SC QUALITY GUILDCost-benefit and payback
SCQUALITYGUILD.COM/TOOLS/COST-BENEFIT-PAYBACK.HTML
Compare the options for an improvement on payback period, net benefit, return on investment and net present value.
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Four ways to compare
- Net annual benefit: the yearly savings or added revenue, minus the yearly cost of keeping the change running.
- Payback period: how long the net benefit takes to repay the one-time cost. Simple and widely used; it ignores everything after the payback point.
- Return on investment: the total net benefit over the period minus the one-time cost, as a percentage of the one-time cost.
- Net present value: each future year's net benefit discounted back to today's money, minus the up-front cost. A positive NPV means the option earns more than the discount rate.
Why discount?
Money now is worth more than the same amount later, because it could be invested or used elsewhere in the meantime. The discount rate expresses that. NPV at a rate of 8% treats $100 a year from now as worth about $92.59 today. Finance will usually tell you which rate the company uses.
Fastest is not always best
A cheap fix may pay back in weeks and save less over three years than an expensive one that takes a year to pay back. The tool shows both, and flags when the fastest payback and the highest NPV are different options. Which matters more depends on the business: cash may be tight, or the product may have only a short life left.
Options that never pay back
An option whose running cost exceeds its benefit never pays back, however small its up-front cost. Adding inspection to catch defects is often in this category; removing the cause usually is not.
Benefits finance will accept
Agree how savings will be counted with finance in Define, not at the end. Hard savings (scrap, overtime, warranty) are easier to confirm than soft ones (time freed up, avoided risk).
On the Yellow Belt exam
Cost-benefit analysis is topic V.A.3 of the 2022 CSSYB Body of Knowledge.