When It Pays to Think Like a Finance Manager, having Net Present Value – NPV in mind
If you want approval for a new project — purchasing new equipment or computer systems, applying for a patent, building a new store — chances are you need your company’s finance department on board. To get the green light, it helps to understand how finance people think.
Most finance managers in both large and small businesses encounter numerous proposals for capital investments and many of the people proposing these investments don’t have a clear picture of what the return will be. They’re essentially asking the company to take the cash it has generated through its business operations and spend it on something with an uncertain future return.
But finance people like me are skeptical even when the proposals do project a return. Here’s why.
Everyone always wants new equipment — new computers or other hot technologies. Do you think they’re going to do a net present value (NPV) analysis that shows they don’t need that computer? Of course not. They figure out how much the new computer system and software will cost and they compare that with the cash flow generated through efficiencies (assuming they know how to analyze returns based on cash flow). If the numbers show a negative NPV, meaning that the proposed investment isn’t justified, they change the assumptions until the NPV turns up positive.