Financial metrics such as NPV, IRR, and BCR are used to assess investment projects. These metrics can help Lean Six Sigma process improvement projects by providing a quantitative assessment of the financial impact of the changes.
The difference between the present value of cash inflows and the present value of cash outflows over time is the NPV (Net Present Value). It quantifies how much an investment project increases or decreases the value of an investment.
The IRR (Internal Rate of Return) is the discount rate that equals the NPV of an investment project. It calculates the profitability of an investment by factoring in the time value of money.
The BCR (Benefit-Cost Ratio) is the ratio of an investment project’s benefits to its costs. It assesses the relationship between a project’s benefits and costs and can be used to determine whether an investment project is economically viable.
The NPV, IRR, and BCR metrics can be used to evaluate the financial impact of improvements in a Lean Six Sigma process improvement project. For example, if a process improvement project is expected to increase revenue while decreasing costs, the NPV and IRR will be positive, indicating that the project is profitable. If the BCR is greater than one, it indicates that the project’s benefits outweigh its costs and that the project is economically viable.
In a product management organisation, these metrics can be used to assess the financial impact of new product development projects or improvements to existing products. For example, if a new product development project is expected to increase revenue while decreasing costs, the NPV and IRR will be positive, indicating that the project is profitable. The BCR can be used to determine whether the project’s benefits outweigh its costs and whether it is economically viable.
While these metrics are useful in evaluating investment projects, they are not the only factors that should be considered. Other factors to consider include market demand, competition, and regulatory requirements. Furthermore, to ensure that the improvements are effective and sustainable, these metrics should be used in conjunction with other process improvement tools and techniques, such as process mapping and root cause analysis.
The formula for NPV (Net Present Value) is:
NPV = (∑ of present value of cash inflows) – (∑ of present value of cash outflows)
where the present value of each cash inflow or outflow is calculated using the following formula:
Present Value = Future Value / (1 + r)^t
where r is the discount rate and t is the number of periods in the future.
The formula for IRR (Internal Rate of Return) is:
IRR = the rate at which NPV = 0
The formula for BCR (Benefit-Cost Ratio) is:
BCR = Total Benefits / Total Costs
where Total Benefits and Total Costs are the sum of the benefits and costs of the investment project over a specified period of time.
