How To Do A Cost-Benefit Analysis

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Consultative Selling is the trademark of Mack Hanan. Copyright 1999 Mack Hanan. All rights reserved.

This tutorial, the third in Mack Hanan's workshop on How To Close High Margin Sales, uses Hanan's ProfitMaster software to illustrate how to calculate high-margin quotes to use in your proposals. ProfitMaster returns a Cost Benefit Analysis you can use to build compelling arguments for the return your clients will experience from their investment in the projects you propose.

To complete this exercise, you will need to download the evaluation copy of ProfitMaster from SalesToolz http://www.salestoolz.com/pmedform.html. Download and install it according to directions on the SalesToolz site. Technical questions about the software should be directed to Rich Press, (602) 998-1862, or e-mailed to rpress@salestoolz.com

Ready? Go!

Launch the ProfitMaster software and click on the New Analysis button to begin the exercise. Type in the name of your project and the site or location of the project. For this example, call the project Batch Digest Optimization and enter the site as Atlanta. Click Create Analysis to continue.

The window called Name Analysis will pop up. Note that it automatically assigns a number to your project name and tells you that you are using the Default template. As you create other analyses, they will be saved as templates and your library of templates will grow with each new analysis you create. For your first, the template is simply Default..Click OK.

The next screen shows the name of your analysis and version number at the top. From this master window, you will enter information needed to perform your analysis. Select 2 - 5 Years in the Term of Analysis box. You may use ProfitMaster to analyze the return on investment over a single year (in which results are returned over four quarters of the business year) or over a two- to five-year period (in which results are returned by year) as we will do in this example. In the Multiplier box, choose (1,000) to indicate that the numbers you enter represent units of $1000 (so an entry of $25 will represent $25,000 in the calculation).

Now you will enter data for each button on the master form. Begin with Equipment.

Equipment

This is where you enter the expenses associated with the hardware you propose purchasing. Start by entering the name of the first piece of equipment you'll use in the project. For this example, highlight Equipment 1 and type Server over it. Click Enter$. A window with the name of the equipment (Server) will pop up. In this window, you will enter the cost under Amount and the month and year when the purchase will be made. For this example, enter 15 (for a $15,000 piece of equipment) in Year 0 and Month 0. Using zeros indicates that this is an up-front cost and not one that will occur during the term of the project. (If the mainframe were scheduled for purchase at the beginning of the second year, for instance, you would enter it for Year 2, Month 1). Click OK.

Back at the Equipment screen, click Add to add the cost of a second piece of equipment or costs related to the equipment. In this example, we'll add Configuration Services. Click Enter$ and enter 25 as the amount and select Month 0 in Year 0 to indicate an up-front engineering setup fee of $25,000.

Click OK. Click on Add and add one more entry for Workstations. Click Enter$ and enter 50 to indicate an up-front cost of $50,000.(You can continue to add as many costs as required by continuing to click Add after each entry and filling in the inputs. To edit any amount, double-click on the amount listed under the year). For this example, go back to the Equipment form and click OK to complete the equipment section.

Software

Select Software and enter the names of applications you will install and their costs as you did for equipment. If, at any time, you need to change or edit an entry, simply double-click on the value. For this example, enter General Ledger software at a cost of $3,200 and Payroll software at a cost of $4,500. (Remember the multiplier? You will actually enter 3.2 and 4.5, respectively.) Once again, use Month 0 Year 0 to indicate these are up-front costs. Click OK.

Expenses

At the main form, choose Expenses. This section is for ongoing expenses across the term of the project, including training and support services other than annually recurring maintenance, and any other variable costs.You will fill in these fields as you did Equipment and Software, but here you will use the button called From This Year On to indicate recurring expenses and when they begin. For this example, assume software support will cost $1,000 per year and will begin in the second year. Erase Expenses 1 and type in Software support. Click Enter$ and type 1 in the Amount field. Enter 2 in the Yr (year) field and click From This Year On button. The software will automatically enter 1 for years 2, 3, 4, and 5 and the entries will appear on the expenses screen. As with hardware and software, here you can continue to add expense costs by clicking on the Add button. For our example, click OK.

Depreciation/Amortization

Back at the master form, click Depreciation/Amortization. In this section, you will specify what method of depreciation your client will apply to the equipment. This is often something you will not know. You can ask the client but, because depreciation is a matter that the accounting office, not the IT department, deals with, your client may not know this either. Whenever the method of depreciation is unknown, use MACRS. It uses a standard formula that should serve you well in most circumstances.

For our example, choose MACRS, a form of depreciation calculation that was popular in the 1980s. (If you choose any option other than MACRS, an input box will pop up to assist you; press F1 for help on how to add the inputs.) Next, click on Amortized Software tab and select Straight Line. When you are prompted to enter the number of years, enter 5 to indicate a five-year project and click OK to be returned to the main information form.

Leasing & Other Data

The leasing information only applies if you have selected items to be leased (See 'Leasing' in Section 3 of the ProfitMaster Help Index). Here, you may choose to use a multiplier that yields a monthly lease payment or an annual interest rate. You will also specify the lease term and a residual value if there is one. Select Leasing & Other Data.

Now enter the Incremental Hurdle Rate and Tax Rate if you know them. The Hurdle Rate is the minimum acceptable rate of return your client wants to reap on incremental investments. The tax rate, again, is something your client may or may not be willing to provide. Note: All leases are treated as operational leases. Meaning that the leasee is not credited with any of the depreciation of the leased equipment. In the Leasing box, you would enter the interest rate you're paying on the lease. For this example, we will accept the defaults. Click OK to return to the main information form.

Cost Savings And Revenue Increases

These two windows are where you'll supply data garnered from your own consultative selling techniques or from the industry data you've collected to enter the costs savings and revenue increases your client will realize from the project. (See How To Close High Margin Sales Seminars 1 and 2).

Click on Cost Savings, highlight Cost Savings 1, and type in Overtime. Click Enter$ to enter the amount saved. Enter 60 for the amount in this example and Year 2 to indicate the savings will begin in the second year and click From This Year On to indicate the savings will be repeated through the end of the project. Click OK.

Go back to the main form and select Revenue Increases. Highlight Revenue Increases 1 and type New Business. Click Enter$ and enter90 for the amount and 2 for the year and click From This Year On to indicate new revenue generated by the project will begin in the second year and continue on. Click OK. Now, click Analyze to review your results.

Analysis

ProfitMaster calculates your inputs and returns a Cost Benefit Analysis that can be used to build a convincing financial representation of the returns your client will realize from your proposals.

Other Features

After your review the analysis, you can go back and make changes to your entries by clicking Edit Data. Oher features you can use at this point include Worksheet which gives you a print out of your Cost Benefit Analysis. Graph gives you a visual representation of the cumulative investment, benefit and cash flow. What If Analysis provides you with a powerful tool. It allows you to keep the present Cost Benefit Analysis in the background as you make changes to your Analysis inputs. In that way, you can compare the results of these changes to your original and to other What If Scenarios. The Save button saves the current information under the project name and number you selected in the beginning, and the Exit button allows you to save the current data and then it exits the program.

Tomorrow's seminar: How To Interpret Your Cost-Benefit Analysis will discuss what kinds of results you should get from your analysis and how to use these results in your proposals.