How to Calculate ROI for IT Projects

How to Calculate ROI for IT Projects

Calculating ROI for IT projects helps measure opportunity cost and evaluate performance.

Many businesses face a familiar problem when it comes to making decisions about IT projects: they know these projects are important and will help them stay competitive in the long run, but they can also be expensive, and when not managed well, the costs can exceed their value.

Understanding how much an investment might cost, or how much revenue it might generate, or whether an ongoing initiative is viable, is therefore crucial to healthy business operations. When calculating the return on investment for a project, the most important factors to consider are:

  • What will your investment cost? There are a number of costs to factor into your calculations, including labor, time, equipment, and rent.
  • What will your investment achieve? Some projects are intended to reduce operating costs, while others increase sales, and still others mitigate risk.
  • How long will it take for your investment to break even? The longer it takes for your investment to pay off, the more carefully you should consider your decision.

With these questions in mind, the calculation for ROI can be described as:

ROI % = (Gains − Cost) ÷ Cost × 100

So, if you are looking at an investment that will cost you 80K, and you expect that investment to save you 50K a year, and you expect the upgrade to last five years. This puts your gains over the five-year period at 250K. Running the math we get:

(250 – 80) ÷ 80 × 100 = 212.5%

What other factors should you consider?

This is a comfortingly simple equation for a complex problem, so it should come as no surprise that there’s more to the story than the math.

Having the return on your investment be worth over 200% of its initial cost sounds great, but it might take several years to see the full potential unfold. Your investment won’t be profitable in the first year, and doesn’t break even until midway through the second. That may still be acceptable to you, but it’s an important variable to factor into your calculations.

Furthermore, while calculating past ROI is valuable for understanding the success of a past or ongoing project where the variables are mostly known, projecting ROI for future projects can be complicated by the vast array of variables at play. Here are just a few to keep in mind.

What is the scope of your project?

How many team members are involved? Will you be bringing in outside contractors or freelancers to help complete the project? What is their rate, and how long do you expect to need their services? And what about infrastructure cost: will you be purchasing equipment, renting space, or investing in R&D?

The more complex a project becomes, the more carefully businesses should factor in known costs. And, just like many projects, they should be aware of ways in which the project could run past its budget. As much as possible, avoid optimistic budgeting, and plan in a buffer for possible error.

Are benefits tangible or intangible?

It may be stating the obvious, but the more you can avoid estimates and stick to objective numbers the more accurate your ROI projections will be. One way to stay objective is to separate tangible from intangible benefits.

For instance, a tangible benefit may be something like “improved task completion time by 30%,” or “increased production by 1000 units per day.” These benefits are specific and measurable, and you should be able to attach a dollar amount to them.

Other benefits are less tangible, but that doesn’t mean they aren’t worth your investment. These “soft” benefits might include “improved customer satisfaction,” or “better analytics reporting.” It’s unquestionable that each of these benefits has some financial merit for the company, but it would be very difficult to put a finger on exactly how much.

The more guesswork enters into your equation, the more carefully you should proceed with your project. That said, you shouldn’t allow yourself to be lulled into a false sense of security by “hard” benefits—a miscalculation or hidden variable might show those numbers to be more bendable than you realized.

Are you reducing costs, increasing revenues, or mitigating risk?

Exactly how you measure the gains from your investment depends on what your project is intended to achieve. In many ways, reducing costs or increasing revenues are two sides of the same coin.

By way of example, let’s say you cut down on the time it takes an employee to complete a task, thereby improving productivity by 20% to the value of 40K a year. Do you measure that increased productivity as added revenue, or as reducing the cost of wasted time?

For the most part, it doesn’t matter, but remembering both sides of the coin can help you identify some of the various benefits an initiative brings the company.

Risk mitigation is a different matter. In many ways, you can only calculate the true cost of a risk if it comes to pass. When risk mitigation works, you may never realize its full value.

However, one way of calculating the value of a risk mitigation strategy is to measure the potential damage that might occur without the IT solution in place. If an internet failure leads to the loss of several hours’ worth of business, you should be able to calculate the potential lost revenue and use that to measure the gains of putting the mitigation strategy in place.

What opportunities are you passing up by moving forward with this project?

The final piece of the ROI puzzle comes in measuring the various possible projects against each other. What if you have one project that can increase sales by 10%, but pursuing it would mean abandoning a project that decreases the cost of energy consumption in your office by 15%. Which do you choose?

At face value, it feels like comparing apples to oranges. But by calculating your anticipated ROI, you can compare the two projects on even footing and make the best choice for your business.

Wondering how to understand the possible benefits of an IT project for your business? Contact us today and tell us about your situation. We offer a free consultation and assessment to help you make the best decision for your business.