When you invest in an asset for your small business, you want it to eventually turn a profit. But, how do you measure the profitability of your investments? You can use return on investment (ROI) calculations to see how much income your assets generate.
But wait, what is ROI?
Return on investment (ROI) is a profitability ratio that measures how well your investments perform. In other words, ROI lets you know if the money you shell out for your business is flowing back in as revenue. To find return on investment, divide your net revenue by the cost of your investment. For example, if you had a net revenue of $30,000 and your investment cost you $20,000, your ROI is 0.5 (or 50%).
ROI = (gain from investment – cost of investment) / cost of investmentYou write ROI as a percentage. The greater the percentage, the better the investment.
The first step to finding your return on investment is to subtract the costs of your investment from the gains of your investment. The costs include any expenses you pay that go directly into the investment. For example, one cost could be a shipment of inventory. Your gains include any revenue you earned from the investment. You do not subtract interest or income tax payments for this calculation.
|Cost of goods solds||$45,000|
The chart above shows one company’s gains and costs in an investment. The company made $100,000 in revenue. The company also spent $45,000 on the cost of goods sold and $20,000 in operating expenses.
First, find the total cost of the investment. To do this, add the cost of goods sold to the operating expenses. The total expenses are $65,000 ($45,000 + $20,000).
Then, subtract the total expenses from the revenue. The difference is $35,000 ($100,000 – $65,000).
Next, divide the difference between the investment’s gain and cost by the cost of the investment.
|Investment gain minus cost||$35,000|
|Cost of investment||$65,000|
|Return on investment||53%|
When you divide the investment’s gain minus the cost by the cost of the investment, you get 0.53 ($35,000/$65,000). To make this a percentage, multiply the number by 100. The ROI is 53%.
This ROI is a strong rate of return and indicates that the company is using its resources efficiently.
Small business benefits
As a small business owner, ROI calculations can help your company. Your return on investment could help you secure outside funding. A strong return on investment can reduce the risk for investors. If you are applying for a small business loan, your ROI could show that you can pay lenders.
Your return on investment can also help you operate your business more efficiently. You can use the formula to see how successful your investments are. For example, let’s say you ran a marketing campaign on the radio and in the newspaper. You can use the ROI of both methods to see which brought in a higher return.
There is no standard formula for ROI. It is a flexible calculation, meaning you can change it to fit your needs. For example, you might be interested in finding the net sales or the cost of goods sold return on investment, for a more granular ROI definition. Return on investment can help you compare the investments you make for your business.
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This article was updated from its original published date (8/2/2012).