Conducting a Cost Benefit Analysis for an Enterprise Incident Management System Part Two: Quantitative Elements of a Cost Benefit Analysis for an EMIS Implementation Bruce McMahon, MBA, PMP Knowledge Management Innovations, Ltd 3/01/2011 Second in a three part series, this paper breaks down the accounting principles and techniques behind a formal Cost Benefits Analysis and helps the reader to apply them to a funding request. The calculation of Net Present Value of the required capital, Cost Benefit Ratio and Payback Period are outlined and utilized to develop an objective business case for implementing and effective EHS Management Information System (EMIS).
Introduction While the value of a structured environment, health and safety (EHS) and sustainability program is widely understood, the purchase of an enterprise-wide software solution to help manage EHS is often seen by upper management as a pure support function expense. Even though most EHS professionals recognize the benefit of a corporate-wide centralized system for managing EHS programs, the financial arm of the organization may be reluctant to fund implementation projects, when the value is not identified in the language of dollars and cents. The onus is on the EHS lead to demonstrate that the cost is actually an investment and that this investment will generate a return which is an acceptable use of the company s limited capital. An integral part of the business case is the cost benefit analysis. This article focuses on the financial calculation components of a cost benefit analysis that is to be included as part of a standard business case for requesting funds to implement an enterprise-wide EMIS. Cost benefit analysis is one of the most widely used techniques for project selection purposes within organizations. In creating a strong cost benefit analysis document; focus will need to be paid on the identification of costs and benefits using reasonable estimates and quantitative data from Net Present Value (NPV) calculations, cost benefit ratios, and payback period identification. Comparison of Alternatives When presented with an idea for a project, most decision makers would like to know what alternatives are available. For this reason, most cost benefit analysis will often represent a comparison of alternative projects. In the case an EMIS implementation, comparisons will often be between implementing a new software solution and doing nothing. Costs and Benefits should be identified for all scenarios. Quantitative vs. Qualitative Data In order for the business case to have the best chance of securing the desired funds, a significant portion of the proposal should focus on the quantitative aspects of proposed projects, as opposed to the qualitative characteristics. Quantitative analysis focuses on measurable numeric data while qualitative analysis is based on observed characteristics that are difficult to measure. An example of qualitative data associated with a software implementation would be the cost of savings realized, while an example qualitative data could be improved employee morale. Cost Identification The first step in preparing the cost benefit analysis is to identify all of the costs to the organization that will be associated with selection of a specific project. Cost should be classified into two categories; recurring costs and non-recurring costs. Non-recurring costs are one time expenditures associated with the purchase and implementation of the software solution. Non-recurring costs are incurred over the life of the solution as a result of maintaining the chosen EMIS software solution. The table below outlines common recurring and non-recurring costs associated with the implementation of an enterprise wide EMIS solution.
Recurring Costs Software maintenance fees (License model) Software subscription fees (SaaS) Ongoing training Non-Recurring Costs Software license fees (License model) Implementation costs Project management salaries System testing List and Quantification of Benefits After defining the initial and ongoing costs for the implementation, benefits must be listed and quantified. Benefits can be classified as qualitative or quantitative. For the purpose of including benefits in financial calculations, the assumptions of value should be included. For an EMIS most of the quantitative benefits come from cost savings realized. Cost savings are typically realized through the streamlining of processes, and reduction of potential fines for non-compliance. Below is an example list of cost savings. Cost Saving Time Savings/Reduction of Labor Expenses Projected Savings Management from actively managing sustainability initiatives Reduction of Injury Incidents Example Value $25000 based on 2 employees reduced report generation time of 10 hrs per week. $0, $15000, $16000, $22000. Year-over-year reduction in energy and water usage. $50000 per injury reduced per year Net Present Value As discussed in the previous paper, Net Present Value calculations are extremely valuable tools for quantitative assessment and are often used in calculating additional financial metrics. Present value for a period is calculated by taking cash flow for the period divided by 1 plus the discounted rate of return for the period. The net present value is the sum of the present values for each period. For more information on present value calculation please refer to Cost Justification Strategies for an EMIS Implementation, Part One: Using the Net Present Value as Part of a Business Case. Cost Benefit Ratio The cost benefit ration is a calculated comparison of the costs and benefits of the investment potential of a given project. This ratio is calculated by dividing the present value of costs by the present value of benefits associated with the given project (CBR = PVC/PVB). Cost Benefit Ratio Calculation Description {CBR=PVC/PVB} Variable Cost Benefit Ratio, CBR Present Value of Costs, PVC Present Value of Benefits, PVB Description A numeric representation of the value of a project or investment. The system costs discounted to the present value. The estimated value of benefits discounted to the present value.
The simple calculation based on the present value of the costs and benefits identified will help decision makers with the go no go decision. While organizations may establish guidelines for acceptable cost benefit ratios, generally speaking a ratio of greater than one indicates a good investment. Payback Period Perhaps one of the most important deciding factors for financial decision makers is the overall payback period for the software implementation. Calculating the payback period involves the summing of the initial implementation costs and the over all operating costs of the implementation compared to the estimated value of the benefits derived over the life of the project. A simple equation to determine the payback period would be the total; cash outflows for the implementation project divided by the cash inflows represented by potential savings. Payback Period Calculation {PBP=TC/ACI} Variable Payback Period, PBP Total Project Cost, TC Estimated Annual Cash Inflows, ACI Description This is the length of time to recover the cost of the project investment. Overall cost of implementation, and the present value of the annual fees. These are the quantified financial benefits for the period. The payback period can also be represented in a balance sheet style table directly comparing the costs and benefits over time. Conclusion Making the business case for an enterprise-wide environmental EMIS requires the ability to present quantitative data in a format that helps financial decision makers, shareholders, and managers understand the value in the system to be implemented. While displaying the qualitative benefits of the system is important, more support for a project will be gained by displaying positive quantitative data. Including net present value calculations, cost benefit ratios and payback period as presented in this paper as part of a cost benefit analysis will make a strong case for securing the funds needed to expand the organization s EHS and sustainability program.
Additional Papers in this Series KMI is publishing a total of three papers in the Cost Justification Strategies for an EMIS Implementation series. Topics of the other two papers include Cost Benefits Analysis and Assembling and Presenting Your Business Case. Check back with your original source of this paper or visit www.kminnovations.com to download copies as they are published. About the Author Since 2007 Bruce McMahon has used his extensive background in enterprise systems implementation and international business management to provide project management, consulting, and training services to clients implementing KMI EHS software. Prior to joining KMI, Bruce spent several years in the finance industry as a business analyst and project manager, consulting for the development and integration of accounting financial systems. Along with his real world experience Bruce holds a Masters of Business Administration (MBA) in Finance and Project Management, and is a holder of the Project Management Professional (PMP) designation. Bruce can be contacted directly at bmcmahon@kminnovations.com or (416) 410-4817. About KMI KMI is becoming the industry standard in flexible, scalable, and usable web-based software solutions that help companies operate more sustainably, safely, and efficiently. KMI enables companies to reduce injuries, increase the effectiveness of regulatory compliance initiatives, manage Greenhouse Gas reporting, and initiate or improve corporate sustainability programs. KMI is a trusted supplier of EHS Management Information Systems (EMIS) to global manufacturing, energy, mining, biotech, service and transportation companies ranging in size from a few hundred to hundreds of thousands of employees. For more information please visit www.kminnovations.com or call (866) 919-7922.