PMP Exam Prep: Return on Investment (ROI)
Most organizations do not want to waste money. The Return on Investment (ROI) tool is a means to compare profits to costs to determine if funds were used effectively. ROI can be used as a predictive tool with expected profits and costs to inform future decisions, or, as an evaluation tool using known profit and costs to determine outcomes. ROI can be used in project management to evaluate potential future projects or the health of a project in progress. A PMP uses ROI when determining how to handle project changes.
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Return on Investment (ROI) Defined
Return on Investment (ROI) is not strictly a project management concept nor term. It is a financial tool applied in investment, business, and project management settings to evaluate decisions from a cost perspective. It can be used to measure or compare the profitability of investments. Consider this Return on Investment definition from a project manager conference paper:
|Return on Investment (ROI)|
Calculation of the rate of return for a given investment for a given period of time
– Source PMI.org Project Schedules Return Investment conference pager (https://www.pmi.org/learning/library/project-schedules-return-investment-7226)
Due to the value that the ROI formula can bring to the decision process within a project, it is a concept included in the Project Management Institute (PMI)’s potential topic areas for their Project Management Professional (PMP)® certification exam. At this time, the terms “ROI PMP” and “PMP ROI formula” are not included in the PMI.org online lexicon. Resources and papers on the Return on Investment formula and applications are available within the PMI.org materials, however.
Return on Investment (ROI) PMP Calculation
When determining the ROI for a project, the goal is to have a reliable value that indicates if there will be a positive return on the project’s investment. And from that return on investment calculation, your organization can decide on if resources should be put forward for the project. “Projects typically carry extra risks, and the ROI is a way to compare the project investment to other well-understood risks available.” To understand the ROI tool, it is important to know more than the definition of it but to also know:
- The quality of the figures used in ROI calculations directly impacts the accuracy of the ROI prediction
- Different organizations may include or exclude specific costs in the overall investment cost
- Spreadsheets and ROI calculators can add efficiencies to the calculations; if bad data is submitted into the tool, the calculation will be faulty
- Incorporate additional project time if the ROI is to be calculated during the project as it is time-intensive
Both Project Management Professional (PMP)® credential holders and those project managers seeking to earn their PMP® designation should seek training and/or collaborate with a financial professional when first using the return on investment tool.
To know the return on investment, in business or a project, the net profit must be known.
|Net Profit or|
|The total residual income that remains after accounting for all cash flows, both positive and negative |
– Source Investopdia.com (https://www.investopedia.com/ask/answers/031015/what-difference-between-gross-profit-operating-profit-and-net-income.asp)
Net Profit, or Net Income, is what funds are left after all expenses and costs have been paid.
Cost of Investment
The other core value needed for the return on investment formula is the cost of investment. It is exactly as the name implies: how much money was spent.
|Cost of Investment||Amount of money spent for the investment|
– Source Igi-global.com (https://www.igi-global.com/dictionary/investment-cost/15660#:~:text=1.,%2C%20i.e.%20the%20operational%20project)
The return cannot be determined if the investment is not known.
There are different formulas for ROI, and businesses and organizations may have their own. There is not an “ROI PMP” formula. Whether ROI is being calculated for a project or a business, the same tenants are used in the formula. Variances are in what term is used (e.g. Net Profit vs Net Income) and the scope of what is included when determining the costs. In the context of preparing for the PMP® certification exam, it is important to know the core ROI formula components and how they are used in the calculation.
Here, the ROI formula is presented using Net Profit (the “financial ROI” formula on top) and with Financial Value – Project Cost (the “project ROI” shown on the bottom). In fact, both depict the same thing but using different terms. Additionally, a business may be using ROI for an investment, not a project, so the term will be “Cost of Investment” vs the “Project Cost.” ROI is determined using the same mathematical process in both cases.
With the values inputted into the ROI formula, the project manager needs to know how to interpret the result. If the return on investment value is less than one, a negative value, there is no profit or financial gain in the project. If the calculation results in a value of zero, there is no loss nor gain. And finally, if the ROI calculation value is greater than one, a positive value, then there is a profit or gain from the project.
|0||Positive < 1|
|unprofitable||no loss nor gain||profitable|
A resulting ROI of zero or a negative value does not automatically mean the project should not be supported or halted. There can be cases where the loss is expected and seen as a risk worth taking to reach a larger goal. Project Managers should work closely with the financial or budget team and other stakeholders to know the parameters of acceptable risk, including how to best interpret the ROI result for the context of a specific setting.
ROI Example 1
ROI Example 2
PMP® exam questions may provide core ROI data from which the test taker must use knowledge of the ROI formula and application to select the strongest answer. Consider this PMP® exam example:
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Anticipated vs Actual ROI
PMP® exam questions may also be positioned to query if a project should be financially supported to proceed or if a project completed was a good investment. These sides of the ROI formula and calculation are referred to as “anticipated ROI” and “actual ROI” respectively.
|Anticipated ROI||Actual ROI|
|–calculated before project start|
–estimates for money amounts
|–calculated after the project ends|
-evaluation after the fact
–actuals for money amounts
The anticipated ROI can be used as a baseline after the project is underway or concludes to evaluate the accuracy of the initial estimates. The anticipated ROI could be calculated multiple times throughout a project as more actuals are known. Note, conducting ROI calculations and analysis can be time-consuming. If it is a tool to be used throughout a project, that time and resource effort should be included in the overall project plan.
What to know for the PMP® certification exam
The return on investment concept is an important one for business and project management. When preparing for the PMP® certification exam, know the core meaning and interpretation of the ROI calculation are potential question topics. Most likely ROI questions will present core information and the potential PMP® credential holder will need to evaluate those data points to determine the strongest option.
The ROI tool can be used in many ways: evaluating future project investments, monitoring costs for active projects, and profit margins for completed projects. In all cases, return on investment is a means to inform resource allocation. ROI can help answer: “where are funds best invested for the strongest outcome?” Project Managers can use ROI as part of overall cost and schedule tools to manage risks and achieve desired business results.
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