Return on investment is arguably the most important metric of all when it comes to small business management. If you do not understand ROI - what it is, why you need it and how to calculate it - you will likely be flying blind in terms of strategic oversight and planning.
Let's take a look at some of the basics of ROI.
What is ROI?
ROI, in its simplest sense, is a measurement of the amount of money the business makes against the level of spending it puts into operations at large. Companies need to measure both the broad and granular matters involved in ROI. For the big-picture, ROI would essentially explain how much the company is spending and making at any given time. For the more granular aspects, this would involve specific investments - such as spending on equipment, software, employees, training and more - and how much money was made as a result of those purchases.
Entrepreneur magazine, a publication devoted to small businesses and startups, points out that ROI is "the most common profitability ratio," but it does not always translate directly to the actual profit margin of a company. ROI only accounts for money spent versus capital gained, whereas the true profit margin is dictated by the overall performance of a business. The source explains that ROI will be highly useful when trying to evaluate how the company's financial moves are playing out in practice, effectively dictating what the business is doing right or wrong on a daily basis.
Why is ROI necessary?
There are two approaches to answering this question. First, there is ROI as a metric, which is fundamentally important to guiding the business in the right direction. This ratio gives small business owners visibility into their own processes, assets, workforce and more that includes some form of hard facts of costs versus rewards. Entrepreneur magazine notes that ROI can help companies to evaluate how financially viable, beneficial, or precarious, inventory and equipment investments, as well as pricing strategies for products, are in real-time.
Secondly, there is ROI as a hard dollar gain or loss. If businesses do not make money on their investments, they will not be able to stay afloat or progress. So, ROI is critical to keeping a business in action.
How do you calculate ROI?
Companies need to find the right approach to calculating ROI in accordance with their specific models, plans and strategies. In most cases, ROI calculations are achieved by taking the net gain realized from a purchase, then dividing it by the initial cost. Inc. Magazine, a trade publication, gives the example of a home that was built for $100,000 and valued at $150,000 10 years down the road. The cost to maintain the home during those 10 years was $10,000, giving it a total value of $140,000. That $40,000 divided by the initial price of $100,000 shows a 40 percent ROI.
To ensure accurate analysis, make sure you track the costs associated with maintenance and management on your purchases.
Let's take a look at some of the basics of ROI.
What is ROI?
ROI, in its simplest sense, is a measurement of the amount of money the business makes against the level of spending it puts into operations at large. Companies need to measure both the broad and granular matters involved in ROI. For the big-picture, ROI would essentially explain how much the company is spending and making at any given time. For the more granular aspects, this would involve specific investments - such as spending on equipment, software, employees, training and more - and how much money was made as a result of those purchases.
Entrepreneur magazine, a publication devoted to small businesses and startups, points out that ROI is "the most common profitability ratio," but it does not always translate directly to the actual profit margin of a company. ROI only accounts for money spent versus capital gained, whereas the true profit margin is dictated by the overall performance of a business. The source explains that ROI will be highly useful when trying to evaluate how the company's financial moves are playing out in practice, effectively dictating what the business is doing right or wrong on a daily basis.
Why is ROI necessary?
There are two approaches to answering this question. First, there is ROI as a metric, which is fundamentally important to guiding the business in the right direction. This ratio gives small business owners visibility into their own processes, assets, workforce and more that includes some form of hard facts of costs versus rewards. Entrepreneur magazine notes that ROI can help companies to evaluate how financially viable, beneficial, or precarious, inventory and equipment investments, as well as pricing strategies for products, are in real-time.
Secondly, there is ROI as a hard dollar gain or loss. If businesses do not make money on their investments, they will not be able to stay afloat or progress. So, ROI is critical to keeping a business in action.
How do you calculate ROI?
Companies need to find the right approach to calculating ROI in accordance with their specific models, plans and strategies. In most cases, ROI calculations are achieved by taking the net gain realized from a purchase, then dividing it by the initial cost. Inc. Magazine, a trade publication, gives the example of a home that was built for $100,000 and valued at $150,000 10 years down the road. The cost to maintain the home during those 10 years was $10,000, giving it a total value of $140,000. That $40,000 divided by the initial price of $100,000 shows a 40 percent ROI.
To ensure accurate analysis, make sure you track the costs associated with maintenance and management on your purchases.
