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How to Calculate ROI (Return on
Investment)
ROI (Return on Investment) is probably the most
important calculation one needs to make to ensure the long-term viability of
their business. It is not enough to build in a profit margin on the product or
service being offered. One must track with proficiency the amount of dollars
being invested into attracting sales and how much ROI those dollars put back
into the business. If the investment meets too little return, a product line is
doomed to fail in the long-term.
THE BASIC ROI PERCENTAGE
CALCULATION
Many experts seem to agree, “calculating an
accurate return on investment (ROI) is not an easy thing to do.”
I do not intend to give you a thorough analysis of the ROI calculation process.
Calculating an accurate ROI is hard to do, but explaining the full scope of ROI
calculations in less than 1000 words is far more difficult.
As such,
this article is only intended to introduce you to the basic concepts behind ROI
calculations. Here is a very basic equation for calculating the ROI:
ROI = [(Payback - Investment)/Investment)]*100
Your payback is
actually the total amount of money earned from your investment in your company.
Investment relates to the amount of resources put into generating the given
payback.
You should run ROI calculations on both monthly and yearly
timelines.
IMPROPER CALCULATIONS BY MANY SMALL BUSINESS
OWNERS
The actual amount of investment into a business is often
misunderstood by the business owner. As a result, true ROI calculations for
most small businesses are skewed.
Most small business owners make
their mistake in this most necessary calculation, because they do not properly
value their own time. Please note that when I previously defined
“investment”, I stated that it relates to the “amount of
resources put into generating the payback.”
Indeed,
“resources” includes cash money. But, it also includes “human
resources” or “time”.
If most small business owners
would value their hours at the minimum wage, and calculate their time into the
investment equation, they would soon realize that their small business is
running in the red!
Some small business owners will finally run ROI
calculations including the human resources, and suddenly realize that they
could make more money working a job. If the small business owner has been
running their business for a really long time, struggling to make ends meet,
they might see this calculation and close their doors once and for all.
PLEASE DON’T LET ME DISCOURAGE YOU
I do not
share this revelation with you so that you will close your business down. Quite
to the contrary. I share this with you so that you can see the big picture and
start running your business in a way that will actually generate a real profit
for you and your business.
If you are within the first two years or
five years of the start of your business, then running in the red should not be
thought of as a bad thing. However, if you are ten years into your business and
earning less than minimum wage from your business, there is a serious problem
afoot that needs to be addressed immediately.
STARTING
OUT
When you are just beginning your own business, you have plenty
of time on your hands. This is the reason why most small business owners do not
properly count their time in the ROI equation. They just look at cash
expenditures and incoming monies, and they are satisfied with that
calculation.
It is often said that people generate the kind of results
that they believe they can achieve or the kind that they want to achieve.
Seeing the goal is the first step to achieving the goal. Expectations will
always bring results equal to the expectation.
Having been down the
business startup path before myself, I too understand the desire to calculate
ROI without consideration to the time invested in the enterprise.
However, I also understand the importance of placing a value on my time and
working that into my final numbers.
In the beginning, I ran two types
of ROI calculations: all resources exempting my time, AND all resources
including my time.
Of course, I actually set a higher expectation for
my own income level. First, I had decided on ten dollars an hour for my time.
Later, I adjusted that amount upward.
Starting out, even though I ran
two versions of my ROI calculations, I relied first on my resource excluding my
own time. Once I had achieved this goal, then I refocused my attention to
reaching the ROI which took into account my own time.
Now, that time
has passed, I can go back and look at my yearly ROI and see that I have earned
enough cash to pay for those early days of famine.
THE SECRET
OF TURNING ROI CALCULATIONS INTO SUCCESS
Every step in your
business startup is a calculated guess as to what you believe you can
achieve.
Measuring your results is essential to making your business
profitable. ROI measurements are imperative to measuring and understanding the
results you are achieving with your new or existing business.
Take
into account all factors relating to the profitability of your business and
don’t smudge on the facts to make it seem more profitable than it really
is. It is important to approach your business and your business results with
absolute honesty. Be honest with yourself and face the facts of your task.
An honest examination of your business at regular intervals will help you
get on and stay on track to keep the doors of your business open. You will
thank yourself later.
Copyright © Stone Evans, The Home Biz Guy
About The Author:
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