NPV is not Enough: Manage your Risks
Evaluating projects using NPV is not enough: take control of your project risks. Financial analysts need to dig deeper in order to understand the returns of corporate projects. Solely relying on classical financial analysis, such as Net Present Value (NPV) and Internal Rates of Return (IRR), is not sufficient to indicate if a project is viable or not. It is necessary to go a step further and appropriately manage risk in order to understand the viability of a given project.
Before Jumping to Conclusions
MBAs love to crunch numbers. This is our forte and our weakness! Give us a spreadsheet full of data and within no time we will came out with all sorts of corelations, rates of returns and indexes. We love digging data and finding the obvious, the oblivious and not so obvious.
But, in reality, jumping directly into calculations can be major distraction and hide major issues in the analysis of a project at hand. Doing a quantitative analysis before looking at the qualitative aspects of a business problem is equivalent to processing a pile of documents without looking if these documents need to be processed in the first place.
Managing your Risks
In order to do an appropriate analysis, consider risk management as one of the most essential elements of your evaluation process. Before starting your analysis, plan your work and find out how risks will be identified and managed.
- Start early: include risk management at the early stages of your analysis. A risk registry, i.e. a simple list of risks, can make an enormous difference when evaluating the project.
- Define a methodology: establish simple and concrete rules on how you will manage risk throughout your analysis. Simple ground rules will help you move faster when analyzing complex projects.
- Qualify before quantifying risks: Look at the qualitative elements of your project first. What is the economic environment? How other projects in the organization can affect this analysis? What is the corporate culture? Has this been done before? Qualitative elements should be considered first before trying to assign numbers to risks and before jumping into a deeper financial analysis.
- Iterate, iterate, iterate: Check the results of your final financial analysis against your risks identified. Revisit your figures once you identified risk mitigation plans and evaluated your results. Understand your risks in order to avoid archiving a project because of extreme risk aversion issues.
When doing the financial analysis of your next project, do your number crunching. But, consider risk from the beginning and incorporate risk management throughout your evaluation process. I am sure you will have much stronger decisions with that.
Corporate Risk Related Articles
Here are some interesting references related to Enterprise Risk Management. They describe a bit more how not considering risks can affect your financial decisions.
- What Is Your Risk Appetite? by Alan Gemes and Peter T. Golder
Well-considered risk taking is critical, not just for the success of individual companies but also to enable a properly functioning economy. - Dynamic management: Better decisions in uncertain times by Lowell Bryan
Companies can’t predict the future, but they can build organizations that will survive and flourish under just about any possible future. (Premium membership required) - How to Develop a Risk Management Plan by wikiHow
An example of how to colect, analyse and quantify risks.


