Learning how to calculate the return on investment (ROI) for your information technology (IT) systems projects is a financial skill that helps you prove the business case for your idea.
Modeling the ROI on IT investments benefits multiple levels of employees, from entry-level employees to managers and executives. Employees can use ROI projections to justify a project they’re interested in pursuing, while an executive can use these calculations to sort through potential projects.
Choosing to pursue one IT project over another can alter the course of your business–you want to ensure you have all the necessary data to make that decision. Calculating the ROI can help.
- An ROI calculation allows executives to evaluate the effectiveness of a new IT system or investment. When done correctly, you can use ROI to measure returns and evaluate employee performance.
- The ROI projection justifies your project’s cost to the financial team. Helping the business team evaluate the costs and benefits of the project builds buy-in.
- You may perform both an anticipated and actual ROI calculation. The anticipated ROI uses estimated costs and revenues to project potential returns, while the actual ROI uses final costs and revenues after a project’s completion.
Calculating ROI on IT Projects
You can express return on investment as either anticipated or actual. Each serves a different function. Anticipated ROI helps you determine whether a project is worth pursuing, while actual ROI compares whether the completed project is aligned with expectations.
To calculate the ROI of an IT project, you can use this basic formula:
Source: Magora Systems
When calculating anticipated ROI, playing with the numbers and running several scenarios is beneficial. Using multiple factors allows you to account for unexpected costs that emerge during development.
With this range of potential outcomes, you can evaluate a project’s risk to see if it’s truly worth it. The higher the ROI, the more justifiable your project is.
For example, say you have an ROI of 200% over an implementation period of three years. This value means that you’ll double your project investment over that period.
If the ROI is minuscule—or even negative—then the business justification for the project isn’t there. When considering implementing multiple IT projects or modernizing an old infrastructure, it’s worthwhile to determine the ROI for each project and begin with the most profitable.
Categories of IT projects where the ROI formula is beneficial to include:
- Replacing outdated hardware, such as computer monitors or other consumables
- Projects required for regulatory or compliance costs
- Projects with intangible benefits, such as increasing consumer goodwill
- Short-term maintenance projects
Calculating ROI: Benefits and Challenges
When calculating an IT project’s ROI, you may derive the net profits from one of several categories:
- Cost reduction or avoidance: An IT project may reduce work travel (i.e., virtual meetings or remote tech support), increase employee productivity and decrease technology maintenance costs.
- Capital reduction or avoidance: Similarly, an IT project may lower costs for systems such as data servers or cloud storage and entirely prevent the need for new data centers.
- Increase revenue: A project that creates a new service or enhances an existing one enables your business to upsell clients on your new capability.
- Non-financial benefits: IT projects also provide intangible benefits such as improved customer and user satisfaction, improved business processes, better forecasting capabilities and improved data input.
Determining an IT project’s ROI also has a few pitfalls to avoid. For example, it’s impossible to estimate a project’s costs and benefits with a high degree of accuracy in every circumstance. This is why it’s imperative to forecast the ROI in several data-based scenarios.
Similarly, a project’s expected benefits may result from a combination of planned IT improvements. Be careful to avoid this kind of double counting.
To avoid these pitfalls, your ROI calculations should include the following parameters:
- Consistency: The assumptions you use in your ROI calculations should be the same for each type of IT project. For example, inflation and tax rates should remain stable (except for the rare circumstances when inflation rises).
- Timeframe: Most IT hardware systems and other technology become obsolete after three years, while software projects usually last five years.
- Precision: The dollar figures used in your calculation should be accurate, but there should be wiggle room. An overly precise estimate could hurt your credibility if the project has a lower ROI, for instance.
The 3 Steps To Determine ROI
The ROI formula requires determining costs and profits, then comparing a project’s ROI in different scenarios.
1. Determine Costs
The cost of a project includes not only the upfront investment but also implementation costs (e.g., project management, software, training, etc.) and operating costs (e.g., cloud services, hardware and licensing).
2. Estimate Profits
It’s more difficult to forecast profits than to estimate initial costs. Considerations include reduced operating costs, improved software or logistics programs, improved or automated services and improved data entry processes.
3. Compare Results
Calculate ROI for a project using several different factual scenarios. You might also compare the ROI of different IT projects to prioritize which comes first.
Other Value-Based Calculations
In addition to ROI, other calculations help you make data-based decisions regarding IT projects. Each of these calculations complements the ROI by providing further metrics you can use to select a project.
- Net Present Value (NPV): This shows a project’s profitability over time. NPV represents the difference between the present value of cash on hand and “the present value of cash outflows over time.” Unlike ROI, NPV determines the time value of money. If the calculation results in a number greater than 0, the project will likely produce value.
- Break-Even Point (or Payback Period): The break-even point shows when your investment will begin to pay for itself. The shorter the payback period, the less risky the project.
- Total Cost of Ownership (TCO): While the TCO doesn’t necessarily inform the riskiness of a project, it does show the overall cost of owning and operating your investment.