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IT Project Valuation, Part I

Continuing with our discussion about financial issues in technology, now we will see a practical approach for technology projects valuation.

Finance people normally think of three valuation techniques:

1. NPV (Net present value)

2. IRR (Internal rate of return)

3. Real Options

1. NPV

For this NPV calculation, you should take into account the costs relating to investment associated with the project as the cash flows received of income.

Remember, longer time --> decreases the value of money

Thus, the value of cash flows today won’t be the same value in the future.

Flows related to income are usually estimated over several years, which mean they must be discounted and converted to their present value using a discount rate appropriate to the project risk.

C_t = net cash inflow during the period t

C_o = total initial investment

r = free risk discount rate

t=number of periods

The problem with this technique is that it does not measure the scenarios that may occur during the same time the project is active.

If you don’t know which discount rate should be used in the formula, just consider the WACC rate of your company to reflect the opportunity cost.

2.    IRR (Internal rate of return)

Is the interest rate at which the NPV of all the benefits and cost cash flows from a project or investment equal zero.

So, you need to compare r, with other investment IRR that the company makes with the same duration. Notice that the IRR does not measure the absolute size of the investment or the return. This means that IRR can be applied to investments with high rates of return, even if the nominal amount of the return is very small. Be aware that the IRR does not consider cost of capital and cannot be used to compare projects with different durations.

If you find a 5% IIR in your IT project but you have other with 9% considering same duration, just choose the second choice.

3.    Real Options

A real option is a right, but not an obligation, to make an action (defer, expand, leave ...) on a real underlying asset (draft investment ...) at a specific cost.

In contrast with the traditional NPV method, this approach recognizes the ability of managers to delay, suspend or abandon a project once it has started. An investment is modeled with the equivalent of a stock call option in which the project manager has the right, but not the obligation, of buying something of value at a future date.

The concept of real options is based upon the fact that management does have the flexibility to alter decisions as further information becomes available. If future conditions are favorable, a project may be expanded to take advantage of these conditions. On the other hand, if the future is unfavorable, a project may be curtailed or even canceled as the conditions suggest and warrant. A traditional NPV analysis does not take these factors into account.

Most research related to the valuation of information technology (IT) investment projects are real options, however, has been limited to the application of the Black-Scholes (BS) formula. Other applications use an options-tree approach based on the binomial model. From my experience, the best choice.

In an IT development project, assets are not acquired instantaneously; rather, it is the result of a development project having an uncertain duration time in which the firm keeps investing at a rate that is less than or equal to a maximum investment rate. Only until the project is completed and the remaining cost (K) is zero, the firm will receive the underlying asset (V).

Developing a model for the generic IT investment project is not trivial because the time in which Cash flows start to be received is also a random variable. However, if we assume a deterministic time to start receiving the cash flows, we can easily adapt the acquisition model for this purpose.

Real options NPV = traditional NPV + real option value

A common strategy to mitigate risk in IT projects is to divide the project into smaller phases. Each phase is committed sequentially with a stage gate at the end of the phase.

This framework gives management the opportunity to review the project at the end of each phase, if finished phases are not generating business value, management may decide not to continue.

Expanding the analysis, read this paragraph from Mark Jeffery:

“Each phase therefore incorporates real option value, at the end of each phase management is actively deciding whether to continue the project, and working to leverage learning to improve results in later phases. These phases each have real option value, since at the end of a consolidation phase management has the option to fund the next phase.

An important management question is: ‘What is the optimal phase-wise deployment strategy that balances risk and return?’ We will use a real options approach to answer this question, and show that the answer depends upon the risk, or volatility, of the project and the traditional NPV of each phase.” Mark Jeffery.

I will mention an example: the implementation of any kind of information system requires one year and comprises four stages: initial preparation, construction, test and go live and will be finished in 1 year, so in 1 year we will know if the project will be successful or not.

According to the explanation in this article, we can have 3 ways to calculate the project value considering a real option to continue, cancel or wait to star the project.

Note: If you choose the formula of Black-Scholes, remember is a normal distribution assumption.

Soo, let’s start with numeric example:

Real options NPV = traditional NPV + real option value 

Real options Project = NPV project + NPV Start 1 year option value, for example here we are considering 2 possible results, successful or not successful project.

The initial investment of the project is 40.000 VEF and the benefits to be in 1 year 150.000 VEF, remember both variables changes stochastically over time as we saw in the stages.

If project is successfully implemented, The NPV of project in 1 year will be 150.000 VEF, if project is not successfully implemented the NPV in 1 year will be 30.000 considering 10% free risk interest rate.

The company wants to know the project value considering a cost of opportunity of 20% of return based on the best second opportunity to invest.

Then, we choose the cost of opportunity as our best discount rate to calculate NPV.

Conclusion: in this example is not good decision to implement the IT solution due to negative NPV considering two options.  We can consider any options as we could analyze, but depends on what requirements, assumptions and probabilities to consider in each occurrence. In this case, I recommend making a complementary analysis with Monte Carlo Simulation.

