Calculating Labor Costs for ROI

Return on Investment (ROI) is often associated in financial reporting as a ratio of the amount of return over the amount invested. It is also an indicator when looking at ROI and ROE in terms of evaluating leverage of a company among other valuable information. In terms of projecting a possible outcome on a proposed project, calculating ROI is a critical step in determining the viability of the execution of that project. Essentially, but calculating an ROI and providing a time frame of when a company may see the return on the capital it invests can determine if the project is even worth doing or at a minimum, when the company may break even from the investment. Also, it is a valuable component to gain the confidence of stakeholder’s interest in the project. In short, calculating ROI for a project is a key first step in the project management and project execution process. It is also an essential part of the Six Sigma management strategy used by many corporations worldwide. mathway calculator

One key component of this process that is often undervalued or overlooked is the calculation of labor in the overall costs of the project. In looking at how ROI for a project is calculated, it is evident that including labor costs into the project as a key resource, such as computer hardware/hardware or any other types of equipment is essential. There are a few methods to consider when calculating labor costs as a component to ROI.

Calculating ROI

First, it is important to understand the ROI calculation of a project. This can be broken down at a high-level into the following components:

ROI = [(Financial Value – Project cost)/Project costs x 100

Financial Value

Many people view the financial value component of ROI as an intangible or subjective value. It does not need to be. The key is to break the project down into known values, defining those values and then compare those to what is expected from the project. These values have the same main components: time, volume and dollars or costs and these apply to both the current value and the projected value once the project is implemented. This results in the following equation:

Financial Value = TVDPresent State – TVDFuture State

Where T = Time, V = Volume or quantity units, D = costs

Project Costs

This value of calculating ROI is where our labor costs come in. Note, there may be a component of labor in the Financial Value calculation as it can be a quantity unit if the project will have ongoing recurring labor costs. However, since there is always labor associated with any project, you should always have labor in the Project Costs Calculation.

The Project Costs variable calculation is comprised of two variables, Work Decomposition Over Time and Cost of Required Work. Work Decomposition Over Time is essentially the Project Management Tasks components that have been valued as detailed as possible over time. For example, picture all of the tasks associated with building a simple wooden box. There is a time to design the box, determine the materials to be used and to draw out a pattern. There is the period to purchase materials, there is a period to deliver the materials, a period to construct, a period to detail the structure, etc. For each of those tasks, there are costs associated but in order to assign these dollars, the Work Decomposition over time is essential. Often a project management tool is used to do this break down such as a Ghatt chart, process flow diagram or Work Breakout Structure (WBS) is used to define the all tasks and associated tasks.

Next, the Cost of Required Work are applied. For each task, an evaluation of costs of ALL resources associated with that task should be evaluated and applied. These include: Resources (type and quantity needed), Hours work is to be performed, Wage rate per resource (more on this in a moment), capital costs ( equipment, hardware/software costs), and any lease/rental costs. Basically, anything that will expense money to the project at that task should be included. This is where we apply cost to labor to the calculation and how to best determine what to include.

What Labor Costs To Consider

Labor costs can vary from project to project. Some projects will be executed using internal resources (i.e. full time employees), others may be bringing in an outside contractor and still others that may use a combination of both. You may even have labor associated with the project long term, like a resource who will be responsible for the management and execution of the final result once it is completed, essentially a recurring costs. In all of these cases, it is important to apply the right metric to the costs calculation of your ROI.


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