexibility and quality of production
Faster time-to-market resulting in a bigger market share
Improved company image, better staff morale and job satisfaction, leading to greater productivity
Quicker decisions due to better availability of information.
It is also important to evaluate these benefits. For example, a manufacturer of machine parts could take a general benefit such as quality and break it down with estimated savings:
Reduced reworking means less disruption to the production process, less manufacturing down-time and fewer design changes, resulting in an overall saving.
The current warranty and service costs per annum are likely to be halved.
Quality assurance staff will be reduced by one as needs for inspections are lower.
Better quality products will increase sales and will also improve the company's current position of fourth among its competitors. It is also important to evaluate the benefits of the investment in financial terms wherever possible.
You should ignore any sunk costs (i.e. costs that have already been incurred and cannot be recovered or would be spent regardless of whether the investment goes ahead), as these are not parts of the specific investment.
Before committing to any investment, it is essential to ensure any financing you need is available. You should also consider the potential risks of any investment
Although profitability and cash flow are important, you should take into account how an investment fits with your existing business. There may also be other, non-financial reasons for making an investment. For example, you may need to update your equipment to improve health and safety or to meet modern standards or new legislation. Strategic issues for investment appraisal
Effective investment appraisal does not consider an investment in isolation. Instead, you should consider how the investment could contribute to your overall strategic objectives. Some investments can offer strategic benefits for your business. For example, you might invest in extending your product range so that you can supply more of the products that your key customers want. An investment like this could help strengthen your brand and your relationship with your customers. Often one of the key benefits of making an investment can be the skills your business learns and the future opportunities that may arise. For example, you might invest in...
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