This is a primer for engineers and operations managers who are hazy about concepts such as the time value of money, discounted cash flow (DCF), net present value (NPV), or internal rate of return (IRR). It is meant to level the playing field for them when dealing with MBAs to whom it’s “Business 101.”
J.M. Juran introduced these terms to distinguish ways professionals discuss their work. The language of the shop floor is that of things, not money. It is a world where you speak in numbers of units made, time spent, or weight consumed, and it is several organizational layers removed from the boundary of the company where money changes hands.
Executives, on the other hand, speak the language of money. Operations generate the cash needed to meet payroll, pay suppliers, and generate the profits used to evaluate their performance. Middle managers are caught in between, expected to speak both languages and translate between the two. It is a tall order, and few can do it.
Shop floor metrics
To be effective, the metrics used on the shop floor should be expressed in the language of things, and translated into the language of money for communication up the management chain. For example, a common way to summarize the effects of improvements on a production line is as box scores like the following:
The columns are “As is” and “To be” when the table is about a proposed design, and become “Before” and “After” once it is implemented. While it clearly shows a line doing more with less, it does not show it in terms of money spent or earned.
This is not to say that financial information should be hidden from shop-floor people; only that it should be made available on request rather than broadcast or posted on bulletin boards and reviewed in daily huddles.
Financial metrics
Metrics based on financials are useful, but at a higher level of aggregation than a cell and for other audiences than teams of operators. In some areas, it is also difficult to derive financial metrics that accurately reflect the business impact of activities and events on the shop floor.
Cost of Quality (COQ) metrics, for example, are limited to the direct costs of failure, appraisal and repair, which do not even begin to account for the sales impact of the company’s reputation for quality. In the Quality Control Handbook, Frank Gryna explicitly excluded such items from the COQ as being too complex and too controversial.
This term is used differently when analyzing the economics of an investment and in everyday conversations, even among professionals. The name seems self-explanatory, as in: “an investor who buys shares in a company expects a return.” It is supposed to be a ratio, but is sometimes confused with the payback period, when you hear managers say things like: “the ROI on this investment is three years.”
In management accounting, on the other hand, it has a precise meaning as a ratio, not an amount of money and not a time. It is the inverse of the payback period. If it takes three years for an investment to break even, then its ROI is 33.33%.
It is also at the pinnacle of a system of ratios that Alfred P. Sloan designed at DuPont in 1915 to compare the performance of divisions in different businesses:
Sloan took this model to GM, and many companies still use it more than 100 years later. For details, see The Lowdown on Lean Accounting.
Net Present Value (NPV) and Internal Rate of Return(IRR)
Payback Period or Breakeven time, and ROI are crude measures, insufficient because the purpose of investing is not just to get your money back but to make a profit.
In a 1907 paper entitled The Rate of Interest, economist Irving Fisher first formulated the notion of the difference in value between instant and deferred gratification: the same amount of money is worth more to you when available now than at some future time.
This difference is exclusively a function of the delay and would exist even with a perfectly stable currency. No one alive today has ever experienced a stable currency and most likely never will. As a result, it is easy to confuse the effect of a delay in receiving money with that of inflation, but they are different. Even with the currency retaining its purchasing power, we prefer money today than a year from today.
Although simplistic, this model supports an analysis of the economics of a project through its entire life cycle rather than until the company recoups its investment.
Per Wikipedia, the net present value theory entered economics and business textbooks in the 1950s. By the 1980s, pocket calculators and electronic spreadsheets could handle the calculations needed to apply it to projects. This allowed masses of project leaders to comply with managers’ demands for these numbers without necessarily understanding what they meant.
The Discount Rate
The key parameter of this theory is the discount ratei. It has the dimensions of an interest rate, but this is not the context of a loan. It means that, for a sum S_1 received a year from now to be equal in value to a sum S_0 today, we must have S_1 = (1+i)S_0. The same rate applies to subsequent years, so that, after n years, S_n =(1+i)^n S_0.
This says that the Net Present Value (NPV) of a sequence of amounts (S_1, \dots, S_n) received or spent at yearly intervals is
The discount rate varies among individuals and institutions. Risk is a factor in the difference between instant and deferred gratification, but discounted cash flow analysis does not explicitly mention it. A dollar received today is a certainty; a year from now, it’s not so sure. Economic agents bundle their perception of risk into the discount rate they choose to use.
