Training should show a return on investmentby
In this two-part feature, Stephen Walker lifts the lid on Return on Investment (ROI) and its place in justifying spending on training. In this part he focuses on finance.
Complications arise when calculating returns and often the cash returns are not forthcoming, turning the investment into simple spending. An understanding of the management accounting function and ROI calculations will make sure you and your clients are talking the same language. After all, we just want to make things better don’t we?
Businesses, corporations, exist to make a profit, to increase the wealth of the owners. It is that simple. There are other goals along the way, of course, but the end point is to make money for the shareholders. The executive team is tasked with managing the business to achieve an increase of wealth over time. Unfortunately government likes to talk about its spending as 'investment'. It uses unproved outcomes of its spending as a payback to justify the investment. Certainly it is the job of government to keep us safe, build infrastructure and do good things. But investment it isn’t. Investment requires a return on that investment.
Return on Investment (ROI)
If you lend a financial institution your money you expect to get back more than you lent them. That increase, the interest, is your ROI. We are all aware that some financial institutions are riskier than others. If the ROI is higher then so is the risk, if the market is working properly. This risk/reward profile is the basis of much financial enterprise. They use their model of risk to squeeze higher interest from your cash than you will. As we all know, sometimes, they get it badly wrong.
There is another element to ROI and that is the effect of time. One pound sterling today is worth less than one pound next year due to the interest you can earn in that year. With interest rates so low at present we forget what justifying investment in the 70s was like with interest and inflation rates at 20% and more.
When justifying investment you will often see Net Present Value (NPV) or Constant £ used. As a pound today is not worth the same as a pound tomorrow the costs and returns on the investment are re-based as the value of a pound today or whenever. This is important when investment horizons stretch over decades or in times of high inflation.
Sometimes inflation exceeds ROI (as today with financial deposits) in which case a pound today is worth more than a pound tomorrow. As a comparison £100 in 1980 has the buying power of £364 in 2014. So for every £1 you loaned someone in 1980, you would need £3.64 just to keep purchasing parity without any ROI.
When justifying investments the cashflow may be a consideration: when do the returns on the investment appear compared to the payment for the investment. Large investments over many years produce complex options to improve the effective ROI in this way.
There is also the consideration of the business’s financial reporting period. If you invest money in this financial year for profit in the next, this will reduce cash generation this year. Published company accounts are full of 'adjustments' to smooth out this effect, so beware. This is why training budgets are so important to us – when the money is spent this year it is futile to keep negotiating, unless you can deliver now and accept payment later.
Part two will be published later this week.
Stephen is a co-founder of Motivation Matters, set up in 2004 to develop organisation behaviour to drive greater performance. He has worked for notable organisations such as Corning, De La Rue and Buhler and has been hired to help Philips, Lloyds TSB and a raft of others. A published author of articles and Conference speaker, Stephen delivers workshops across the country. It is all about 'making people more effective by appropriate managerial behaviour' he says. You can follow Stephen on LinkedIn, Twitter, YouTube and Blog