In simple terms, a return on investment (ROI) analysis, oftentimes called a cost-benefit analysis, seeks to estimate and compare costs and benefits of an undertaking. This cost-benefit analysis can be used in any or all of three ways:
As a planning tool in choosing among alternatives and allocating scarce resources among competing demands;
As an evaluation tool to study an existing project or service;
As a way to develop quantitative support in order to politically, economically or socially influence a decision.
The first two ways in which an ROI can be applied make the most sense from an economic perspective when comparing alternative projects; the third use may be the most common in the public sector. It is important to recognize that it’s difficult to accurately calculate or estimate the value of the benefits of a service and that those benefits will occur for many years to come. Costs are much easier to determine, assuming an effort has been made to identify and include all relevant recurring and non-recurring costs. And “positive thinking” may lead to underestimating the time and costs to complete a project.
How Can the Tool Help You?
By using ROI, EMS organizations can better position themselves to justify and maximize the impact of their investments and initiative. ROI can be used as both a planning and evaluation tool.
Using ROI as a planning tool: During the planning process before implementing improvement actions, projected ROI can be calculated to estimate how long it will take for an intervention to break even—that is, for the returns of the project to offset the upfront and ongoing implementation costs.
Using ROI as an evaluation tool: Actual ROI can be calculated after a project has been implemented to assess its value and inform decisions on future improvement actions. This analysis can be done using actual data gathered as the project moves forward.
Calculating and Interpreting Return on Investment (ROI)
An ROI is calculated as the ratio of two financial estimates:
Where the numerator and denominator of this ratio are defined as follows:
Economic gains: The financial gains from the implementation of the improvement actions, which are generated by net changes in quality, efficiency and utilization of services, or in payments for those services.
Investment costs: The costs of developing and operating the improvement actions.
The step-by-step procedure described here can be used to perform ROI calculations to assess your financial return on improvement actions and projects that you either are planning or have implemented.
The term “improvement actions” refers to any program or initiative that aims to improve the quality, productivity, safety, operational performance or financial stability of the EMS organization.
Step 1: Determine the Basic ROI Design
Before starting the calculation of an ROI for any given improvement actions, you will need to make four design decisions that will structure the approach to the analysis:
Define the scope of services affected by the improvement actions. Some actions will be limited to making improvements in one specific aspect of the organization (e.g., clinical functions only), and others will have a broader scope (e.g., across all department functions). Carefully define the scope of services to be included in the ROI calculation, and ensure that financial estimates are specifically related to that scope of services.
Define the timeline for implementation of improvement actions. When implementing improvement actions, those actions will occur over a time period that could be as short as a few months or as long as years. The ROI analysis needs to capture when those actions change the department’s operating functions over time, to be able to estimate both the implementation costs and the financial effects of improvement actions. If changes occur over years, you will need to adjust the estimates for inflation and discount future costs and revenues.
Define the comparison group. To estimate the numerator (net return portion) for the ROI ratio, you need to compare the organization’s functions under two conditions—with the improvement actions implemented and without them. Typically, this will be a comparison over time, with the “before” condition being the service processes before improvement actions, and the “after” condition the service processes after implementation.
Capture complete information on financial contributors. To obtain the most accurate ROI estimate, you will need to identify and quantify as many of the financial contributors as possible for both the numerator and denominator of the ROI formula. For a planning phase ROI, you will be working with your best estimates of improvement action costs and of the components of net returns. For a post-implementation ROI, you will have actual data from your financial system on those contributors.
Step 2: Calculate the Return on Investment
To calculate the ROI for the improvement actions, you will develop estimates for both the numerator and denominator of the ROI ratio:
Net returns from the improvement actions (the ROI ratio numerator)
Investment in the improvement actions (the ROI ratio denominator)
The main benefit of using ROI and the reason for its popularity is the simplicity of its calculation. ROI estimates the return of an investment by looking at the benefits and costs associated with the investment. ROI is particularly easy to calculate and understand when compared to other financial tools such as net present value (NPV), internal rate of return (IRR) and payback period. Although the calculations for these financial tools are more complex, the results are arguably more accurate. Nonetheless, ROI is an appropriate first step for estimating the economic return of an investment.
ROI is also a useful vehicle to communicate the return of an investment to those who have varying degrees of financial knowledge. The ROI concept allows EMS managers to speak the same language when communicating project goals in financial terms to, for example, elected bodies whose members might have limited financial knowledge.
In addition to being useful as a communications vehicle, ROI can be used as an initial filter in the evaluation of projects. For example, ROI can be calculated for all the projects and only those projects that exceed a minimum ROI are further analyzed. Thus, ROI can identify worthwhile projects without using considerable resources.
Other ROI benefits include the use of the tool to establish an initial framework of assumptions to ultimately determine the value of the project. The ROI calculation forces a thorough thinking of investment variables such as intangibles, risk and timing. These assumptions are as important as the ROI calculation itself because they are the inputs that will ultimately impact the overall ROI result.
To understand the benefits and potential of using the ROI methodology, one also has to understand its limitations. EMS managers having a clear understanding of the limitations can take full advantage of the methodology without overextending its value as an evaluation tool.
Simplifications—Time Value of Money/Risk
The ROI calculation does not take into account the time value of money, or the risk associated with a project or investment. The time value of money concept says that a dollar earned today is worth more than a dollar earned tomorrow. This is particularly true when considering other investment alternatives and the effect of inflation from a macroeconomic perspective.
In addition, the risk of the project needs to be accounted for by incorporating all the possible financial outcomes associated with the project. These possible outcomes include the possibilities that the project will not yield the expected results because of the inherent risks of the project.
The fact that risk and the time value of money are omitted in the ROI calculation may cause EMS managers to mistakenly reject projects that otherwise should have been approved. This is particularly the case if projects with different risk profiles were compared using the ROI methodology.
ROI calculations may over value investments, since the equation favors short-term savings and overlooks long-term costs such as maintenance, support and software upgrades. This problem is the result of using a one year or longer time span in the standard ROI calculation to determine the value of the project. Therefore, projects having large costs in the future may incorrectly appear to give a higher return because the future costs are not included in the calculation. This problem may be averted if, for instance, the project is software as a service. In this case the vendor would bear long-term risks and upgrade costs in most cases.
The fact that ROI can be calculated several different ways creates a problem of consistency. Few organizations have developed a single ROI methodology, thus making it difficult to accurately compare and evaluate the economic return of several projects.
This problem is accentuated when comparing the value of projects with multiple vendors, each of whom may have used a different methodology to arrive at the ROI for their particular product. EMS managers selecting a vendor have the task of untangling the true ROI from each vendor, and creating a normalized, single view for comparison purposes.
Formulated and interpreted correctly, ROI tools and techniques can be a very powerful tool for EMS managers when evaluating various competing projects and initiatives within the organization. More so, decision makers and elected bodies responsible for approving the financial support of these initiatives are demanding that they be presented with a more complete picture of the return for any dollars allocated under ever tightening financial considerations that all organizations face today. ROI can be a powerful tool in supporting your organization when competing for limited dollars.
Steve Cotter, MBA, NREMT-P serves as an at-large member of the Board of Directors for the National EMS Management Association.