An insufficient return on investment is your canary in the coal mine, it tells you when your business is failing and, with proper examination, why. Better still, it does this before all the money is spent and Tony Soprano is knocking at your door, calling in his loan.
What is Return on Investment for a Small Business? บาคาร่า
If you have experience as an investor then your are familiar with return on investment as being the amount you earn on your investment over the amount that you paid for it. So when you shop around online to get a half a percentage higher interest rate on your savings account you are looking for a higher return on investment.
How Do I Calculate It?
For your small business, the concept is the same, return on investment is a measure of what you get out of your business divided by what you have invested in it. The key word here is measure, the return on investment formula is a tool to help your measure how efficient your business is at generating profits.
Why Is It So Important?
Your assets are the resources that you have put into your business, your investment. When you calculate return on investment you are concerned with two things: first, the opportunity cost of your resources, and second, the trend of your business’s return on investment over time.
The opportunity cost of your resources basically answers the question; “would I be better off putting these assets to a different use.” Think back to the example of a savings account, if the return on investment from your business isn’t beating the interest you would get if you sold your assets and deposited the money in a savings account, then you’re pretty much screwed. Either you have to take drastic action to improve the ROI or you should find a more effective use for your assets.
Change Over Time
The trend of your ROI over time is the canary in the coal mine; a steady and increasing ROI means a strong and healthy business while a negative or decreasing ROI is usually a precursor to a long, slow, and painful death for your business.
When you start your business you are often a one-man band, you are not only the Chief Executive, Sales, and Financial Officer but also the delivery boy, the maintenance man, and the head of productions. As such, you get a huge amount of time wrapped up into your business and this creates what Steve Wilkinghoff, in his amazing book for business owners Found Money, calls “hidden inventory.” It is hidden because it is not captured by traditional accounting but it is crucial to achieving success in a small business. If you are a lawyer and a client hires you to handle a certain legal issue and you go to work at it but then, after putting say 20 hours into the project, get called aside to do a second project and leave the first on hold then you have hidden inventory. The time that you invested in that project should be billable to the client but you can’t bill them until you’re done. So there you have hidden inventory, it is the work in process that can’t be collected upon until the job is done. The danger for the small business owner, who often is a one-man (or woman) show, is that they build up this hidden inventory, and work like crazy to do so, but are too slow at bringing it to the point of billing and thereby run into the trap of too much work and not enough money. Estimate how much hidden inventory you have and add this hidden inventory to your assets when you calculate return on investment.
What Is an Adequate Return
As we already discussed, if you have another investment immediately available to you (like a certificate of deposit or a savings account) and it offers a higher return on investment than your small business then you should feel really, really, uncomfortable. I will tell you that so many times I have seen businesses borrow money with a higher interest rate than their return on investment and I just to take them gently and tell them to go spend that cash at the casino, because it is about that bad of an investment. Your small business should generate for you several times the ROI of just about any investment you can readily find. Why, because it is very risky investment. 1 million and one things could go wrong and you will find yourself back to square one, only this time you will owe tons of money. So, the higher the risk the higher the required return you should require.