Once you've identified an opportunity for savings, you must determine the best way to exploit the opportunity. Let's say, for example, that ABC Inc. is manufacturing a new product that is expected to earn $200,000 a year and increase annual fixed costs by $85,000. You are an engineer at ABC and have researched semi-automatic and fully automated machines that produce this product. Now you want to compare costs so you can earn the most for your company.

Under Method A, you will buy the semi-automatic machines, which last 10 years and cost $250,000. Under Method B, you will buy the fully automated machines, which also last 10 years but cost $400,000. Depreciation, out-of-pocket expenses and interests costs for the two methods are shown here. Which is the better way to go?

An analysis of Method A shows that it will yield profits of $40,000, compared to Method B, which will earn the company $45,000 a year. You choose Method B.

Although the principles in this example are sound, analysis in the real world is much more complicated, because projects involve a complex series of time-dependent cash flows. This is further complicated by the time value of money and the effects of inflation. Cash today is generally worth more than the same amount of money a year from now because of the potential interest that could be earned during the next year (the time value of money) and the erosion in the future buying power due to inflation.

Fortunately, you can quantify and compare projects using established, financial-evaluation techniques that take all these factors into consideration. The most common technique is an incremental cash flow analysis.