Because organizations are financially driven, they are likely to place the greatest value on the economic benefits a program generates. Developing the capacity to accurately estimate the economic impact of projects may demand research, new technologies, new systems, and/or the delivery of training. Some economic sources of impact are very concrete and quantifiable (e.g. capital costs, formulaic government incentives), while others will demand a more subjective assessment of their expected cost or benefit (e.g. risk of utility prices increasing, employee retention). Each will require a unique approach that cannot be universally prescribed and will vary based on the level of measurement accuracy and reliability that is deemed worthwhile. The key is that the limitations of existing economic measurement capacity are identified and addressed while working in collaboration with those responsible for the finances of the organization.
Calculating a Payback Period
There are many ways to measure the potential economic impact a project can generate, but we will focus on one invaluable technique: the payback period.
A payback period is simply the length of time required for the capital invested into a project to be recovered through revenues or savings that are subsequently returned. The payback period is especially valuable because it provides a concrete measure of the net financial impact a project is expected to have on an organization over time and so it naturally appeals to decision makers concerned with the bottom line.
The calculation of payback periods is quite commonly performed but rarely considerate of all relevant sources of economic impact. Often, calculations only consider primary cost savings against the initial capital investment required. The following is a broader list of sources of economic impact that may be relevant and valuable to consider as part of calculating a complete payback period:
- External Grants and Loans: funding available from external sources may reduce or eliminate the need for capital to be invested internally.
- Capital Required: is the internal budgetary contribution required to undertake a project including any purchases required as well as the cost of implementation. If a project, like the replacement of a boiler, is already planned and budgeted, it may only be relevant to consider the incremental capital required to pursue a (in most instances) more expensive, environmentally sound choice.
- Borrowing Costs: with most loan programs, interest is paid on the borrowed amount.
- Operating and Maintenance Costs: some projects may result in an increase or decrease in ongoing operating costs, depending on what is required after they are implemented.
- Carbon Offsets Generated / Tax Avoided: voluntary markets exist through which verified carbon offsets have a concrete financial value today. In some places, controlled markets already exist that facilitate carbon trading. Similarly, carbon taxes are already being imposed in some jurisdictions. If carbon trading or taxes don’t affect an organization, this source of impact can be used as a measure of risk in the form of a future potential cost to bear or revenue lost.
- Training Costs: some projects may demand new training be provided.
- Loses Due to Disruption: the implementation of projects may temporarily impact daily operations, resulting in the loss of revenues or productive time.
The following sources of impact only apply to projects that involve the replacement of physical assets with solutions that consume fewer resources e.g. LED lights or low-flow toilets.
- Avoided Maintenance & Replacement Costs: a new asset that has a longer expected lifetime will save money by not needing to be maintained or replaced as frequently.
- Utility Savings: a more efficient asset will reduce energy or water use, saving money.
- Projected Increases in Utility Pricing: credible, publicly-generated projections show how utility prices will increase over time. Assets that use less will save more as prices climb.
- Utility Incentives: some organizations offer guaranteed funding in exchange for demonstrated utility savings.
Establishing an agreed-to payback period calculation is likely to help garner the interest of decision makers, especially when projects demonstrate they offer a return that is greater than the cost of borrowing. In some cases, organizations are known to commit to projects if deemed to offer a payback period below a particular threshold of time.
Financial risk represents a set of unique sources of impact that can be tremendously important, though also particularly difficult to quantify. Risk simply refers to exposure to some form of consequence or danger. Many organizations attempt to quantify risk with some degree of accuracy, while others simply consider it more intuitively. Some may use statistical quantities like expected values and standard deviations, while others may use best-case/worst-case scenario projections to get an understanding of risk.
Projects that address sustainability often provide a means for reducing exposure to different forms of financial risk, which should be measured as part of recognizing the full benefit of taking action. Whatever method your organization chooses, it is important that there is some official recognition and, ideally, quantification of financial risk.
To learn about a risk management framework used to assess and manage environmental and social projects click here