Abstract
For an organization looking forward to growth and development in the business world as well as assurance of improved quality on service, investment becomes the best option to resort to. The question therefore arises on what should be invested in and whether such investment would be of any utility or detriment to the organization. Further, it also remains uncertain how such uncertainties such as the probative value a future investment would be addressed and by whom. The grotesque nature of the success of an investment therefore can be clarified by predicting the probability of success of the same. Return on investment is therefore the most preferable method of assessment of the gain accrued from a specific investment in relation to the costs incurred in setting up the same. By adopting the return on investment strategy, an organization is therefore able to clear the uncertainties that it is confronted with while trying to find an ideal plan regarding investment for its growth and expansion.
Outline
The research paper shall therefore assume the following layout. First, there shall be an introduction to the concept of Return on Investment, illustrating what the concept entails, tracing its history and emergence and briefly outlining the potential utility it bears for organizations in terms of growth and development. Further, there shall be an in-depth examination of the areas in which the Return on Investment concept is effectively applicable and how it is applied. The third limb shall involve the calculation, analysis and evaluation of risks attributed to implementation of capital investment acquisition, where rubber meets the road in terms of Return on investment. In the fourth limb, there shall be an assessment of the Post Implementation Audit, a process integral to the Return on Investments concept, breaking down the procedure the audit undertakes and its utility to Return on Investment. Finally, there shall be an elaborate illustration of the Post Implementation Review, the procedure involved and its importance to the Return on Investment concept.
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Introduction to Return on Investment
Being a development of F. Donaldson Brown, Return on Investment (ROI) is a concept that measures the benefit derived from a specific investment in relation to the cost incurred in setting up the investment in an organization (Thomas & Kaplan, 1987). The concept comes in two forms of calculations for Return on Assets and Return on Equity, both aimed at calculating and evaluating the effects of an investment but on different platforms. The main objective behind the concept is to enable an organization to pinpoint potential investment opportunities that manifest high returns in relation to the amount invested, as well as taking to account unforeseen risks that the organization may encounter in the course of its investment adventure.
The kinds of investment an organization considers while implementing the ROI include capital investment or upgrading facility equipment. The concept is mostly effective when an organization is able to account for its costs, returns and cash flow calculations among other fiscal requirements. Despite the benefits, the concept come in this mode of prediction has been criticized for lack of consistency. This is because the calculations vary depending on the user. Moreover, its failure to consider the time factor in the calculation has caused the concept to be related to predicting profitability or an investment rather than accuracy and efficiency as unforeseen events and risks still remain unaccounted for (Thomas & Kaplan, 1987).
Application of Return on Investment Concept
The ROI concept has been linked to effective application in various organizations for different purposes, for either soft returns or pecuniary returns. Three instances of its application shall be taken into consideration. First, ROI reflects an effective application in healthcare organizations in terms of investment in Electric Medical Records (EMR). Through ROI it is established that EMRs or installation of other IT equipment in healthcare organizations to monitor patient records, has increased revenue and specifically soft returns. For instance, the EMRs improve the quality of care by reducing patient wait time as well as diagnosis since information is easily obtained and progress is effectively monitored (Sidorov, 2006).
In another instance, ROI can be applied in terms of capital acquisition in business. Here, besides looking at the pecuniary benefits that come with such investment, business owners and organizations consider capital investment as a means of improving productivity and establishing the bedrock for internal control in the organization or business. In terms of productivity, capital investments have been linked to customer satisfaction and mitigating the strenuous working environment for employees.
Finally, a suitable area of application would be in Project Management Office (PMO) to enable provision of guidance in standardized and validated tools and techniques pursuant to mitigating possible problems through various project methods. PMO therefore establishes mechanism for project control allowing integration, planning and control for all projects.
