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A-Z of Business: R – Return on Investment (ROI)

Return on Investment (ROI)

You’re in business to make money, so understanding the return of your investment is critical.  You can do this in advance of your decision to invest and also to see how your investment is performing over time.  A related measure is the timing of your break-even point.  Can your business bear that delay as you wait for the returns to roll in?

A simple ROI calculation is the amount of financial gain divided by the amount invested multiplied by 100.  So, if you invested £10,000 to develop, manufacture and sell a new product, and the sales of that product achieved a revenue of £11,000 in year one, that would give you an ROI of £11,000 ÷ £10,000 = 10%.  That return is quite modest and, with related costs could signify a loss for your business.  What would it take to increase that to, say, 25%?  Or 50%?  And what about the potential sales year-on-year?

Sometimes the returns are less tangible, or less direct.  Instead of focusing on increased revenues, the return may involve a reduction in cost, an improvement in quality, an increase in customer satisfaction levels, enhanced employee morale, etc.  These should all have a consequent effect on your bottom line in time, though it is difficult to determine whether this improvement is as a direct result of the investment, or some other measure such as improved hiring decisions or the introduction of sales incentives.

These days a lot of marketing decisions have a longer term view.  For example, free applications being built as a loss leader to attract users to upgrade to more profitable versions of a product.

When planning the return on your investment, do be aware of the hidden costs which can erode your profits.  Costs such as legal fees, administration costs, equipment, maintenance, staffing, training, office space, design, manufacture, packaging, advertising, warehousing, distribution and also the cost of delays.  When budgeting and contracting services, do think about having project-based quotes with penalties for delays to preserve your investment.

Those of you that know me well will also know that I couldn’t write about ROI without mentioning the importance of thinking about the return of investment of your time and energy into a particular activity.  I wonder how much time and energy you spend on things which have little or no impact on the success of your business?  Just busy-ness getting in the way of business?  This impacts your bottom line too.

© Tricia Woolfrey 2013

About Tricia Woolfrey – click HERE to find out about the author.

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