A business investment can be a crucial step in growing your business and achieving your strategic goals. However, it could also burden you with unexpected costs that harm your finances and hinder your growth.
Many businesses make investments emotionally without thoroughly assessing the opportunity. Whether it’s expanding your team, investing in new technology, or entering a new market, the key is how well you evaluate, plan, and align your investment with your business strategy.
Resources
- Data-Driven Decision Analysis Tool - A Google Sheet tool designed to help you input your data, calculate key investment metrics, and present the results in an easy-to-analyze format. This workbook streamlines the decision-making process, enabling you to make informed, data-driven investment decisions with confidence.
Here is a 3-step process to help you evaluate potential business investments and confidently make a decision:
1. Determine if the investment is a good strategic fit and the right timing.
Overview: Ensure the investment aligns with your company's long-term strategy and assess whether the timing is right given your business and industry outlook.
Importance: Aligning investments with your strategic goals ensures that resources are used efficiently and effectively, contributing to sustainable growth.
- Determine if the investment aligns strategically with your business goals.
- Determine if it is the right time for the investment, based on your short-term goals and current financial and operational status.
- Does the investment align with our strategic goals for the next several years?
- How does this fit into our overall business strategy?
- Is the timing right for this investment given our current business outlook and potential industry disruptions?
- Is this investment a good strategic fit for our company?
- Are there potential market or industry changes on the horizon that could affect this investment?
- Strategic alignment might overlook short-term opportunities that could be beneficial; aim to maintain flexibility to capitalize on immediate gains while pursuing long-term goals.
- Timing assessments can be challenging due to unpredictable external factors, but careful planning and flexibility can mitigate this.
2. Calculate the Impact on Cash Flow
Overview: Evaluate the immediate and long-term impacts of the investment on your cash flow, ensuring it is financially sustainable.
Importance: Maintaining healthy cash flow is crucial for business operations and avoiding financial distress.
- Calculate The Initial Investment: Identify all costs associated with the investment upfront and take into consideration all of the items needed to put the investment to use. This may include: (acquisition costs, installation fees, training costs etc.)
- Calculate annual cash inflow: The net amount of cash generated by a business in a year
- Calculate Payback Period: The payback period measures the amount of time it will take to recoup your investment.? Formula: Payback Period = Initial Investment / Annual Cash Inflows
- Determine Annual Cash Outflows:? Include all expected cash outflows, such as financing payments? interest, upgrades & maintenance, additional training, etc.)
- Calculate the Total Cash Impact: Subtract the total cash outflows from the total cash inflows to determine the annual net cash impact of the investment
- Determine How You Are Going to Pay for the Investment: consider your financing options, which may include: using existing cash reserves, taking out a loan, securing external investment, leasing or financing options
Don't forget to download the Data-Driven Decision Analysis Tool to help with the above-mentioned process and calculations.
- What are all the initial investment costs and annual cost of the investment
- What cash inflows will the investment bring in annually (including cost savings)
- Do I have enough operational cash flow to cover increased outflows?
- Will we need additional financing, or do we have sufficient assets?
- What are the risks if cash flow projections are not met?
- These formulas do not take into account varying annual cash inflows or outflows. If these vary, using an average for the year will still give you an idea of the long-term impact but will require deeper analysis.
- Securing necessary financing might require careful planning and negotiation, but having a solid financial plan can make this more manageable.
3. Evaluate Risks & Other Alternatives
Overview: Identify potential risks associated with the investment and evaluate alternative options.
Importance: Understanding risks and considering alternatives helps mitigate potential downsides and ensures more informed decision-making.
- Determine the risk if you do not make the investment, such as losing clients, losing employees, reduce sales.
- If possible, quantify each item by assigning a cost to it.
- Determine alternate options such as fixing or improving existing assets/resources, heaper, less ideal option, doing nothing at all
- If possible, quantify each item by assigning a cost to it.?
- What are the risks if the investment is not made (e.g., losing clients, falling behind competitors)?
- What is the impact on our ability to make other necessary investments?
- Will an alternative option sufficiently solve the problem?
- Could this investment limit our ability to pursue other opportunities?
- Risk assessments might not capture all potential threats, but it needs to capture the most impactful and harmful ones.
- Alternatives may have their own sets of risks, but comparing multiple options can help identify the best path forward.
Evaluating the Data: When to Say Yes (and When to Say No)
After thoroughly analyzing the data, you may find that the investment aligns well with your strategic goals, shows a positive impact on cash flow, and presents manageable risks. Here are key indicators that suggest you should say yes:
- Strategic Fit: The investment aligns with your short and/or long-term business strategy and goals.??
- Right Time: The current market conditions and business outlook are favorable, with minimal potential disruptions on the horizon.
- Quick Payback Period: The investment has a quick return on investment. Investments with a shorter payback period are generally considered less risky and allow for faster reinvestment.
- Positive Cash Flow Impact: The analysis shows a favorable net cash flow over a defined period, and you have the financial capacity to support the investment.
- Manageable Risks: The risks associated with the investment are quantified, understood, and deemed acceptable or mitigable.
- Does this investment support our long-term goals?
- Will it improve our market position or operational efficiency?
- Do we have sufficient cash flow or financing options to sustain this investment?
- Are the potential risks and challenges manageable?
Conversely, if the data reveals misalignment with your strategy, negative cash flow implications, or unacceptable risks, it may be wise to reconsider. Here are signs that you may need to say no:
- Strategic Misalignment: The investment does not support your core business objectives or diverts resources from more critical initiatives.
- Incorrect Time: The current market conditions or your business conditions are unstable/uncertain or there are potential disruptions on the horizon that could negatively impact the investment.
- Long Payback Period: Investments with a long payback period are generally considered higher risk.
- Negative Cash Flow Impact: The cash flow analysis shows a strain on your finances, making it difficult to sustain ongoing operations.
- High Risks: The risks involved are significant, with the potential to negatively impact your business without clear mitigation strategies.
- Does this investment divert focus from our main strategic goals?
- Will it create financial strain or require more resources than we have available?
- Are the risks too high or difficult to manage?
Conclusion
By following these steps, you can make more informed and confident investment decisions that align with your strategic goals, ensure financial stability, and consider potential risks and alternatives. However, this process is not all-encompassing and is designed to help you quickly assess whether you should pursue the investment. Depending on the investment size and potential impact and risk, a deeper investigation and consulting with a CPA or other professional is highly recommended.