Next, what happen when we like to cancel an ongoing project??    See you next..!

Daniel juvinao

Banking: Customers View - Q&A Part II

The Bank is good performing with current Banking Core, and then what do you suggest we need to improve?

In this case, transactional Core business is good supported but is this information available to CFO, COO, CMO, CEO….?

What about information visibility to managers and when is available to make decisions?

So, from my experience, this is the order of things you need to focus in order to support Directors and Managers to conduct appropriate decisions on time:

a.       Strategy Vision (Try to understand why your company need to perform this process
b.      Financial Vision (Where  money come from and what is going to be used for)
c.       Operational Vision (Understand your macro chain processes and evaluate their pensiveness to a and b points.
d.      Risk Vision (In any step of your vision, focus in: operational risk, credit risk, market risk, free risk, franchise risk and cross border risk, translate to figures and triggers)
e.      Shareholder vision (What do they expect from their capital)
f.        Competitive vision (Understand your market share and position in your peer group)
g.       Market Vision (Understand what your company wealth is producing for market)
h.      Working Capital (Do we need a plan career, a valuable position, avoid competitor stolen, provide training on specialist matters and culture)

Once you have evaluated these eight points, you need to answer from top down way, what IT can offer for your company.

Check de following picture I do for you:

 

As you can see, try to focus yourself in the company and start to interact with peers to find an appropriate sponsor to improve numbers and performance.

How can I convince the company that actually needs to implement a solution to improve my team performance?

It’s not an easy way to convince your boss, but I suggest four points to at least he thinks about it

1.     KPI Based, use your team KPI performance and calculate how much you think can improve with a new solution
2.        Objectives Based, measure not reached objectives and probes you can reach this year with the new solution.
3.       Vision & Mission based, align your point 1 and 2 with your boss Objectives and CEO Vision into a special RFP. Include a functional rationale a business rationale, and an Overall better performance due to better deliveries to other areas.
4.        Resources Based, use a capacity plan with your current team and create a cost plan that allows you to define the need to hire external resources.

 Be prepared to defend your proposal!

How can I make a capacity plan to actually convince my boss?

You should actually think like him to start a proposal. So, to convince your boss, you need to include her experience and skills as your adviser to your proposal, next try to mix your objectives with her feedback.

Next, answer five questions to him:

1. Who
2.  How
3. When
4. Where
5. Risk & Opportunities

At this point, only you need your teams cost by hour, sizes your subordinates’ occupancy % and demonstrate they are at least 85% working.

Next, calculate how many hours do you need to do not interrupt your current service and how many labor hours you can use to continue in compliance with your current KPI.

In other words, you can work in your usual job as the new project, even without altering your current performance.

Finally, translate to numbers, hours, weeks and occupancy%

Finance & IT: RENTABILIDAD EN LOS BANCOS

Finance & IT: RENTABILIDAD EN LOS BANCOS

RENTABILIDAD EN LOS BANCOS

Es vital para la operación bancaria adaptar sus procesos para responder a sus usuarios internos y externos en tiempos más cortos.

Generalmente existe la tendencia de comparar los estudios realizados en el contexto bancario entre diferentes regiones. El impacto en el margen financiero hace de los informes resultantes de estos estudios contar con métricas comparativas que no necesariamente representan la realidad de un mercado de oferta y demanda de dinero en un contexto diferente en cuanto a regulaciones, clientes, cultura, etc.

En nuestra región los Bancos se adaptan al uso de aplicaciones focalizadas, no siempre con el equipo  y la asesoría apropiados. No hace sentido tener toda una gama de servicios bancarios disponibles en una región, si estas no están en su contexto y uso orientados a ofrecer  adecuadas soluciones fácilmente adaptables a las necesidades reales de los clientes. Estas soluciones usualmente se venden y obligan a ser adaptadas en lugar de ser adoptadas, generando así más trabajo, mayores cambios, más costo y mayor esfuerzo, temas que al final pueden resultar también más frustrantes por invertirse mucho más tiempo en su implementación.

Las inversiones destinadas a las mejoras operativas basadas en reducir los tiempos de las tomas de decisiones deben estar apoyadas por los mejores de la industria, no se da terreno al fracaso, ya que afecta directamente los resultados del banco por diferentes ángulos (clientes, morosidad, errores operativos,..., finalmente rentabilidad).

¿Cómo se puede incrementar la rentabilidad de un banco en términos prácticos que involucren mejoras de procesos simples y apoyo tecnológico focalizado?.

Se deben definir cuáles son las prioridades de un banco comercial, donde su principal cliente en las latitudes latinoamericanas tiene una cultura propia de consumo, expectativas y necesidades inmediatas  fundamentadas en  el entorno actual.

