Why designers need to understand Net Present Value

For most designers, accounting and finance are pretty far from their practice. Designers are the human-centred creative ones and balance sheets and cash flows can feel like the furthest thing from those attributes.

But I feel that designers do themselves a disservice by not having a level of fluency in accounting and finance concepts, particularly in Net Present Value (NPV). The reason NPV is important is that it is a key metric used to determine if a project is worth investing in. This matters to designers because often we are designing a new product or service (or re-inventing a current one). This means we are expecting some kind of investment in whatever we have designed. Therefore, we need to be able to credibly speak about how financially sound this new product or service is.

What is NPV?

Net Present Value is the discounted value of the future cash flows of an investment, minus the initial cash investment. Let's break that down.

At its most fundamental level, NPV is one number that summarizes whether a project is worth the initial investment. It does this by comparing the initial investment required in the project with the cash flows that the project will generate over a period of time. If the cash flows are greater than the initial investment, your NPV will be positive and you should do the project. This is the basic concept.

However, NPV gets tricky because we need to account for the fact that cash has a different value over time. If I get $1 today, it has a different value than if I got $1 in 5 years. The reason the value changes is because if I had $1 today, I could invest it and earn returns on it. If I have $1 in 5 years, I can’t earn returns on it now, because I don’t yet have it. It is better to have money today rather than in the future because I can do things with that money in the short term. Therefore when we calculate the NPV we need to discount future cash flows to acknowledge that they have less value than today’s money. 

To get the final NPV of a project, you will need to sum the discounted future cash flows and then subtract the initial investment. In financial terms, if the number is positive this means you should do the project because the future cash flows will be greater than the initial investment. If the number is negative this means you should not do the project because the initial investment is greater than the future cash flows.

As an aside I do want to say that there are many reasons to invest in a product or a service that does not generate a positive NPV in and of itself. This is particularly true in the public or non-profit sector where metrics other than finances are more important. This may also be true in private sector companies where the potential losses of one project can be offset by the gains in another. But regardless of these factors, it is likely that someone will want to understand the potential financial impact of your specific project. Understanding the project’s NPV will go a long way to helping you communicate it.

There is lots of nuance in NPV of course. The actual calculations can be complicated by understanding what actually goes into the cash flows for the specific product or service you have designed. For example the role that taxes and depreciation play, whether a proportion of the organisation’s incremental overheads will be accounted for by your projects etc. Even though there is a lot of complexity, I still believe that it’s important to understand NPV at its fundamental level. For designers, I believe that it’s important to understand NPV even if we don’t take the lead on the calculations. Being able to have conversations about the financial return of your product or service is critical to get buy-in from stakeholders and investors and will give your project the greatest chance of success. 

The views expressed in this article are mind and do not necessarily reflect the views of my employer.