Return on Investment and Cost-Benefit Analysis


Return on Investment and Cost-Benefit Analysis

ROI is profit or savings (benefit) divided by capital invested (cost).

—David H. Miles

Return on investment (ROI), an accounting invention by DuPont during the 1920s, is increasingly being invoked in the world of learning and performance. Here are some initial definitions and steps, plus pointers to expert texts on the topic, and also an explanation of cost-benefit analysis, which is directly related.

ROI is a measure of financial performance that is used to project revenue or savings in order to position the cost of training as an "investment" rather than a cost. In its simplest terms, ROI is defined as return (or profit or earnings during a given accounting period) divided by the capital that was invested. Here is the formula:

To make this clearer, let's take an example. Let's assume that during your first year as training manager you spend $100 for training, and that this results in $125 of additional sales for that year. The formula would look like this:

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Note that one must always give the time period involved, in this case a year. ROI is always for a specific period of time; otherwise it is meaningless. This time period must be included in the final figure, as "an ROI of 25 percent per year." The challenge in calculating ROI for training is in attaching dollars and cents to what is often an abstraction, namely improved performance. The books listed in the Fastpaths section below will help you along this route.

Cost-Benefit (Inverse ROI)

ROI can be computed either before or after a training initiative. If after-wards, it assesses the payback or breakeven point in time of an investment; if computed beforehand, it represents a projected ROI, and this projection is sometimes called a cost-benefit analysis. Like ROI, cost-benefit analysis can be extremely complex, but is always used for the same basic purpose: to determine whether a given initiative is worth funding. It sets out the factors that need to be taken into consideration in making such an economic decision, and as such, it is an essential tool for strategic planning and decision-making. Cost-benefit analysis (projected ROI) asks the basic question: "Will this given project save more money in the long run than it costs?" Using the previous ROI example (a $100 cost and a $25 benefit or return), the cost-benefit ratio would be 4 to 1 (per year), as follows:

Notice that cost-benefit is the same thing as projected ROI, but with the numbers inverted: A 25-percent ROI, as in the present example, represents a 4-to-1 cost-benefit ratio.

Fastpaths

1971

Ezra J. Mishan: Cost-Benefit Analysis. A classic text, updated numerous times since.

1972

Richard Layard (ed.): Cost-Benefit Analysis: Selected Readings. The Introduction and Part I provide good overviews. Updated several times since.

1983

Jack J. Phillips: Handbook of Training Evaluation and Measurement Methods. One of several titles by Phillips, who specializes in evaluation and ROI. Available in more recent editions as well.

1986

Lyle Spencer: Calculating Human Resource Costs and Benefits: Cutting Costs and Improving Productivity.

1995

John Noonan: Elevators: How to Move Training Up from the Basement. Noonan, basing his work on Lyle Spencer (1986), adds a creative suggestion for extrapolating Level 4 ROI from Level 1 interview data—when no financial data for ROI is available. Offbeat but plausible in certain situations, given appropriate disclaimers. (See "Tips for Level 4" in Evaluation: The Four Levels and ROI section.)

1996

Anthony Boardman et al. (eds.): Cost-Benefit Analysis: Concepts and Practice. Updated several times since.

1997

Jack Phillips: Handbook of Training Evaluation and Measurement Methods.

2000

Jac Fitz-enz: The ROI of Human Capital.

2001

Matthew Adler and E. Posner (eds.): Cost-Benefit Analysis: Legal, Economic, and Philosophical Perspectives.

2002

Patricia Phillips: The Bottom Line on ROI: Basics, Benefits, and Barriers to Measuring Training and Performance Improvement.

See also Evaluation, Level 4