Small-business owners often need more than just their own money before they open the doors or choose to expand. Private investors or established financial institutions want to know why they should finance someone else's idea. A common way to present a project is through a business plan that includes an overview, a strategy for implementation and projected financial data. Net present value and the internal rate of return are two popular methods of demonstrating whether a project will be a good investment. A common but less-effective method is the profitability index.
Non-Financial Data
An explanation of what a project will entail is as important as its expected financial results. Investors want to see that a business owner has a well-thought-out plan, including contingencies. A thorough plan should include who the project will benefit, potential roadblocks and the reasons for its implementation. Some investors are primarily swayed by the project's idea and its principles. For example, some investors back projects based on their social value. An example of a project with social value would be the building of a new homeless shelter.
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Net Present Value
Most investors want to know that they will get something in return. At the very least, they need to know whether an investment will make financial sense. Net present value is a calculation that shows the present-day value of a project's expected future income minus its initial cost. Future income is discounted according to an acceptable return rate. A positive net present value means that a project will make money. Higher net present values tend to be strong indicators of profitability.
Internal Rate of Return
The internal rate of return is an effective calculation, because it shows the project's return rate when net present value is zero. Instead of figuring out a project's present value at a predetermined rate, this method shows what that rate will be at the break-even point. Higher income projections tend to correspond with higher rates of return. Some investors have a minimum rate of return in mind. They will decline to lend money to initiatives that are not likely to produce this rate.
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Profitability Index
The profitability index divides the present value of a project's expected future income by its initial investment. According to the index, a project that has a calculation greater than one is a good investment. If the project has a calculation of less than one, it does not make financial sense. Higher profitability index calculations translate to higher returns. Projects that have strong index calculations -- such as two or three -- will be competitive contenders for investors' dollars.
