Evaluating return on investment
May 1, 2012
by Lucy Sutton
The equipment necessary for automating a baking or snack food operation can take a sizeable chunk out of the bottom line, so proper evaluation of that investment's return is crucial. Baking & Snack Contributing Editor Jim Kline, president of The EnSol Group, Flemington, NJ, offers his advice on the subject to Operations Update readers.
Baking & Snack: What are the best ways to calculate return on investment (ROI) for the capital investment of new equipment?
Jim Kline: There have been various financial models introduced over the years, but the old tried-and-true ROI model — modified to include discounted cash flow (DCF) analysis and factoring in inflation and savings streams — is really a good analytical tool. The results provides you with net present value, a solid indication of whether it will be a cash-positive or cash-negative investment; an ROI, with which you can judge against other investment opportunities; and payback, which enables you to judge cash flows going forward. This method provides easily understood results that can be benchmarked against industry performance standards.
What factors are typically ignored or forgotten when putting together an ROI equation?
It is uncommon to find errors that result from pulling together the ROI equation. Rather, the error comes from a lack of understanding of what the analysis is telling you and a failure to quantify the risks.
The DCF model is a tool, not an end result. You can have a project with a 20% ROI that, as a project, is a far better investment than a project that is projected to have a 34% ROI. How is that possible? Perhaps the 34% return project had a high portion of its return based on future sales after year five, and the sensitivity analysis (SA) projected a 50/50 chance of those sales figures actually materializing.
So what is SA? Simply stated, it is assessing the probability of occurrence to either a single or combination of events. In the example below, the likelihood of savings being realized is weighed as against the capital invested.
Analysis like this, along with ROI analysis, can help put into perspective the true risk associated with the investment. Other forms of sensitivity analysis include labor against time against capital investment or against production volume; sales volume projections against time or against profits; timing of capital spending or of cash flow; and ingredient or utility costs.
How can bakeries maximize their ROI when they install automated systems?
By doing their homework up front to ensure selection of equipment matched to their need; by being involved as the equipment is installed; and by ensuring that adequate training is provided to their operators, maintenance and sanitation personnel. The homework phase needs to include development of equipment specifications that describe the product and the process, soliciting multiple bids, defining the roles of those involved, and actively managing the project and installation team. Lastly, follow up to ensure the returns are met.
This story is sponsored by POWER Engineers, which has one of the most comprehensive teams of engineers and specialists serving the baking and snack industry. As an extension of its clients' engineering teams, the company provides program management, integrated solutions and full facility design for the baking and snack industry. Learn more at www.powereng.com/food.