Managers often complain that their organizations don’t put money into projects they should – or close down a ‘profitable’ operation. But funds for capital expenditure are normally limited. It could be a choice between new technology, new buildings, new markets – or whatever. Only the propositions which offer good returns will be favoured.
The Video Arts film Return on Investment features Jon Cleese and Julian Carruthers. It’s his birthday, and he’s inherited money which he plans to invest in his business. He’s convinced the returns will be astronomical – better the 10% rate his late Aunt Edith made by keeping the money in the bank.
Under the watchful eye of the expert Ron Scroggs (John Bird), Carruthers soon begins to have doubts. He learns that his existing Return on Capital Employed – his real rate of profit – is far from being 100% or even 50%. That’s because he shouldn’t simply compare Profit with Sales Turnover, nor with Operating Costs, he has to compare his profit with the total amount of capital tied up. He learns how to assess whether money left on deposit, for example, will produce a better rate of return than the investment opportunities contemplated.
Scroggs encourages Carruthers not to sell up, and with lucid graphics teaches him how to choose between two proposals. Not by pickling the one with the smartest cover, but by using Discounted Cash Flow techniques to work out which will give the highest Net Present Value or NPV.