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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. You need to make decisions regarding how to allocate resources. For example, one course of action might require spending more than another. Which is the best choice? The answer depends on the anticipated ROI. You want to invest in things that provide the greatest return. In order to do this you must first calculate your ROI.

The Basic ROI Formula for Percentage Calculation

A detailed ROI analysis requires identifying all the variables that could impact the outcome. This includes everything that could impact the return, and everything that should be considered as part of the investment. This is challenging, as is anything that requires us to predict the future and things that may be difficult to quantify. So let's start with a very basic equation for calculating ROI:

ROI = [(Payback - Investment)/Investment)]*100

This takes the Payback and converts it to a percentage.

Your payback is actually the total amount of money earned from your investment. Investment relates to the amount of resources put into generating the given payback.

When you spread these over time, it gets more complicated. For example, should you measure by months or by years? And by how many? You might also consider what accountants call the time value of money. The more considerations you add, the more accurate the result and the more difficult the calculaton becomes.

Frequent mistakes that lead to improper calculations

Business owners often misunderstand the actual amount of investment. One common error is to not include the value of their time or the time of their staff as part of the investment calculation. To be accurate, the investment calculation must include the value of all resources invested, and not just "out-of-pocket" cash.

If most small business owners divided their return by the actual number of hours they put into the business, both before opening and after, they'd find their ROI expressed as an hourly rate to be much lower than they probably think it is.

What understanding ROI does for you is help you make correct choices before you find yourself in that situation.

This should not discourage you! For as the business grows, your ROI should increase. If you invest a lot in opening a business and then measure your ROI the next day, you'll probably find yourself in the red. But if the business is successful, then over time the returns grow while the continued investment, if any, declines.

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.

By Stone Evans, Portions Copyright © Stone Evans, The Home Biz Guy.

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