Financial Justification
Encyclopedia of Business Terms and Methods, ISBN 978-1-929500-10-9. Copyright © 2011 by Marty J.Schmidt. Revised 29 january 2012.
The Meaning of Financial Justification
A Financial justification is a business case that asks whether or not an investment is justified—in financial terms. Financial justification, in other words, is a business case analysis that helps decision makers decide whether or not to go forward with a proposed action. The financial justification case is also created for accountability purposes, to establish later that decision makers complied with regulations and policies, and that the action taken represents a good business decision.
The results of a financial justification business case address questions like these:
- Does the proposed software system represent the best use of funds?
- Can we use the proposed new building to improve our financial position?
- Will the proposed security service "pay for itself"?
It is distinguished from other business case approaches only by the special emphasis on financial decision criteria. Otherwise, a strong financial justification has the same characteristics as other kinds of business cases—a clearly communicated cost model and a good benefits rationale, for instance (see Business Case Essentials or the Business Case Guide for more on what makes a strong business case).
Just which criteria determine justification in any one case depend heavily on the organization's business objectives and the current business situation. A profit-making company with aggressive sales growth goals will probably focus on different criteria than a non-profit or government organization driven by the need to deliver high quality services. A company with cash flow problems or a net loss on the income statement will have different financial priorities than a company that is in excellent financial health.
A crucial early step in designing the financial justification business case, therefore, is to determine specifically which financial criteria are important to decision makers in the present situation. Depending on their needs and priorities, financial justification may be decided by any one or several criteria like the following:
- Projected net cash flow
- Net present value (NPV) of the projected cash flow (discounted cash flow analysis)
- Internal rate of return (IRR)
- Return on investment (ROI) for the proposed action
- Payback period
- Total cost, or Total cost of ownership
- Total capital costs
- Total operating expenses
- Cost per transaction (or cost per person, cost per seat, cost per ... etc.)
For a working spreadsheet examples of financial metrics calculations, download either the free financial metrics tool (click here), or the more in-depth coverage in Financial Metrics Pro.
All of these criteria can be derived from business case cash flow projections, which are usually estimated for a period of several years or more. Each criterion says something different about the advisability of making the investment.
For practical guidance on on building a financial justification business case see the Business Case Guide, or Getting Your Budget Approved, or the world's most frequently cited business case resource, Business Case Essentials.
[ Page Top ] [ FAQs ] [ Business Case Books & Tools ] [ Home ]
[ Pacioli ]
© Copyright Solution Matrix Ltd and 
Marty J. Schmidt+ 2004 - 2012. Legal notice. Unauthorized use or publication strictly prohibited under United States and International Copyright Law. Request permission to use.
