Return on investment (ROI) is a calculation that can help you determine whether a business purchase is worth its weight. It calculates the money you can gain from an investment and gives you an idea of efficiency increases.
When it comes to investing in new software, many businesses think in terms of how it will impact the numbers. This is where calculating ROI can come in handy.
As a payroll software provider, many of our conversations with businesses centre around the topic of costs and benefits. Great solutions will help streamline your operations and boost productivity, cutting down billable time and automating tasks. However, it can be difficult to make a strong business case based on figures.
In this article, we cover a step-by-step method to calculating the ROI of new payroll software, as well as the pitfalls of solely relying on measurable gains in your business decisions.
How to calculate the ROI of software
A return on investment (ROI) is a set calculation that is applicable to any business asset. Here’s the formula:
ROI = [Gain on investment – cost of investment] divided by [cost of investment]
When it comes to software, this will translate to:
ROI = [£X saved by using software – £X spent on software] divided by [£X spent on software]
In other words, the value of new software is calculated by the monetary gains it brings with it, set off against its costs.
When you purchase new software, there will be a temporary setback in terms of time spent onboarding and training your team, however the true value will become clear after this stage.
On this basis, your initial ROI calculation will include upfront costs and implementation time commitments. This is why we recommend several ROI calculations later on in this article.
Before then, let’s split the formula down further.
1) Gain on investment
In the context of payroll software, gain on investment refers to the money you can save through increased efficiency. Optimised solutions will save you billable time and allow your team to redirect time to other business tasks.
You should also consider the cost difference between your existing system and the new system. In some cases, you may increase your software bills for something that pays for itself in its benefits.
This means you’ll need to work out the cost of your existing system in the same way you’ll work out the ‘cost of investment’ of the new one – we’ll cover this in a little while.
For now, we’ve included this in our formula below (cost of old solution – cost of new solution).
Gain on investment = [Annual time spent running payroll in hours] x [Payroll team hourly salary] divided by [Projected amount of time saved (e.g. divide by 2 for 50%)] + [Cost difference between new and old software]
The tricky part is estimating the projected amount of time saved, as it depends on your current software and assumes the new solution will meet expectations. That’s why we suggest forecasting both a pessimistic and an optimistic estimate, then landing somewhere in the middle.
Bear in mind that your new software may not include some of the features that currently save you time, so factor this in for an honest representation.
If you’re moving from legacy software that’s on-premise and not automated to a cloud solution, we’d suggest a conservative 30% productivity increase. If you’re already in talks with software vendors, it’s worth asking how much of an increase in efficiency they would anticipate.
2) Cost of investment
This refers to all the costs associated with purchasing new software (and as mentioned, you can use it to calculate the cost of your existing solution). This will include the following:
- The software itself – upfront and ongoing
- Employee training
- Cost of employee time spent onboarding
- Maintenance of IT to support software
- Technical support
- Data migration and storage
- Additional costs if your business grows
- Subscription services for apps
- Hidden costs (upgrades, premium features, etc)
Note: some of these may be one-off costs while others may be ongoing or annual. Run a calculation for 1) the first year 2) the second year to compare ROI once you’ve been up and running for a period of time.
An example calculation
Let’s put the calculation into practice.
1) Work out the cost of investment
Firstly, we need to calculate the costs involved with purchasing new software. Add up the costs of the below, plus any other associated costs, for both your new and old software.
- The software itself
- Employee training
- Cost of employee time spent onboarding
- Maintenance of IT to support software
- Technical support
- Data migration and storage
- Additional costs if your business grows
- Subscription services for apps
- Hidden costs (upgrades, premium features, etc)
Once you’ve got these figures, you’ll be able to subtract the cost of the new software from the cost of your old software. For sake of example, let’s say the new software costs £10,000 in the first year compared to your old software that costs £12,000 on average per year. That’s a £2,000 saving – we’ll use this figure in the next section.
