Many business professionals wonder whether it’s possible to assess the profitability of a project before they begin. The simple answer is yes, it is. However, determining profit can often be much harder than you’d expect. Keep reading below to find out more. We’ll discuss the key things you need to consider to understand whether a project can be profitable as well as how to concretely calculate the profitability of a project.
The First Step: Understanding Your Company’s Finances
The first step when it comes to deciding whether a project is profitable or not is to consider your company’s finances. You will need to become familiar with your company’s financial statements. To calculate expected financial returns and profitability, you need to be able to read and understand an income statement.
Familiarize yourself with your company’s cash flow statement and balance sheet. The parts of these documents are the building blocks for the formulas that determine profitability. They act as the starting point for the strategic decisions you will make in the future.
By getting to grips with your organization’s financial position, you will be able to calculate the return on equity of the project.
Assessing the Profitability of a Project
There are 7 key things you need to consider when assessing the profitability of a project:
Structured installation – projects need to be set up in a way to allow efficient management of the project through its lifecycle. You will need to decide on a basic set of goals for your project. This will need to be reflected in your project budget.
Hidden business management – remaining competitive is an important consideration that will affect the activity of a business. You will need to understand the key performance indicators of your business.
Cost control – you can only keep track of the costs (and the profitability) if you have defined a basic budget. It’s important to try and control the costs of a project and try and balance them with the estimated costs set out in your budget.
Keep track of the scope of the project – it’s easy to lose track of the scope of a project due to changes that occur. Businesses need to be aware that any activity that was not included in the original scope will involve additional costs and efforts. This can have a huge impact on the profitability of a project.
Increase communication and transparency – as you may already know, communication and transparency are the basis of any successful business. They are also the basis of any profitable project. The performance of a project is much harder to predict if there is no clarity between teams and departments.
Evaluate throughout – it’s crucial to evaluate the success of a project in relation to your basic budget. This will allow you to notice and avoid any potential risks or delays which could impact the profitability of a project.
Use project management tools – project management tools can help business protégés to get quicker and more accurate project reports.
Measuring the Profitability of a Project
Before proceeding with any type of project, it’s always a good idea to measure the profitability of the project first. When it comes to measuring the profitability of a project, there are several methods you can use:
Profitability index – this shows the degree of profit or loss. Business owners can use the net present value or the value of future cash flows to calculate the profitability index. The profitability index = 1 + (NPV / invested amount) or (PV / invested amount). The higher the profitability index, the better the investment.
Net present value – this is the correct value of future cash flows minus the amount invested. This measurement shows the difference between the amount of money a business has invested to get the desired return and what the business is going to spend.
The present value of future cash flows – this determines how much the investment (and the project) should return. It can be calculated using the formula: Present value = Future value / (1 + interest rate) number of years.
Business professionals are constantly asking themselves how they can bring tangible value to an organization. One way they can do this is to leverage financial accounting skills to work out the profitability of a project or your business. Business professionals can then use this knowledge to make better, more strategic decisions.
Whether you realize it or not, every decision we make in business impacts the company’s finances. Businesses should consider changing to a top-down mindset. Start by getting a better understanding of your company’s finances. You can then use this information to predict the profitability of future projects to determine which ones will have the most impact on your business.