Making money is the reason most people start a business, but when the economy sours, just covering expenses and staying solvent can be challenging enough.
Do the math
Determining a realistic return on investment, or ROI, is a matter of numbers. A prudent business owner will consider the ROI when preparing a business plan, reviewing year-end financial statements, evaluating the effectiveness of marketing and deciding whether to add or drop a product or service.
When considering if more money should be put into a business, the goal for return on investment should be to exceed the average certificate of deposit rate for one year. Return on investment is determined by dividing net profits (sales minus expenses) by total assets (what the business owns).
If an entrepreneur has cash to invest in expanding the business, he or she should first consider how much money could be made by placing the money in a one-year CD. If the average annual CD rate exceeds what profits the business can expect by expanding a product line or expanding into a new market, the prudent business owner should invest in a CD. After all, a CD offers a guaranteed payoff; running a business does not.
But with market rates for a one-year CD hovering near historic lows, many business owners may decide to invest in their own business infrastructure.
ROI can also be used to compare and evaluate the return on investments already made. A business can evaluate the effectiveness of different types of advertising by separating the expenses related to TV advertising from those devoted to print advertising and tracking which advertising attracted the most customers. ROI for each marketing method could be calculated and compared; the higher ROI would be the better investment for continued advertising.
To get an accurate comparison, results should be easy to track. One way is by offering distinct coupons or discounts with each advertising venue that indicate where the customer learned about the offer.
ROI isn’t the only way to measure a fair rate of return or the success of a business, but it’s a good financial tool for business owners trying to decide whether to open a store or close one, change marketing strategyand so on.
The return on investment calculation is important in determining business success as part of the annual goal setting. Business owners should set a ROI goal and review the ratio regularly.
For more information about setting business goals or using quick ratios to improve your business performance, visit the advisors at any of the 19 SBDC offices in New Mexico.