Ideally, a business should have a varied portfolio of projects. Some may be risky with high returns, and some may be easier with lower returns. But how does a company choose which projects go ahead, and which ones to reject? That is the role of project selection.
This short blog will overview project selection methods, which can be broadly broken down into financial and non-financial methods.
Financial Project Selection Methods
Since most business projects are run to make money, financial methods of project evaluation are fairly commonplace:
- Payback. This method calculates the amount of time it takes to recover the projects investment cost. As an example, £100,000 invested in a project which returns £10,000 a month, will pay back in 10 months.
- Return On Investment. This method looks at the percentage value of incomes divided by the initial investment. There are in fact many different methods and definitions of ROI. One method takes the average annual profits, and divides by the initial investment, and then multiplies by 100%. As an example, a project with average annual profits of £20,000 and an £80,000 would have an ROI of 25%.
- Net Present Value (NPV). This method takes into account the ‘time-value’ of money. This is critical if inflation is high, or money is being borrowed over a set period, or the amounts are large. In these situations, money in the future is worth less than at today’s value. Profits in future years are therefore discounted to a ‘Present Value’ and the total value (or Net Value) is the sum of these less the investment value. Different discount rates can be used.
- Internal Rate of Return (IRR). This method is similar to the NPV method in that it discounts future money. However instead of using a discount rate to calculate the NPV, the Internal rate of return is the discount rate at which the net present value of all the cash from the project equal zero.
Very often a business will use one of these methods, and state the values that are required for success. However these four different methods can favour different projects. The Payback method is very short term (and ignores incomes after payback is reached). The Payback and ROI method both ignore the ‘Time-Value’ of money, which is important on longer projects. I now have a set of blogs on Financial Approval Methods.
Non-Financial Project Selection Methods
For some projects, a financial return is not the direct benefit (but often the ultimate goal). For instance, a new computer installation may be run as a project to speed up some internal processes, without any direct measurable financial benefit. It isn’t possible to perform a payback or ROI calculation on these projects. Therefore, some non-financial project selection methods may be required:
- Scoring Matrix. This method will identify key benefits for a project (such a market share, processing time, or development time) and places an importance weighting on that criteria. Competing projects are then scored against each criteria, with the weighting taken into consideration to identify the highest-scoring project.
- Risk-Return Matrix. This method will evaluate projects into low/high ‘Risk’ against low/high ‘Rewards’. Ideally low risk projects with high rewards are favoured, although a business may choose to undertake easier low value, low risk projects to create a balanced portfolio of projects.
- Benefit Mapping: A benefits map will help link the deliverables of a project to the organisations goals by identifying the benefits attained. For instance, a new computer system as a project deliverable, may create three benefits of; Reduced process times, Improved levels of service, and Fewer mistakes. These will all help the organisation increase customer satisfaction. It is important to add in all of the benefits (and dis-benefits) to such as map, which can then be subjected to a scoring system to identify where the greatest benefits of the project are.
Many projects in social care, charity, or health care may have benefits that cannot be financially measured, however decisions need to be made on which ones to progress. Benefits mapping can help identify where the important benefits of each project really are.
Using a common process for project selection makes it easy to compare projects against each other. This will make the decisions about which projects to undertake easier to make.
Regardless of the method used to justify a project, the management will at some point have to make a go/no-go decision, and select some projects for progression, and some for termination or postponement. These decisions need to be clearly communicated to (and accepted by) the employees, such that everybody understands why they are working on the projects that have been approved.
Financial methods may provide a ‘hard-number’ with which to compare projects against each other, but usually provide a single figure or value for comparison. Non-financial project selection methods such as benefits mapping, may reveal the details of the real project benefits (and their importance) , and take a more holistic view of each project when making important selection decisions.