A-Head for Success

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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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A-Z of Business: F – Finance – 5 Tips to Help Your Business Succeed

 

1.  Cash is King

Cash flow is the main reason for business succeeding or failing.  An apparently successful business may have a full order book, and even good levels of projected profit, but if funds cannot be collected from customers in a reasonable timescale the business will fail.  You should ensure your customers are aware of your payment terms before carrying out tasks and where possible advanced payments, should be requested.

Tip – Get paid on time by ensuring you have regular communication with your customer and that you have an effective credit control procedure.

 

2.  Overtrading

This is where a business has a full order book but struggles to convert turnover (sales) into profit.  This situation usually develops when tasks are taken on at a cheaper rate when compared to competitors in order to secure orders.  Subsequently, the business becomes very busy but the income generated is not sufficient in order make a profit, and so the business fails.  This strategy can be used carefully in order to try and build a reputation but for small businesses it should not be used in the long-term.  Remember “turnover is vanity, but profit is sanity”.

Tip – You are usually in business to make money so ensure you do not under-sell your products or services unless you have a clearly defined plan.

3.  Control the Controllable

Fixed costs – these costs do not vary regardless of the business activity undertaken, i.e. rent and rates.

Variable costs – these are dependant on the level of activity, i.e. heat and light or staff overtime.

Tight control and effective monitoring of these costs is essential.  Whilst fixed costs by their very nature are easier to control, effective negotiation with suppliers is an important step.  Variable costs can often get out of control if not properly managed, i.e. buying stock recklessly can tie up cash and may lead to unforeseen losses.

Tip – Ensure there is an efficient method of recording  and managing costs.  Monitor them on a regular basis.

4.  Supplier Relationships

Negotiating with your suppliers is important in order to gain value for money but when evaluating a potential supplier do not focus solely on the costs.  You should try and build a close working relationship with your suppliers and also consider the following:

  1. Product efficiency – do they have a good reputation for supplying reliable products?
  2. Delivery – can delivery be made in a timely manner?
  3. Payment Terms – extended terms can often ease your own cash flow concerns.

Tip – Ensure you question potential suppliers to ensure they meet your key criteria.

5.  Initial Funding

Many small businesses often underestimate the amount of necessary funding needed to commence trading or start a new product line or service.  This lack of funding will immediately restrict any business capacity and will greatly threaten the potential growth and stability of your business.  Always identify and try to properly estimate the amount of money needed to launch your business and to cover the costs for at least the first year which should include both running expenses and capital investment.

Tip – Take time to plan the financial implications of your business plans.

With thanks to:

Colin Bentall FCCA
Ford Bentall LLP
www.fordbentall.co.uk

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