 

 

 

El impacto regulatorio en el margen financiero exigen la mayor de las capacidades de todo el equipo y una orientación destinada a la eficiencia financiera. ¿Cómo se puede lograr esto sin apoyo tecnológico?, ¿cómo se logra reorientar la tecnología para apoyar a los funcionales en el trabajo de entender la situación del Banco y tomar las decisiones de negocio asertivas en el momento adecuado?     .

¿Qué se pregunta el CFO cada vez que llega a su oficina?

·         ¿Cómo van los Costos vs Ingresos?

·         ¿El nivel de Liquidez está dentro del margen de tolerancia?

·         ¿Se han optimizado los costos transaccionales?

·         …

¿Qué se pregunta el CMO?

·         ¿Cómo están los niveles de atención de mis canales?

·         ¿Ha mejorado la rentabilidad por cliente?

·         ¿Se ha mantenido el nivel de lealtad y satisfacción del cliente?

·         …

¿Qué se pregunta el COO?

·         ¿La Plataforma está operativa?

·         Razones que afectan el nivel de Morosidad en este entorno

·         ¿Se aplican las evaluaciones de riesgo y se canalizan las políticas de cumplimiento?

·         …

Para lograr responder algunas de estas preguntas se han desarrollado soluciones que permiten re direccionar el trabajo tecnológico al funcional experto en la materia y descargar el área TI de su enorme responsabilidad como es mantener la operación disponible 24x24.

 ¿Qué soluciones proponemos para medir la rentabilidad y tomar las decisiones acertadas?

Un conjunto de soluciones que permiten responder todas las preguntas expuestas anteriormente y muchas más…  SAP EPM y SAP BI, portafolio de soluciones corporativas destinadas a crear una vista integral y consistente en los diferentes ángulos expuestos anteriormente. https://help.sap.com/boepm/

¿Cómo se define rentabilidad en los bancos?, como ROA, ROE, Margen,  Spread(%) y todos aquellos ratios que permitan relacionar el flujo de caja o resultado neto con los recursos invertidos.

¿Qué pensaría si hablamos de rentabilidad por agencia?

Primero debemos decir que para la continuidad de la operación y desarrollo de la agencia, ésta debe ser rentable; así que medimos efectos cuantitativos (volumen de negocio, margen financiero bruto, tasas, gastos)  y cualitativos (nivel de atención) que impactan al resultado total del banco. Son entidades casi autosuficientes que distribuyen productos y servicios. Cuando miramos el portafolio de SAP EPM encontramos la solución que permite modelar esta visión de rentabilidad y se llama SAP PCM (Profitability and Cost Management) y cuando miramos SAP BI encontramos soluciones que permiten extraer información y crear indicadores que permiten medir la rentabilidad.

SAP PCM ofrece una interfaz más intuitiva y enfocada a ser utilizada por el equipo de finanzas, por esto es una herramienta más flexible que puede ser utilizada de manera independiente al equipo de TI.

Ambas se integran con aplicaciones BD SAP y No-SAP

 BENEFICIOS

En relación a las necesidades de información

Mayor calidad de los informes de rentabilidad y costes en diversas dimensiones ya que SAP PCM elimina los repartos de ingresos, costes, gastos e inversiones por capas y los hace a través de iteraciones con un gran volumen de datos y dimensiones.

·         Rentabilidad por cliente.

·         Rentabilidad por canal de atención.

·         Rentabilidad por agencia.

·         Costes por servir.

·         Costes logísticos.

·         Costes por transacción de back, middle y front office.

·         Valor del cliente en el tiempo.

·         Utilidad económica (Valor económico agregado) por objeto de coste.

Diversas alternativas para emitir la información, ya sea en informes web propios, emisión de datos a otras bases de datos y data warehouse ó herramientas de inteligencia de negocios sean o no SAP.

 

En relación al modelo y proceso financiero

•        Manejo del modelo financiero de manera independiente al área de TI.

•        Flexibilidad para manejar diversas versiones del modelo financiero (Real, Presupuesto,

Pronóstico, Valor económico agregado).

•        Interfaz del usuario cumple con estándares tipo CAM-I o BBRT para la elaboración de

Modelos de rentabilidad y costes complejos.

•        Facilidad para hacer escenarios de simulación, planeación basada en indicadores y

Pronósticos continuos.

·         Informes de errores y advertencias de cálculo que permiten al responsable del modelo tener un mejor control de los cálculos para mantener la seguridad y veracidad de la información que se provee a los usuarios.

·         Facilidad para crear pantallas web de captura de datos y drivers que no se encuentren en alguna aplicación o base de datos.

·         Ejecución de cálculos de un gran volumen de datos en tiempos cortos (este punto sin duda es un gran diferenciador).

 

 

Este artículo en su primera edición se  dedica a rentabilidad y manejo de costos, posteriormente en próximos artículos se irán analizando las diferentes soluciones SAP EPM que consideran Planificación y Estrategia y otras soluciones para implementar Modelos predictivos.