If finance doesn’t speak your language, why not learn theirs?
You’ve got a software project on the table and everyone agrees that it’s a clear win. Everyone but finance, that is, and that’s who you’re presenting to next. Your concern is that the proposal will lose traction as soon as the decision rests with someone who doesn’t fully understand the technical nuances. To get your point across, you’ll probably do one of three things:
Confuse everybody. Remember the Retro Encabulator?
Take the time to educate your audience. (See #1)
Take the time to build a presentation in their native dialect.
Finance has its own set of processes, acronyms and values, just like IT organizations do. Learning more about their world will go a long ways in helping them understand what you are trying to accomplish in yours.
Understand What They Value
Let’s start with some perspective. It’s the job of finance to reduce every decision to what is the lowest common denominator for any business: profit. Other factors such as technical debt, brand, customer satisfaction, employee experience, efficiency and risk only matter in that they help the company increase revenue or reduce costs. While that sounds a bit cold, they shoulder the responsibility for the financial stability of your company, so we can probably cut them some slack.
Proposal meetings may feel like an interrogation, but there’s a reason for all the hard questions. You aren’t the only person asking for funding and there’s only so much to go around. Finance is accustomed to reviewing ROI analyses that look self-serving and smell like a BS sandwich. It’s common for people to decide on a project and then try to figure out why it’s good for the company.
A project with average returns and a credible ROI analysis will be approved before a project with high returns and a questionable or biased analysis.
Understand How They Talk
If there’s anything I’ve learned from traveling it’s that you tend to get better deals when you talk like a local. You could write a book just summarizing the key points of financial language, and come to think of it - someone already has. I recommend the book Financial Intelligence as a great way to boost your financial IQ. In the meantime, here’s a summary of terms related to funding a software project:
Time Value of Money - Money today is always worth more today than money tomorrow. If I offered you $100 today or $100 next year, the choice would be easy. If you took the $100 next year, you wouldn’t be able to earn interest and its value would be eroded from inflation. There’s also the risk that I might not be around to pay you next year.
Cost of Capital - Think of this like the interest rate on a loan. It’s the value your organization assigns to money over time. Finance needs to make a certain amount of return on each dollar to either pay interest to lenders or dividends to shareholders. Let’s say your company’s cost of capital is 5%. If your project had a 4% return over the course of the year it would be considered a 1% loss instead of a 4% gain.
Discount Rate - This is Cost of Capital plus risk. Back to the loan example, the interest rate on your mortgage is the combination of the prevailing prime rate (Cost of Capital) plus your credit rating (Risk.) Discount Rate is used to determine the time value of money. If your Discount Rate is 6%/year, one dollar today is the same as $.94 a year from now. You may be assigned a different Discount Rate depending on how likely your project is to deliver the promised results. Discount Rate and Cost of Capital may be used interchangeably in some organizations.
Hurdle Rate - This is the minimum return your company expects to see when funding projects. If your company’s hurdle rate is 15% and your project’s return is 8%, you know that it’s time to go back to the drawing board. This is often the same number as Cost of Capital but isn’t always an exact formula. It can vary based on risk, cash reserves or other factors.
Return on Investment - ROI is what the company will get back for the money they invest in your project. But you probably already knew that.
Finding your company’s Cost of Capital, Discount Rate and Hurdle Rate can be very useful for building proposals, but they are not always readily available. Even if you don’t get an answer, asking the question is a great way to sound really smart. Here are a few more words you can use to sound like a local:
Opportunity Cost - This is what you have to give up in order to capitalize on the opportunity at hand. Non-financial people just call this "Cost," sales people would call this the "Investment."
OpEx - Operational Expenditures are generally ongoing expenses to “Keep the lights on” such as maintenance costs, power, subscriptions or employee salaries. CapEx and OpEx can be pulled from completely separate budgets and you may be asked to delineate which costs are which.
It’s probably large
It requires an investment now and the returns come later, so the time value of money comes into effect.
There is generally some form of risk involved. You may be confident of success but the probability is rarely 100%.
Understand What They Do After You Leave
There are three standard ways to measure ROI. Finance will likely use two or three of them to make a well-rounded decision of which projects to fund. Doing the calculations in advance makes it easier to get a quick approval or to at least be included in the discussion.
Payback Method - (Or break-even analysis) This is simply how long it will take for the investment to pay for itself. Example:
Project cost = $1,000
Project return = $100/month
Payback period = 10 months
The Payback Method can be a useful sniff test to quickly evaluate the viability of a project, but does not tell us what the actual return is or factor the time value of money.
Net Present Value - NPV is a much better lens to evaluate ROI but is also more complicated. It calculates the return of an investment over a longer period of time, but in today’s dollars. Since money today is always worth more than money in the future, simply subtracting today’s investment from tomorrow’s return will not give us an accurate picture. It’s tempting to use simple a ROI that looks like this:
Project cost = $1,000
Project return = $1,200/year for three years
Raw ROI = $3,600
However, that return is paid out over the course of 3 years and needs to be discounted to determine its true worth in today’s dollars. Assuming a Discount Rate of 6%, the NPV of this investment would be $2,207.61. Math nerds can find the full definition and formula here but the rest of us can just use the calculator.
Internal Rate of Return - IRR is useful for determining the return of an investment as a percentage instead of a dollar value. Using the example of a $1,200 investment with an annual return of $1,000 for three years, the IRR would be 65%. I don’t recommend spending a lot of time trying to master this principle. The theory behind IRR is not simple, but the calculator is.
This may be a lot to incorporate so be realistic. Finance won’t expect you to have mastered these concepts, just like you wouldn’t expect them to know their way around Command Prompt. If you really want to be a part of the evaluation conversation, consider involving finance earlier in the process. If the proposal is for the CFO, ask someone on the CFO’s team to validate your assumptions and build the business case with you. This lends credibility to the proposal and puts both teams on the same side of the table.
Remember, acronyms and fancy formulas won’t make a bad project more appealing. They will however, draw focus to your message instead of your medium. If you want help proposing or building your software project, start a conversation with a Sembit Business Technology Expert and start getting answers today.
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