The Net Present Value
An investment involves both a schedule of outflows and a schedule in inflows. For a new production line, for example, you first buy equipment and then incur recurring operating expenses. In the other row, you have the revenue from sales of products from this line. Here is a simple example:
If the net present value of the inflows exceeds that of the outflows, the plan for the new line is profitable. In this example, with the discount rate at i=15% the Net Present Value of the schedule of outflows given by Excel’s NPV function is $1,284,486, and, for the inflows, $1,785,441. In other words, this ten-year schedule is equivalent to a transaction today, where you buy something for $1,284,486 and sell it for $1,785,441, at a 39% margin.
The choice of the discount rate obviously makes a difference, particularly in the effect of the distant future. The higher it is, the more heavily discounted the future amounts are, and the more the short term matters. In companies that evaluate projects in this manner, the accounting department sets the discount rate. The project leaders just use it. It is commonly based on the company’s Weighted Average Cost of Capital (WACC), which represents the mix of retained earnings, debt, and equity used to finance the company’s investments.
The Internal Rate of Return (IRR)
When you use the Internal Rate of Return (IRR), the discount rate is the output, not an input. If the outflows of your project were loans and the inflows were repayments on this loan, the IRR would be this loan’s interest rate. Formally, it is the discount rate that equalizes the net present value of the inflow and outflow schedules.
It is not easy to calculate the IRR manually. Since the 1980s, software has been doing it on long schedules instantly, which has made it a popular metric. However, using the IRR() function in Excel and understanding what it means are different things. In the example, IRR = 23%.
Companies that use IRRs to approve projects often set a hurdle rate that may seem unrealistically high. Any project with an IRR exceeding the WACC is profitable, but that’s not enough. You have to factor in how management plays the project game. The managers in charge of approving a project expect its advocate to make a credible case based on aggressive numbers. While they don’t really expect these numbers to come true, they won’t fund a project where the advocate’s optimistic projections don’t clear a high hurdle.
The most extreme case of this kind of behavior is venture capital. Venture fund managers look for investments to multiply in value by a factor of 7 to 10 within 3 to 5 years. In terms of returns, these correspond to yearly rates between 48% and 115%. They do this because the minority of projects that succeed pays for the majority that don’t. At the opposite end of the spectrum are individual retirees willing to take low but safe returns.
Funds Flows versus Cash Flows
The outflow schedule contains both capital investments and recurring expenses. You buy machines .up front, then operate and maintain them, and consume materials on an ongoing basis.
While the literature often calls this a schedule of cash flows, the entries do not necessarily correspond to cash payments. They represent commitments instead. A $1M machine is a commitment of $1M to the project. This is true regardless of whether you pay for it in a lump sum or on an installment plan. How you finance the investment is irrelevant to this analysis. This is why some authors talk about flows of funds rather than cash.
The same logic applies to the inflow schedule. They are revenues from sales, recognized in this schedule for the customer commitments they represent. It doesn’t matter how customers finance their purchases.
Company Valuation
Assume an infinite sequence of future yearly earnings and a discount rate. Then their net present value is the value of the company. When you invest in a company, you are not really buying a share of its assets but a share of its future earnings. It’s not what the company has acquired in the past, but exclusively about its future.
Beyond intellectual satisfaction, however, this valuation is, in most cases, practically impossible. You never know future earnings, particularly decades into the future, and there is no standard discount rate to go by. Investors use other valuation metrics, such as price-to-earnings ratios.
Project Valuation
By considering the entire life of a project and focusing on the commitment of funds, this method avoids discussing depreciation, a highly gameable concept central to the unit cost calcul ations traditionally used to evaluate projects.
Discounted Cash Flow analysis depends on point forecasts for future inflows. These become less and less reliable as you look farther into the future. In principle, you should be able to work with probabilistic forecasts.
The schedule of outflows usually also includes charges for shared resources, like floor space, a paint shop, and machines used by other products. What to charge each product for the use of a shared resource is a whole other problem.
References
For details, see Chapter 6 in Eric A. Helfert’s Techniques of Financial Analysis. It provides clear explanations for professionals who are not specialists in finance.
Mar 9 2026
The Language of Money for Engineers and Managers
This is a primer for engineers and operations managers who are hazy about concepts such as the time value of money, discounted cash flow (DCF), net present value (NPV), or internal rate of return (IRR). It is meant to level the playing field for them when dealing with MBAs to whom it’s “Business 101.”
