Return on investment (ROI) is often associated in financial reports as a ratio of the amount of return over the amount invested. It is also an indicator when looking at ROI and ROE in terms of assessing a company’s leverage, among other valuable information. In terms of projecting a possible outcome on a proposed project, the calculation of ROI is a critical step in determining the feasibility of executing that project.
But the calculation of an ROI and providing a time frame of when a company can see a return on the capital it invests can determine if the project is worth it or, at a minimum when the company can recover the investment. In addition, it is a valuable component in gaining the trust of the stakeholders interested in the project. In summary, calculating the ROI of a project is a key first step in the project management and execution process. It is also an essential part of the Six Sigma management strategy used by many corporations around the world. The calculation is the process to solve queries by applying different mathematical formulas. Different techniques are used in calculation.
A key component of this process that is often underestimated or overlooked is the calculation of labor in the overall costs of the project. When looking at how the ROI of a project is calculated, it is clear that it is essential to include labor costs in the project as a key resource, such as hardware/computer hardware or any other type of equipment. There are a few methods to consider when calculating labor costs as a component of ROI.
Calculation of return on investment
First, it is important to understand the ROI calculation of a project. This can be broken down at a high level into the following components:
ROI = [(Financial Value – Project Cost)/Project Costs x 100
Many people view the financial value component of ROI as intangible or subjective value. It doesn’t have to be. The key is to break the project down into known values, define those values, and then compare them to what is expected of the project. These values have the same main components: time, volume, and dollars or costs, and these are applied to both the current value and the projected value once the project is implemented.
In results, we have:
Financial Value = TVD Current State – TVD Future State
Where T = Time, V = Units of volume or quantity, D = Costs
The calculation of the Project Costs variable is made up of two variables, Breakdown of Work Over Time and Cost of Work Required. Work breakdowns over time are essentially the components of project management tasks that have been valued in as much detail as possible over time. For example, imagine all the tasks associated with building a simple wooden box.
For each task, an assessment of the costs of ALL resources associated with that task must be evaluated and applied. These include: Resources (type and amount needed), Hours of work to be performed, Wage rate per resource (more on this in a moment), Capital costs (equipment, hardware/software costs), and any lease/lease costs. rental. Basically, anything that costs money for the project should be included in that task. This is where we apply labor cost to the calculation and how to best determine what to include.
What labor costs to consider
Labor costs can vary from project to project. Some projects will be executed using internal resources (ie full-time employees), others may bring in an outside contractor, and still others may use a combination of both. You may even have labor associated with the project in the long run, as a resource.
Step 1: Calculate WEC
WEC = ($65,000 + [$65,000 x .31]) / 26
WEC = $3,275 per salary for one FTE
Step 2: Calculate the costs per FTE
Cost per FTE = WEC / Total hours worked
<NOTE: There are 80 hours for this calculation as the total hours per paycheck is for a weekly pay period>
FTE = $40.94 or $50.00
So for every hour of work for this FTE, the cost would be $40.94 per hour.
Step 3: Integrate all FTEs during the duration of the project
Total labor costs = number of FTEs * costs per FTE * number of labor hours for the project
Using the numbers from the above calculations:
Total Labor Cost = 4 * $50.00 * 960.00
Total Labor Cost = $192,000
Further we will discuss:
But what about that half of the FTE calculated for the project? That half can be tackle in different ways. First, you can round it up by making the total number of FTEs 5 versus 4. The advantage of this is that you give some leeway in the estimate so that if the project goes a bit further, there is some extra money available if the project is approved. The other reason is that if the project is presented and during the approval process, the review committee requests some cuts in the project, this would be an area that can be reduced without significant impact on the work.
Also, not all FTEs would use exactly the same labor costs. Suppose on this project some FTEs are specialists and their cost is $50.00 per hour but others are $45.00 per hour and maybe part timers are $30 per hour. Each of these costs will take into account when we will calculate the labor costs. So if we use these factors as an example, suppose the half hour is a part-time worker.
Total Labor Cost = (4*$50.00 +.5*$30.00)*960 = $206.400.00
Important element to keep in mind are:
the.5 does not necessarily equate to a part-time employee, it corresponds to the amount of time a resource is committed to the project.
The example might as well have used an FTE for the factor of 0.5, indicating that that FTE was only working for half the project duration than previous resources.
· Be conservative in your labor numbers: When calculating FTEs, make sure you include enough “rainy days” in your project task calculations. This means considering possible areas where a project delay may occur such as equipment waiting, weather, approval process, permits, etc. Task dependencies such as these can increase labor costs as labor will often still issued.
Dedicated resources for a project:
· Be accurate in costs – This simply means try to ensure that there are good labor numbers in the cost analysis. When we are using averages, round up. Again, there is always an opportunity to reduce costs as you go through the estimate, but don’t start low as there is rarely, if ever, an opportunity to recalculate the estimate.
· Understand the benefits of your business – This is an important element that is often overlooking because of above reasons; however, in an accurate ROI, these costs will add to the equation.
In short, set back labor costs with ROI
Remember, from the ROI calculation,
ROI = [(financial value – project costs)/project costs x 100
This article provides the basic steps for calculating the labor costs of a business process, including:
List the activities and times of the process.
Identify the annual volume.
Determine the FTE number for use.
Determine the salary and the employee benefit for use.
Learn more about each of these steps here. I will take the development of a product quotation as an example.
You need to know the processing time of the relevant business process. Determine this by determining how long each step in the process takes and adding up the actual time consumed by the activities. So let’s say it takes 46.0 minutes for each quote. Converted to hours, this equates to 0.8 hours (rounded up) to make each quote.
Multiply the time from step 1 by the annual volume. Let’s say we make 3,200 product quotes per year. In our example, multiply the 8 hours ( labor per quote) by 3,200 quotes (volume). This equates to 2,560 hours spent on the listing process in one year (annual work hours).
Determine which full-time equivalent (FTE) number to use in your calculation. FTEis generally means the total number of hours an employee will paid in a work year. If an employee works 40 hours a week, one FTE is equivalent to 2,080 hours in a year (52 weeks x 40 hours a week). Of course, employees can have vacation days, vacations, and sick days available. To arrive the use at the correct estimate of the labor , subtract the number of hours your company gives your employees for paid vacation, illness, and vacation.
Once you know the number of FTEs to use, divide your answer from step 2 by the number of FTEs. In our example, you divide 2,560 (total annual hours spent on the quotation process) by 1,880 hours (number of FTEs) and you get 1.36 FTEs. This means that the quote process takes a little more than one employee and almost 1-1/2 employees. Using the FTE concept, you can account for percentages of the time an employee spends on a business process.
Multiply the employee’s salary by the FTE number. In simple way, assume that the job of creating a product quote will complete by one type of worker: entry-level workers. If they make $30,000 a year, multiply $30,000 by 1.36 (FTE) to get $40,800, the labor cost for the process alone.