Time and Money
By James M. Apple, Jr.
40 years ago, Sid Gilbreath, my favorite professor at Georgia Tech, drilled us on the time value of money in our course in Engineering Economy. As a result, I have always felt myself to be pretty proficient at calculating the return-on-investment (ROI) for materials handling projects. But, there are definitely some traps that I have fallen into myself.
Consider the simple cash flow diagram that shows negative and positive cash flows over the life of the project. The diagram illustrates a capital investment in year 0, followed by an annual savings for 10 years.
But, there are factors in real project life that alter the cash flow diagram.
Engineering and progress payments
Only when we buy an off-the-shelf machine that we can plug-in and turn on do we get instantaneous savings following the lump sum investment.
For large systems, the costs for engineering, progress payments and installation are spread over 1-2 years, before we can even begin operation and then enjoy the savings.
The system that we implement is designed to handle peak demands for some year in the future. Consequently, the actual annual savings will fluctuate with volume, usually beginning small in the first year, and then gradually rising as business grows. This should be reflected in the initial calculations, but will yield a much smaller ROI.
If business changes such that the projected volume levels never materialize, that too, will stretch out the payback, reducing the actual ROI.
Perhaps the most common, and most insidious project event is a significant delay in system start-up. The loss of expected savings in the first year, probably accompanied by additional costs for de-bugging and work-around operations will drop the ROI to a level below what would have been approved in the first place.
By the time we finally get things up and running, we may have spent more than the originally justified investment. Although a cost overrun certainly does affect the ROI, unless it is extreme, its impact is less painful than a delay.
Does all of this mean that we should shy away from capital projects? Not at all!
For, if we don’t invest in the future, it will surely be bleak.
Some principles to observe
- If a project won’t fly with a realistic budget, then don’t start.
- Prepare for extra help and training at start-up to avoid costly delays.
- If the system is especially complex, consider implementing in phases to reduce the initial investment and to make start-up more manageable.
- Be a clock-watcher. Time is everything.
ABOUT THE AUTHOR
James M. Apple, Jr. is a Director in The Progress Group. Prior to co-founding The Progress Group in 1991, he was a Partner with Coopers & Lybrand’s SysteCon division. During 1992-1995 he served as a Senior Systems Advisor with Vanderlande Industries, a major conveyor and systems provider in Europe.
Jim is an internationally recognized thought leader in the area of facility design and integrated distribution systems. His contributions to the improvement of distribution practices have been recognized by his receipt of the prestigious Reed-Apple Award, which is given for lifetime contributions to the advancement of the material handling profession. Jim has also received the Institute of Industrial Engineers’ Facilities Planning and Design Award. He has written numerous articles and handbook chapters on warehousing and logistics operations and is a popular speaker on logistics seminar and conference programs.
Prior to SysteCon, Jim worked as an Industrial Engineer with IBM, was Supervisor of Facilities Planning for the Oldsmobile Division of General Motors and was Executive Vice President for an automotive aftermarket parts supplier. He holds B.S. and M.S. degrees in Industrial and Systems Engineering from the Georgia Institute of Technology.
Source: The Progress Group