Strategic investments — such as expanding a plant, purchasing a major piece of equipment or introducing a new product line — can add long-term value. But management shouldn’t base these decisions on gut instinct. A comprehensive, formal analysis can help minimize the guesswork and maximize your return on investment.
Financial forecasts typically start with the most recent income statement. Then assumptions are made about 1) how much revenue (or cost savings) will the project generate, and 2) what incremental expenses will the project incur. In some cases, a project may create special tax savings (for example, first-year bonus depreciation or Section 179 deductions) that may need to be factored into the decision.
Strategic investments will also affect your company’s balance sheet and statements of cash flows. For example, they may require additional working capital and fixed assets. Preparing comprehensive financial forecasts helps management evaluate how much cash the project will need each period and whether internal resources will be sufficient to finance it. Some projects will require the company to tap into the company’s line of credit — or require additional loans or capital contributions.
Company resources are limited. So, once cash flows have been forecasted, it’s time to analyze the results and prioritize competing investment alternatives. For example, you might have $50,000 to invest in either a new machine or IT upgrades. Which alternative is better from a financial perspective?
Three financial tools that are used to evaluate such decisions include:
These financial tools may sometimes conflict with one another. So, it’s important to consider qualitative factors, too. For example, IT upgrades might also protect against cyberattacks and reputational harm, which may be difficult to quantify in financial forecasts.
Contact us to evaluate the quantitative and qualitative effects of strategic investment alternatives. We can help determine what’s right for your situation.