Investment appraisal techniques

Effective investment appraisal does not consider an investment in isolation. Instead, you should consider how the investment could contribute to your overall strategic objectives.

Some investments can offer strategic benefits for your business. For example, you might invest in extending your product range so that you can supply more of the products that your key customers want. An investment like this could help strengthen your brand and your relationship with your customers.

Often, one of the key benefits of making an investment can be the skills your business learns and the future opportunities that may arise. For example, you might invest in developing and trialling a new product even if you don't expect to make any profits at that stage.

If the trial is successful, you can use what you have learned to make a larger, more profitable investment in bringing the product into full-scale production.

On the other hand, making an investment can limit your flexibility to respond to future changes. For example, you would not want to invest heavily in new manufacturing equipment unless you were confident of the demand for your product - see investment risk and sensitivity analysis.

Timescales can also be an important strategic issue. For example, shareholders may prefer investments that are expected to produce a quick return - see payback period.

A useful test for a possible investment is to think about your alternatives. For example, instead of buying new machinery you could:

• do the minimum necessary to maintain your existing machinery
• achieve a similar outcome a different way, eg by outsourcing production to a supplier
• invest in an alternative project instead