It happens many times in life that you have many choices when selecting the best option. For example, you may have the option to select which movie you want to see or where you should go for your next vacation.
You may make the decision just randomly, or based upon your experience or suggestions from your family members or friends in your life.
However, in professional life when you have been given options to make a selection, you go by a set of rules because here, the stakes are high and you can’t afford to make a wrong decision.
Suppose your organization has the opportunity to work on multiple projects, but cannot undertake all of them at once due to resource constraints. Therefore, your organization has to decide to select a project that is less risky and could provide them with maximum profit and recognition.
At the end of the day, the basic principles and ultimate goals are often similar … to provide your organization with the maximum profit and recognition.
Every organization has a defined process that helps them to choose the right project aligned with its strategic objectives.
Generally, this process is performed by upper management such as a Steering Committee, Project Management Office (PMO), Project Selection Committee, etc.
They will evaluate many areas while evaluating the project, such as:
- Whether they are capable of doing it or not;
- If they have all the resources required to complete the project; and
- If it will help them achieve their objective (recognition and maximum profit).
There are various methods which help when choosing which project(s) to pursue. A common method – especially for small to medium-sized businesses – is the benefits measurement method.
Benefit Measurement Methods
This technique is widely used in the selection of projects, which is based on the present value of estimated cash inflow and outflow. Here, you calculate the cost and benefits and then compare them with other projects to make a decision.
We have to understand one crucial concept before we move to benefit measurement techniques: Discounted Cash Flows.
Discounted Cash Flow
We all know that the worth of money received today is more than the money received in the future. For example, the value $10,000 CDN after ten years will not be the same as today; its worth will be far lower than the current value of $10,000 CDN.
Therefore, we have to consider the concept of discounted cash flow while calculating the cost invested and return on investment.
Now, let us get back to benefits measurement methods.
The following is a list of techniques used in benefit measurement methods:
- Benefit/Cost Ratio
- Economic Model (Economic Value Added)
- Scoring Model
- Payback Period
- Net Present Value
- Discounted Cash Flow
- Internal Rate of Return
- Opportunity Cost
Benefit/Cost Ratio
This technique is also known as the Cost or Benefit Ratio.
As the name implies, it is the ratio between the present value of inflow (cost invested in the project) and the present value of outflow (value of return from the project). If the budget is not a constraint, the project with a higher Benefit-Cost Ratio (BCR) will be selected.
Economic Value Added
Economic Value Added (EVA) is a performance metric that calculates the worth creation for the organization and defines the return on capital (ROC). It is the net profit after deducting all taxes and capital expenditure.
The project with the higher Economic Value Added (EVA) will be selected if you have many projects. Please note that EVA is expressed in dollar value, not a percentage.
Scoring Model
This is more like an objective technique. Here, the project selection committee will list a few relevant criteria, weigh them according to their priorities and importance, and then will add all these weighted values.
The project with the highest score will be selected once you complete scoring the projects.
Payback Period
This is the ratio of total cash out with an average per period cash in. In other words, it is the time required to recover the cost invested in the project.
The project with the minimum payback period will be selected if other parameters are the same.
Net Present Value (NPV)
This is the difference between the current value of cash inflow and the current value of cash outflow of the project. Net Present Value (NPV) should always be positive, and the project with the highest NPV will be the better option.
Internal Rate of Return (IRR)
This is the interest rate at which the Net Present Value becomes zero. In other words, you can say that it is the rate at which the present value of the outflow is equal to the present value of inflows.
You will select the project with the highest IRR if you have many projects to choose from.
Opportunity Cost
This is the cost that we are giving up by choosing some other project. You will choose the project with the lesser opportunity cost if you have many projects.
These are the few benefits measurement techniques used in the selection of projects. In general, for most organizations benefits measurement methods are enough to lead them to a decision.
Summary
Project selection techniques help you to select a project which could provide you with a better return on investment and recognition. There are various methods to select a project; however, if the project is small and not very complex, you will go for the benefits measurement model.
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