Capital Investment Acquisition, Calculation, Analysis and Evaluation of Risks
With a view to determining how constructive the ROI process is, a case for instance is going to be put in the limelight. From the premise that businesses value investment in capital acquisition, an evaluation of the capital expenditure needs for an organization within a period of 5 years shall be considered. This shall be approached by calculating the present value of annual costs, present value of annual benefits, the present value of net benefit, before establishing the profitability index for each year.
Calculation
Taking the discount rate to be 6%, using the formula:
where i is the number of years
The Present Value of Annual Costs shall be;
Year 1: $13,490, Year 2: $2,759, Year 3: $8,144, Year 4: $2,455, Year 5: $2,317
Total: $42,300
The Present Value of Annual Benefits with the new discount rate would be:
Year 1: $5,377, Year 2: $21,627, Year 3: $20,403, Year 4: $39,842, Year 5: $37,587
Total: $124,800
The Present Value of Net Benefit from the above results would be:
Year 0: ($13,100), Year 1: ($8,113), Year 2: $18,868, Year 3: $12,259, Year 4: $37,387, Year 5: $35,270
Total: $82,600
The Profitability Index for Each Year using the formula would be:
Year 1: 0, Year 2: 0.82, Year 3: 1.76, Year 4: 3.67, Year 5: 7.30,
Analysis
A tabulated outline of the calculations and results would reflect as follows:
|
Initial |
Year 1 |
Year 2 |
Year 3 |
Year 4 |
Year 5 |
Total |
|
|
PV of annual costs |
$13,100 |
$13,490 |
$2,759 |
$8,144 |
$2,455 |
$2,317 |
$42,200 |
|
PV of annual benefits |
$5,377 |
$21,627 |
$20,403 |
$39,842 |
$37,587 |
$124,800 |
|
|
PV of net benefit (cost) |
($13,100) |
($8,113) |
$18,868 |
$12,259 |
$37,387 |
$35,270 |
$82,600 |
|
Profitability Index |
0 |
0.82 |
1.76 |
3.67 |
7.30 |
It is clear from the above data that the profitability of the project gains a positive growth after Year 3 and accelerates henceforth. It therefore means that the capital expenditures would start realizing full compensation after three years of investment and more years of patience would be inevitably endured to realize significant returns.
Risks
It is quite clear that only figurative financial predictions can be predicted through the formula. However, such risks as the quality of services, the probability of malfunction of equipment, competition from other organizations, accuracy of market data analysis and new industry regulations cannot be accounted for (Ewert & Wagenhofer, 2012). Such risks should therefore be identified and assessed with a view to averting them.
Post Implementation Audit
After putting to assessment the feasibility of getting into an investment, the Post Implementation Audit enables the organization to be able to assess what went wrong, thereby establishing the causes of the project deviating from the expected value. The process provides an overview of the tangible evidence based on performance of the project, while identifying the factors that may diminish its ROI. The process starts by identification of a team to perform the audit, then carrying out an audit review while involving the project implementation team, audit professionals and internal audit and finance departments (Ewert & Wagenhofer, 2012). The audit runs parallel to the implementation project, before which a review is conducted, comparing results of the audit and the actual project.
Post Implementation Review
This is a review involving the evaluation of the hard and soft benefits accruing from the investment integral to the ROI concept. The review is conducted procedurally, first by planning for the review, preparing for the review, conducting the actual review before a review follow process. The review bears the information on the faults that were experienced during implementation and a determination of how such faults would be fixed to avoid future problems.
References
Ewert, R., & Wagenhofer, A. (2012). Using Academic Research for the Post ‐ Implementation Review of Accounting Standards: A Note. Abacus, 48(2) , 278-291.
Sidorov, J. (2006). It ain’t necessarily so: the electronic health record and the unlikely prospect of reducing health care costs. Health Affairs, 25(4) , 1079-1085.
Thomas, J. H., & Kaplan, R. S. (1987). Relevance lost: the rise and fall of management accounting. Cambridge, MA: Harvard Business School Press.
