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Actionable Analysis

Creating a Financial Pro Forma

By Shane Atchison, ClickZ, Sep 21, 2006

In my recent reality marketing columns, our fictional CMO aligned his team to improve accountability and get more value from his Web analytics data. As part of that effort, he established a 12-month series of mandates. One of them is to "create a financial pro forma for the value of site behaviors and goals."

Pro forma statements contain the projected effect of business initiatives. In other words, if a company decides to implement changes to its Web site, it should create a financial pro forma that lays out, in dollar terms, how those changes should improve the bottom line.

We almost always begin a Web engagement by asking our client what the financial goal of the initiative is. The question doesn't make everyone comfortable. We find marketing professionals can be intimidated by terms like "pro forma," particularly as they involve math. But though they can be complex to implement, these documents aren't at all tough to understand.

Defining ROI

The heart and soul of a financial pro forma is to calculate the ROI (define) of an initiative. Basic ROI is a key financial metric that determines the value of business investments and expenditures. Mathematically speaking, it is a ratio of net benefits divided by costs and is usually expressed as a percentage:

ROI = [(monetary benefits - cost)/cost] x 100

An ROI Calculation

Let's say a company's e-business team wants to implement Web services technology, which will cost $75,000. They believe the initiative will result in a 10 percent increase in software automation. What does that mean to the company as a whole? Does it make financial sense to do so?

At this point, the e-business team has the Web analysis group look at other data. They learn each 1 percent increase in software automation increases overall annual profit by $25,000 per year. This would yield $250,000 in a 10 percent increase. The company can calculate this investment's ROI as follows:

[($250,000 - $75,000)/75,000] x 100 = 233%

Payback Period

ROI is merely a percentage, however. To get real visibility into ROI, you also need to look at payback time. This is the time it takes an investment to pay for itself. For example, if a $100,000 investment in Web services technology generates $400,000 a year in profit, it pays for itself its three months.

Payback periods are very important. What if you make an infrastructure enhancement that will pay for itself in four years? Chances are, the particular change you made may be replaced by other systems before it pays for itself. In that case, you'd realize a net loss rather than a gain.

Payback Period Analysis

The best way to understand the value of an initiative is to use payback period analysis. This methodology looks at the entire effect an initiative will have on every aspect of a company's bottom line. It then calculates the length of time it will take for the initiative to yield enough returns to pay for the initial investment.

To do this, you have to look at the initiative's direct and indirect benefits. Direct benefits measure the cash flow generated by the initiative. Indirect ones include such things as overall brand impact. They're more much more difficult to measure.

Some examples of direct benefits include:

Visit-to-purchase conversion
Online media units
E-mail conversions to purchase
Articulation and measurement only moderately difficult
Self-serve via the Web vs. higher cost channels, such as retail or phone systems (IVR)
Automation of services, such as account access in financial services and airlines
Account tracking

Indirect benefits include:

Word of mouth
Brand affinity
Visit length
Product consideration
Branded entertainment
Communities

Of course, other metrics can be useful in payback period analysis. Customer lifetime value, value of leads, and value of cost savings can all contribute to overall ROI.

Conclusion

With his new insistence on financial pro forma reporting, our fictional CMO will be able to understand the financial impact of every Web initiative his company undertakes. That way, he can focus on things that help the bottom line... and shelve those that don't.

Are you doing something similar? Have questions or need clarification? Shoot me an e-mail, and I may include your story in an upcoming column.

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Biography

Shane Atchison

In 1998, Shane co-founded ZAAZ to advocate a different approach to Web services — one that respects and delivers on the power of the individual and the promise of Web technologies. As CEO, Shane leads the company's long-term strategic vision of working with leading financial service organizations, consumer brands, startups, non-profits, and community-based organizations, helping each realize the potential of the Internet and its meaningful impact on their business. He has over 11 years of strategic consulting, business development, and advisory experience in Web marketing, design, and customer relationship management. Prior to building ZAAZ, Shane was a partner in a Web development firm, overseeing strategy, service delivery, and business development. His clients have included Converse, Starbucks, T-Mobile, Disney, Fox Television Network, Microsoft Corporation, National Geographic, PBS, Warner Brothers, Boeing, and Washington Mutual. Shane has been a keynote speaker for major conferences and business associations, including eTail, eMetrics, CREDO, the DMA, and AIGA. Together with Jason Burby, he's co-author of Actionable Web Analytics: Using Data to Make Smarter Business Decisions. Shane lives with his family in Seattle, Washington.