Contents
The Language of Things and the Language of Money
J.M. Juran introduced these terms to distinguish ways professionals discuss their work. The language of the shop floor is that of things, not money. It is a world where you speak in numbers of units made, time spent, or weight consumed, and it is several organizational layers removed from the boundary of the company where money changes hands.
Executives, on the other hand, speak the language of money. Operations generate the cash needed to meet payroll, pay suppliers, and generate the profits used to evaluate their performance. Middle managers are caught in between, expected to speak both languages and translate between the two. It is a tall order, and few can do it.
Shop floor metrics
To be effective, the metrics used on the shop floor should be expressed in the language of things, and translated into the language of money for communication up the management chain. For example, a common way to summarize the effects of improvements on a production line is as box scores like the following:
The columns are “As is” and “To be” when the table is about a proposed design, and become “Before” and “After” once it is implemented. While it clearly shows a line doing more with less, it does not show it in terms of money spent or earned.
This is not to say that financial information should be hidden from shop-floor people; only that it should be made available on request rather than broadcast or posted on bulletin boards and reviewed in daily huddles.
Financial metrics
Metrics based on financials are useful, but at a higher level of aggregation than a cell and for other audiences than teams of operators. In some areas, it is also difficult to derive financial metrics that accurately reflect the business impact of activities and events on the shop floor.
Cost of Quality (COQ) metrics, for example, are limited to the direct costs of failure, appraisal and repair, which do not even begin to account for the sales impact of the company’s reputation for quality. In the Quality Control Handbook, Frank Gryna explicitly excluded such items from the COQ as being too complex and too controversial.
The problem is that what he included is negligible compared to what he excluded. Just ask Firestone about tread separation, or even Toyota about its 2010 recalls. As a result, the COQ cannot be used to justify improving quality.
Return On Investment (ROI)
This term is used differently when analyzing the economics of an investment and in everyday conversations, even among professionals. The name seems self-explanatory, as in: “an investor who buys shares in a company expects a return.” It is supposed to be a ratio, but is sometimes confused with the payback period, when you hear managers say things like: “the ROI on this investment is three years.”
In management accounting, on the other hand, it has a precise meaning as a ratio, not an amount of money and not a time. It is the inverse of the payback period. If it takes three years for an investment to break even, then its ROI is 33.33%.
It is also at the pinnacle of a system of ratios that Alfred P. Sloan designed at DuPont in 1915 to compare the performance of divisions in different businesses:
Sloan took this model to GM, and many companies still use it more than 100 years later. For details, see The Lowdown on Lean Accounting.
Net Present Value (NPV) and Internal Rate of Return(IRR)
Payback Period or Breakeven time, and ROI are crude measures, insufficient because the purpose of investing is not just to get your money back but to make a profit.
In a 1907 paper entitled The Rate of Interest, economist Irving Fisher first formulated the notion of the difference in value between instant and deferred gratification: the same amount of money is worth more to you when available now than at some future time.
This difference is exclusively a function of the delay and would exist even with a perfectly stable currency. No one alive today has ever experienced a stable currency and most likely never will. As a result, it is easy to confuse the effect of a delay in receiving money with that of inflation, but they are different. Even with the currency retaining its purchasing power, we prefer money today than a year from today.
Although simplistic, this model supports an analysis of the economics of a project through its entire life cycle rather than until the company recoups its investment.
Per Wikipedia, the net present value theory entered economics and business textbooks in the 1950s. By the 1980s, pocket calculators and electronic spreadsheets could handle the calculations needed to apply it to projects. This allowed masses of project leaders to comply with managers’ demands for these numbers without necessarily understanding what they meant.
The Discount Rate
The key parameter of this theory is the discount rate i. It has the dimensions of an interest rate, but this is not the context of a loan. It means that, for a sum S_1 received a year from now to be equal in value to a sum S_0 today, we must have S_1 = (1+i)S_0. The same rate applies to subsequent years, so that, after n years, S_n =(1+i)^n S_0.
This says that the Net Present Value (NPV) of a sequence of amounts (S_1, \dots, S_n) received or spent at yearly intervals is
S_0 = \sum_{k=1}^{n} \frac{S_k}{\left ( 1+i \right )^k}The discount rate varies among individuals and institutions. Risk is a factor in the difference between instant and deferred gratification, but discounted cash flow analysis does not explicitly mention it. A dollar received today is a certainty; a year from now, it’s not so sure. Economic agents bundle their perception of risk into the discount rate they choose to use.
