By Morris Bocian

In today's economic environment most CEOs, business owners and entrepreneurs feel compelled to allocate their resources effectively. Squandering resources such as cash or your credit facilities can prove to be fatal especially if the current recession is longer or more severe than many economists and analysts predict. With limited exception most analysts were encouraging people to invest in the stock market throughout the first and second quarter of 2008. Many of them were encouraging (and investing for the portfolios they managed) others to invest in Countrywide, Washington Mutual, AIG etc., espousing that these were "deals of a lifetime," can't lose, stalwart companies that will be around for decades.

We live in a different paradigm than we lived in a mere 18 months ago. The credit crunch that started in August 2007 (and the so called experts claimed it was a minor inconvenience but a non-event) turned out to be a tectonic shift in our economy, yet the so called experts missed it. Throughout the first 3 quarters of 2008, most of those same "so called experts" were "in denial" as to the U.S. economy being in a recession. In my opinion, in today's environment it is time to be conservative as to your underlying assumptions.

Whether you are an entrepreneur, a business owner a manager or a "C" level person at a company, the first step you need to take is to develop your underlying assumptions. What do you think the state of the economy is going to be? Credit availably? How do those factors impact on sales? I remember a conversation I had with the chief trader of an international bank when he was projecting trading results for the next 3 years and I asked questions about the state of the economy, credit availability, market volatility as well as numerous other questions. His reaction was what do those factors have to do with my projections? If you assume things will stay the same as part of your assumptions, make sure that it is a conscious business decision, not an assumption made by default.

How you spend your dollars, whether on technology or in other areas, should be in a manner consistent with achieving your goals and objectives. If it doesn't get you closer to achieving your goals, conserve your cash and credit facilities, you might need to use it in the not too distant future.

With that opening, why would anyone advocate spending money with so much uncertainty? When there is a low risk quick "pay back" on that investment, it must be "cost effective." How do you calculate the cost effectiveness for an investment?

In the following simplistic example let's determine what the investment might be.

"Should I hire a new person or assign overtime?"

If we assume we have to invest in the new full time hire, some of the factors we might consider are:

• Costs to hire the new person (in terms of dollars and person hours to find the right person)
• Training (in terms of dollars and person hours)
• How long will it take to get the person working at a standard where he/she needs the "normal amount of" supervision
• Employee benefits costs
• Based on anticipated work load, will that person be utilized more than 70% of the time?
• Employee morale if you decide to use overtime instead of hiring new employees and it is over an extended period of time
• What type of payback can I expect from the employee vs. from assigning overtime

If you assume your business needs the person and you are prepared to make the commitment to hire someone, but it turns out the person is utilized only 25% of the time, was that a good investment? Could you have accomplished the same with a part time person (with no benefits)? A side by side analysis as to the costs and benefit of hiring someone would be a good and valid approach.

Wikipedia states "a Cost Benefit Analysis is done to determine how well or poorly, a planned action will turn out. Although a cost benefit analysis can be used for almost anything, it is most commonly done on financial questions. Since the cost benefit analysis relies on the addition of positive factors and the subtraction of negative ones to determine a net result, it is also known as running the numbers.

"A cost benefit analysis finds, quantifies, and adds all the positive factors. These are the benefits. Then it identifies, quantifies, and subtracts all the negatives, and the costs. The difference between the two indicates whether the planned action is advisable. The real trick to doing a cost benefit analysis well is making sure you include all the costs and all the benefits and properly quantify them."

If we assume a company is seeking to upgrade its information systems at a cost of $500,000 installed. Assume the vendor is prepared to finance the costs as follows:

Information Technology System		$ 500,000
Financing Period		36months
Annual Interest Rate		6.00%
Monthly Payment		$ 15,210.97

Further, assume it costs $ 72,000, including the time employees are less productive due to a learning curve, to learn the system. Although most of this expenditure may have to be made within the first two months of the new system placed in operation, we will be amortizing the costs over the anticipated life of the system, 36 months. Since the company will be funding this expenditure internally, it will be seeking a higher return on its capital than the vendor, 20% was assumed.

Information Technology System		$ 72,000
Financing Period		36 months
Annual Interest Rate		20.00%
Monthly Payment		$ 2,675.78

If we look at the Cost Benefit Analysis, below, it would appear that this is a worthwhile allocation of resources.

	Scenario 1
	Costs	Benefits
Monthly Payment on New Info System	$ 15,210.97
Amortized monthly training costs	$ 2,675.78
Reduced Monthly Labor Costs		$ 28,000.00
Reduced Employee Benefits		$ 4,200.00
Est. Monthly Increased Productivity		$10,000.00
Increased Insurance Costs	$ 250.00
New hire to operate new info system	$ 8,000.00
Employee Benefits - New hire	$ 1,200.00
Impact of Square footage needed	$ -	$ -
Total	$ 27,336.75	$42,200.00
Net Benefit for acquisition		$ 14,863.25

If we change the fact pattern in instead of the equipment being an information system, it is production equipment, thereby increasing your company's productivity a similar analysis would be conducted.

	Scenario 2
	Costs	Benefits
Monthly Payment on Production	$ 15,210.97
Amortized monthly training costs	$ 2,675.78
Increased Monthly Revenue Potential		$ 22,000.00
Increased Material Costs		$ (5,000.00)
Increased monthly quantity produced		400 units
Decreased Utility Costs		$ 500.00
Reduced Monthly Labor Costs		$ 28,000.00
Reduced Employee Benefits		$ 4,200.00
Est. Monthly Increased Productivity		$ 10,000.00
Increased Insurance Costs	$ 250.00
New hire to operate new	$ 8,000.00
Production Equipment Employee Benefits - New hire	$ 1,200.00
Impact of Square footage needed (A)	$ -	$ 250.00
Total	$ 27,336.75	$ 59,950.00
Net Monthly Benefit for acquisition		$ 32,613.25

(A) At 1,000 square feet, $3.00 per square foot rent.

Neither of these examples takes into account risk. In other words, what if sales decreases and the need for increased production capabilities is unimportant or detrimental? What will the impact be on costs?

What if you assumed that your production needs were at the 2007 levels and based upon today's estimates you feel the equipment will only be 50% utilized? A new analysis would show the new technology will only be 50% utilized. The decision that might have made sense at 70-80% utilization often doesn't make sense at 50-60% utilization. And, it makes no sense if it puts your company at risk if by making the investment you are depleting too much of your cash and you can not effectively use the technology. In my opinion, a cost benefit analysis should be conducted before making any material expenditure. You should be prepared to defend your decision to your superiors. If you are the owner of your business or the CEO of a business be prepared to defend your decision to the Board.

Morris Bocian is CEO of Creative Business Planning Inc., an established Business and Strategic Consulting company. His email is mb@creativebusinessplanning.com

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