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What are the Different Project Evaluation Techniques Used in PM?
While project management handles the nuts and bolts of getting a project done, project evaluation takes a wider view. It examines how every aspect of the project impacts both its outcomes and the overarching business context.
In essence, where project management keeps the train on the track, project evaluation makes sure the train is heading to the right destination, and that the fare is worthwhile.
There are numerous project evaluation methods you can use, depending on the level of financial detail and forecasting required when looking at your project. While some of the formulas used in project evaluation might seem technical, don't let that deter you.
Online calculators or spreadsheet software can help simplify the calculations. Developing a general grasp of the methods employed in project evaluation will empower you to utilize the appropriate techniques effectively in your projects—and that’s exactly what you’ll be able to do after reading our guide.
Why Project Evaluation Is Important
Project evaluation is an important part of effective project management for several reasons:
- Resource Management: By evaluating a project, you can determine if the resources (like time, money, and staff) are being used efficiently and effectively, allowing you to adopt more lean management practices.
- Decision Making: The information gathered through evaluation helps to make informed choices about whether to continue, modify, or end a project. It prevents blindly following a plan that might not be working.
- Measuring Success: Evaluation provides a way to measure the success of a project against its initial objectives. Essentially "Did the project achieve what we set out to do?"
Additionally, project evaluation can also involve considering external factors such as a partnership proposal that could bring in expertise, resources, or funding to enhance project outcomes and success.
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Project Evaluation Techniques
As project evaluation techniques continue to evolve, they intersect with the use of advanced tools that enhance project management. By incorporating tools such as attendance tracking software, project managers gain insights into the actual hours invested by team members, leading to a more accurate assessment of resource utilization.
This real-time data can play a significant role in refining project plans and making informed decisions about project continuation, modification, or termination.
Let’s take a look at some of the commonly used methods of project evaluation, and how to apply them.
1. Return on Investment (ROI)
ROI is a straightforward way to gauge how profitable an investment is. It divides the net profit earned from the project by the initial cost of investment. This is commonly shown as a percentage.
For example, let’s imagine that a video production agency has decided to integrate MarkUp.io video markup into its project workflow.
As the project progresses, they evaluate the net benefits achieved from this integration, such as time savings and fewer errors and reworks required.
By quantifying the value of these benefits, such as $5,000 saved in reduced project reworks, they determine the net profit from the endeavor. They then weigh this net profit against the investment cost.
Calculating ROI reveals the return gained per dollar invested, allowing them to assess the investment's profitability and make informed choices about whether the project was worthwhile.
2. Net Present Value (NPV)
NPV calculates the present value of expected future cash flows, deducting the initial investment. A positive result indicates that the project is potentially profitable, while a negative one helps you to identify a project that might not be a good investment.
To calculate the Net Present Value (NPV):
- List Cash Flows: Write down all the money you expect to receive (cash inflows) and spend (cash outflows) over the project's life.
- Choose Discount Rate: Decide on a discount rate, which could be the expected return or a required rate.
- Apply Present Value: For each cash flow, divide it by (1 + discount rate)^time period. This gives you the present value of each cash flow.
- Sum Present Values: Add up all the present values you calculated in step 3.
- Subtract Initial Investment: Subtract the initial investment from the sum of present values.
Just remember, a positive NPV is usually a good sign!
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3. Internal Rate of Return (IRR)
The internal rate of return (IRR) is a financial tool used to gauge how well an investment performs. The traditional definition says IRR is the interest rate that makes the net present value zero. But many find this definition confusing. Thankfully, there's a simpler way to think about IRR.
In plain terms, IRR is the percentage you earn on every dollar you invest over time. To understand this better, let's break it down into an example:
Consider a fictional company facing a choice between two projects: For Project A, the company plans to establish an inbound call center platform, requiring an upfront investment of $5000. On the other hand, Project B represents an alternative approach—launching an AI TLD (top-level domain) to host a chatbot service—entailing the same upfront cost of $5000.
Both projects are expected to generate an additional revenue of $1100 after two years. However, there's a subtle timing difference in the cash flows: Project A generates the revenue at the end of the second year, while Project B generates the same revenue slightly earlier, during the middle of the second year.
When we calculate the IRR, it considers not only the size of the cash flows but also their timing in relation to the initial investment. Since Project B's cash flow occurs slightly earlier, its IRR is affected, resulting in a slightly lower IRR compared to Project A.
In this example, even though both projects have similar cash flows, the slight timing difference causes Project A, establishing an inbound call center platform, to have a marginally higher IRR than Project B.
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4. Payback Period
When deciding whether to invest in something, people often ask, "How long until I get my investment back?" This is what the payback period method helps us figure out.
The regular payback period is the time needed for the money earned from the investment to cover the initial investment cost. In simpler words, it's the time it takes to get back the money you put in. The payback period is usually measured in years.
Imagine a company that wants to upgrade to a VoIP phone service from Vonage. They invest $80,000 upfront. With the new system, they save money and work more efficiently, resulting in annual cash gains:
- Year 1: $15,000
- Year 2: $20,000
- Year 3: $25,000
- Year 4: $30,000
- Year 5: $35,000
In this case, the Payback Period is reached in Year 4, as the total gains of $90,000 cover the $80,000 investment. This means it takes around 3 years and 9 months to recover the initial cost.
Utilizing Project Evaluation Techniques
Using a combination of project evaluation methods provides a comprehensive way to make informed decisions in project management. For instance, NPV is ideal for assessing long-term projects with expected cash flows, IRR is suitable when comparing multiple investments with varying returns, and Payback Period is handy to gauge how quickly an investment pays off.
By utilizing the methods outlined to evaluate your projects, you can secure the financial soundness of your investments, instill confidence in key stakeholders, and achieve successful outputs.