How to Calculate ROI (Return on Investment) by Stone Evans, The Home Biz Guy
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.
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