As the economy starts to improve, you may be ready to start making investments that will improve your operation. As the time approaches to start making these purchases, the first step is to complete a financial analysis to determine the benefits of the proposed investment. This is usually completed as part of a business case.

There are a few basic assumptions that must be identified when starting a financial analysis and a business case. The time frame over which the financial analysis is being conducted should be determined up front and used for all the necessary methods. You may need to run other analyses to show that the financial stability does not change if the time frame is lengthened. Questions that might be asked as part of the future analyses are "Does the expected maintenance cost increase over time?" and "What is the lifetime of the piece of equipment being purchased?"

You should also determine what is being included and what is being left out of the financial analysis. You will need to supply justification for why you only include certain things. An example of something that may be left out is the maintenance cost of the new equipment because it may be equal to the maintenance cost of the old piece of equipment.

A good business case is based on a sound financial analysis. This can be completed using a wide variety of methods. Some of the methods that you may see are return on investment (ROI), present value (PV), present worth (PW), net present value (NPV), payback and internal rate of return (IRR). These are all terms that may be used to demonstrate the value of the investment to the company.

As we introduce each method we will use the following example to calculate the value of example. ABC Company is interested in purchasing a widget maker process line to replace a batch processing assembly station. The investment needed is $300,000 and the expected savings are $60,000, $80,000, $100,000, $100,000 and $100,000 per year over the next five years. The current rate of inflation is 3%.

The first method, "return on investment (ROI)", is used to figure out the amount of money made or saved when compared to the cost of the investment. The following formula can be used to calculate ROI, which is usually reported as a percentage.

Present value (PV), present worth (PW) and net present value (NPV) are terms that are interchangeable. They all refer to the concept that money now is worth more than the same amount of money in the future. For instance, you can buy more now with $100 than you can in 10 years with the same $100. Use the following formula to determine the PV of some amount of money in the future (FV = Future Value) with the rate of change being the rate of inflation (RI) and n being the number of years in the future.

One of the most common financial analyses completed for projects is payback. The payback refers to when the initial investment will be repaid. If the savings is constant each year, use the following formula:

If the savings each year is not constant, this number can be found by generating a plot using time, initial investment and annual savings.

The last financial method is the Internal Rate of Return (IRR) and can be referred to as the cost of money to the company. This may be used to determine the risk of an investment or to set a minimum level of return that an investment needs to achieve to justify the investment. A higher IRR indicates a more robust investment. The IRR uses the NPV formula, solving for the rate of return.

If your calculator or spreadsheet doesn't have this formula built in, you can solve for RI by trial and error. To reduce the time and effort to find RI, there are several online calculators that can be used. A free downloadable Microsoft Excel spreadsheet that can be used to solve for RI can be obtained from www.solutionmatrix.com.

Example: Using the downloaded Excel spreadsheet and entering our example cash flow as follows -$240,000 year 1, $80,000 year 2, $100,000 for years 3 through 5, you will get 20.5% for your IRR.

If you include a good financial analysis and the proper documentation of the assumptions that were made when conducting the financial analysis you will have a sound business case and justification for your purchase. This increases the chances of success for both you and your company.