The Net Present Value
An investment involves both a schedule of outflows and a schedule in inflows. For a new production line, for example, you first buy equipment and then incur recurring operating expenses. In the other row, you have the revenue from sales of products from this line. Here is a simple example:
If the net present value of the inflows exceeds that of the outflows, the plan for the new line is profitable. In this example, with the discount rate at i=15% the Net Present Value of the schedule of outflows given by Excel’s NPV function is $1,284,486, and, for the inflows, $1,785,441. In other words, this ten-year schedule is equivalent to a transaction today, where you buy something for $1,284,486 and sell it for $1,785,441, at a 39% margin.
The choice of the discount rate obviously makes a difference, particularly in the effect of the distant future. The higher it is, the more heavily discounted the future amounts are, and the more the short term matters. In companies that evaluate projects in this manner, the accounting department sets the discount rate. The project leaders just use it. It is commonly based on the company’s Weighted Average Cost of Capital (WACC), which represents the mix of retained earnings, debt, and equity used to finance the company’s investments.
The Internal Rate of Return (IRR)
When you use the Internal Rate of Return (IRR), the discount rate is the output, not an input. If the outflows of your project were loans and the inflows were repayments on this loan, the IRR would be this loan’s interest rate. Formally, it is the discount rate that equalizes the net present value of the inflow and outflow schedules.
It is not easy to calculate the IRR manually. Since the 1980s, software has been doing it on long schedules instantly, which has made it a popular metric. However, using the IRR() function in Excel and understanding what it means are different things. In the example, IRR = 23%.
Companies that use IRRs to approve projects often set a hurdle rate that may seem unrealistically high. Any project with an IRR exceeding the WACC is profitable, but that’s not enough. You have to factor in how management plays the project game. The managers in charge of approving a project expect its advocate to make a credible case based on aggressive numbers. While they don’t really expect these numbers to come true, they won’t fund a project where the advocate’s optimistic projections don’t clear a high hurdle.
The most extreme case of this kind of behavior is venture capital. Venture fund managers look for investments to multiply in value by a factor of 7 to 10 within 3 to 5 years. In terms of returns, these correspond to yearly rates between 48% and 115%. They do this because the minority of projects that succeed pays for the majority that don’t. At the opposite end of the spectrum are individual retirees willing to take low but safe returns.
Funds Flows versus Cash Flows
The outflow schedule contains both capital investments and recurring expenses. You buy machines .up front, then operate and maintain them, and consume materials on an ongoing basis.
While the literature often calls this a schedule of cash flows, the entries do not necessarily correspond to cash payments. They represent commitments instead. A $1M machine is a commitment of $1M to the project. This is true regardless of whether you pay for it in a lump sum or on an installment plan. How you finance the investment is irrelevant to this analysis. This is why some authors talk about flows of funds rather than cash.
The same logic applies to the inflow schedule. They are revenues from sales, recognized in this schedule for the customer commitments they represent. It doesn’t matter how customers finance their purchases.
Company Valuation
Assume an infinite sequence of future yearly earnings and a discount rate. Then their net present value is the value of the company. When you invest in a company, you are not really buying a share of its assets but a share of its future earnings. It’s not what the company has acquired in the past, but exclusively about its future.
Beyond intellectual satisfaction, however, this valuation is, in most cases, practically impossible. You never know future earnings, particularly decades into the future, and there is no standard discount rate to go by. Investors use other valuation metrics, such as price-to-earnings ratios.
Project Valuation
By considering the entire life of a project and focusing on the commitment of funds, this method avoids discussing depreciation, a highly gameable concept central to the unit cost calcul ations traditionally used to evaluate projects.
Discounted Cash Flow analysis depends on point forecasts for future inflows. These become less and less reliable as you look farther into the future. In principle, you should be able to work with probabilistic forecasts.
The schedule of outflows usually also includes charges for shared resources, like floor space, a paint shop, and machines used by other products. What to charge each product for the use of a shared resource is a whole other problem.
References
For details, see Chapter 6 in Eric A. Helfert’s Techniques of Financial Analysis. It provides clear explanations for professionals who are not specialists in finance.
Claude Riveline best explained these concepts in Évaluation des coûts: éléments d’une théorie de la gestion. France: Presses des Mines (1993). Unfortunately, this book is not available in English.
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