2) Work out the gain on investment
Here’s a reminder of our formula for this:
Gain on investment = [Annual time spent running payroll in hours] x [Payroll team hourly salary] divided by [Projected amount of time saved (e.g. divide by 2 for 50%)] + [Cost difference between new and old software]
Let’s assume your payroll team collectively spends 80 hours a month running payroll, that’s 960 hours annually. You can work out a rough figure by pulling data from your time tracking tool, or by asking your team for an estimate. You’ll then need to multiply the annual hours spent running payroll by their collective hourly salaries to calculate the labour costs.
In our example, we assume two people run payroll on an hourly rate of £12p/h:
960 hours (80 hours per month) x £24 (combined hourly salaries) = £23,040 a year spent on labour
Assuming the new software would boost productivity by 30%, that’s a £6,912 gain of investment in the first year. However, let’s tweak this to include the cost difference of the new software.
So, if the new software costs £2,000 less annually, this leaves us with a gain on investment of £8,912 in the first year.
3) Calculate the ROI
Now’s the part where we put the pieces together and calculate the ROI. Here’s the formula again:
ROI = [Gain on investment – cost of investment] divided by [cost of investment]
Adding in the calculations we’ve made, here’s what we have.
ROI = [£8,912 saved by using software – £10,000 spent on software] divided by [£10,000 spent on software]
In that case, we’re left with an ROI of -10.88%. Meanwhile, in the second year, assuming the removal of upfront costs takes the cost of investment down to £5,000, it would be an ROI of 78.24% – and that’s assuming the % of improved efficiency didn’t increase.
While the initial figure doesn’t look impressive, let’s consider the alternative. If you stick with the same software, there would be no gain of investment, meaning it would solely be a cost of investment plus labour, without the potential of savings.
Using our examples, this would look like:
£12,000 (cost of investment) + £23,040 (cost of running payroll) = £35,040
compared to
£10,000 (cost of investment) + £23,040 (cost of running payroll) – £8,912 (gain on investment) = £24,128 in the first year
That’s a saving of £10,912!
Plus, that’s in the first year. Productivity may increase as your team becomes accustomed to the software and costs may go down following the initial start-up costs, which would increase the ROI.
For a better view of ongoing ROI, complete step 3 but remove any start-up fees (e.g. training, onboarding) from the cost of investment.
Another significant factor is the additional business you could take on as a result of process efficiencies. Continuing with the assumption of a 30% productivity boost, your business will be able to increase the number of workers on your payroll, increasing your revenue totals.
The caveats (because forecasting is never clear cut)
As shown in our above example, sometimes ROI can paint a negative picture of an investment when this isn’t necessarily the case. However, the process of calculating ROI will make you aware of your current expenditure and where you can cut costs.
Plus, the figure is only an assumption based on:
- The estimated time saving from your new software
- The amount of time spent running payroll currently
- Your current business size and payroll requirements
Framing it in a financial light means you could find it hard to make a business case for the software if the numbers are poor. Upgrading your software is often worth the investment from the point of view of propelling your business forwards, for example, by moving away from on-premise software.
ROI also doesn’t account for other non-financial gains from new software:
- Increased satisfaction from payroll staff, strengthening employee retention and reducing turnover
- Improved experience from workers and clients, through touch-points such as worker portals and communications
- Improved leverage when dealing with prospective clients (if an outsourced payroll company or umbrella / agency)
- Optimised systems and improved data security, helping to futureproof your business
To summarise
We often speak with businesses that want to discuss the commercial value of moving to Codapay payroll software, which we’re always happy to do. However, we encourage them to look at the wider picture. While cost savings are an important consideration in any business, moving to a new provider is an investment that can pay off in more ways than increased revenue
So, take your projected ROI with a pinch of salt and think practically in terms of how a new solution could benefit everyone involved.
While you’re here, check out our cutting-edge payroll software for umbrella companies, recruitment agencies, payroll bureaus and accountants. If you like what you see, book a free, no-commitment demo!
