cost and benefit analysis

7/29/2019 Cost and Benefit Analysis

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Cost And Benefit Analysis


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Costs

ERP projects are typically significantinvestments in time, effort and capital

ERP project costs will include items such assoftware, servers, client upgrades, networkupgrades, support and maintenancecontracts, professional services, IT training,

application customization and development,implementation labor and on-going supportand administration.

Business unit costs are often underestimated

and include user training and change


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Benefits

Business benefits are improvements inrevenue or development of new revenue

opportunities. Operating efficiency benefits are the process

improvements that can help the companyimprove productivity, re-deploy labor

resources, avoid purchases or eliminateexpenses.

Intangible benefits are strategic andimportant but non-quantifiable in monetary

terms such as brand advantage or business


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Project risk

It includes everything from

schedule and budget overruns,

functionality shortcomings,

slow adoption and resources risks

This all may affect planned costs andbenefits.


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Tangible Benefits

Inventory reduction

Personnel reduction

Productivity Improvements Order management improvements

Financial close cycle reduction

IT cost reduction

Procurement cost reduction

Maintenance reduction

On line delivery improvements


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Intangible Benefits

Information visibility

Improved processes

Customer responsiveness Integration

Standardization

Flexibility

Globalization

Business Performance

Supply and demand chain


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Cost - Benefit

The tangible costs and benefits can be analyzed and presented

to the team using five key financial calculations:

ROI = net benefits / costs

Risk adjusted ROI = Net present value (NPV) of net benefits / NPV

costs.

Net Present Value = net cash flow of the project translated into

today's dollar terms using a risk adjusted discount rate.

Internal Rate of Return = the effective project return, calculated as

the discount rate for this project which brings the net present valueequation to zero.

Payback Period = the period it takes, usually in months, for the

project to reach cash flow positive (where cumulative benefits

exceed cumulative costs).


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Main focus of Business Excellence is CustomerService

make for stock company in a competitive situation

should be able to estimate the possible extra salesthey could capture if they always had their productson the shelf.

For other types of business,

assemble to order, make to order or engineer toorder,

the benefits from a Business Excellence projecttypically come in the form of

reduced lead time (a 50% reduction in 12 months

is common), and on-time delivery close to 100%.


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Case: Benefits

It would not be realistic to believe that all thepotential increase in sales could be realized, sothe potential benefit from increased salesshould be calculated as the gross margin on aproportion of the potential increase

we will be taking half of the potential benefitfor a Make to stock Company with a 40m p.a.turnover .

Sales: Some companies will get increasedsales from both the off the shelf and lead timeimprovements but for most it will be aneither/or situation.


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Labor : The most basic improvement thatBusiness Excellence companies achieve is a

stable, managed master schedule out to thecumulative lead time.

When a manufacturing department hasstable, reliable schedules so that supervision

can spend their time managing and improvingtheir processes instead of chasing materialand shuffling priorities, there will be a savingin both direct and indirect labor costs.


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Purchase Material Cost:Direct material is frequently a largeproportion of the cost of sales.

There are many potential savings in this area that arise fromimprovements in master scheduling.

If you give your vendors stable schedules they can achieve thesame manufacturing cost savings as you.

The greater visibility will enable your suppliers to invest inbetter equipment and to take on value engineering work withyou.

Single reliable sources of material, rather than multiple butunchecked sources, opens up the possibility of point of usedelivery which saves inventory and administration time.

We find that purchasing department can typically achieve a20% reduction in material costs with as little as 3 months

forward visibility of requirements.


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Inventory is the last main category ofquantifiable savings

With inventory there are two types ofsavings. The cost of holding inventory, including the cost of

the storage space and its overheads, inventory

management etc., is an annual cost saving. RM,WIP,FG

It is reasonable to take half the potential annualsaving in inventory holding cost.

In addition there is a one time capital saving

which will offset the one time capital cost of the


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Case: Costs

Hardware cost varies as per Scope of the project . Thesre willbe ongoing cost of H/w upto 20 %

There will be a one time capital cost of the software which willvary enormously depending on the complexity of the softwareand size of the company

TIP:Whilst every effort should be made to resist thetemptation to customize the package, there may have to besome changes which should be allowed for and somepackages (e.g. SAP R/3 and JDE's EnterpriseOne) may be

cheaper for the software but much more expensive toconfigure. SAP R/3, for instance, may only cost 3,000 forthe software per user license but 15,000 per user licensefor consultants to configure.

There will also be an ongoing maintenance cost to install theupgrades along with further customizing (typically 15% to 20%

per annum of the software cost).


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Data Control Cost

You have to allow for costs associated with gettingthe bill of material and inventory record accuracy

above the 98% that is vital to get meaningful datafrom the system.

Forinventory records, the cost of cycle counting will

be on-going but bills of material will generally remain

accurate, once the process for maintaining the bills ofmaterial has been established, without any significant

on-going cost.

The same applies to routings.


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Education Cost

As well as the initial cost of education and training, there will be

an on-going cost of training new recruits and for adjusting the

process as the business changes. An allowance of 25% per

annum of the start up training and education cost is a goodestimate.

Many companies start out with the intention of not having a full

time project leader let alone a full time project team.

At this stage it is not necessary to decide whether you will have

these full time people but the justification should include them.As a rule of thumb, a project team of three people is necessary

for companies with up to 300 employees. One more project

team member is needed for every 200 employees.


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Cost- Benefit

The last stage of the analysis is to bringtogether the costs of implementing and

compare it with the net annual benefits The pay back period can then be calculated

and compared with the company norm. It isvery unusual if the pay back is not one of the

best the company has seen for a while. The final figure to calculate is to divide the

net annual benefit by 12.

This gives the cost of one month delay

cost and benefit analysis

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