Conduct Cost—Benefit and Risk Analysis

By this stage, you should have a financial estimate of benefits and costs, and when these will be incurred. These are now brought together in a cost—benefit analysis. The cost—benefit analysis will determine the value for money of the transformation programme.

A variety of measures exist to analyse costs and benefits. These include such measures as Return on Investment (ROI), internal rate of return (IRR) and net present value (NPV). The measure that is most widely used across both public and private sectors is the NPV.

NPV is widely used because it provides a more accurate tool for evaluating costs and benefits over a number of years. A traditional analysis of a programme's costs and benefits simply adds together each year's cost or benefit and subtracts total costs from total benefits to produce a total net benefit figure for the programme. This analysis does not recognise that a £5 million saving today will not necessarily be a £5 million saving next year or the year after because the financial value of costs and benefits changes over time.

The NPV method addresses this problem of fluctuating costs and benefits by converting the value of future costs and benefits to today's actual value. The NPV delivers this analysis by applying a discount rate to the costs and benefits in future years of a transformation programme which compensates for the fact that costs and benefits will fluctuate over time.

Therefore, when using the NPV there are three key steps:

• forecast the costs and benefits for each year of the transformation programme;
• apply a discount factor to the forecasted costs and benefits for future years;
• add the cumulative savings after the discount factor rate has been applied.

The cost—benefit analysis is, however, not the only factor that will be taken into account in approving the business case. The risks in achieving the predicted benefits need to be considered. It demonstrates that when assessing risks there are a number of factors to consider, these include:

• Defining the risk. This should provide a clear statement of what will happen if the risk is not managed.
• Mitigation. This should summarise the actions that are required to manage the risk and prevent it from happening.
• Probability. This is a subjective assessment of the likelihood of the risk materialising and could change when the risk register is reviewed. Typically these are classified as:
  • 0% — will not happen
  • 25% — unlikely to happen
  • 50% — equally likely to happen or not to happen
  • 75% — likely to happen
  • 100% — will definitely happen
• Impact. This is an assessment of the impact that the risk will have upon the programme if it materialises and involves determining whether the impact is high (red), medium (amber) and low (green). The impact is also considered in three areas:
  • time, that is, will the risk extend the deadlines and time required for the programme;
  • cost, that is, will the risk require additional expenditure to manage if it materialises;
  • performance, that is, will the risk adversely affect the ability of the programme to deliver its benefits and hit its financial and non-financial targets.