Ask yourself these questions. When you make any "investment" in your business, do you just "do it because you have to," or do you figure out what it's really worth? Do you struggle once in a while choosing between two alternatives? When you hire a new employee, do you calculate what you have to get back? How about when you spend your own time doing something? Can you explain to your customers the specific value of what you sell to them? Does your business "think" in terms of ROI?

If you're answering any of these (or similar) questions the wrong way, you might be selling yourself short. Keeping your eye on the return on every "investment" you make is critical to the long term success of your business. If that was hard to do, or took you a lot of time, you'd have a good excuse not to bother. But, it's not hard, you can do it in a few minutes, and it will give you a very different perspective on choices you think about every day.

Let's take the mystique out of Return On Investment - it's just not as complicated to calculate as it may seem. Small business owners have to deal with ROI questions a lot more often than they think and the concept doesn't have to be as difficult as a financial analyst, or a CPA makes it sound. So, let's define in simple terms what ROI really is.

* Investment: The amount of money you have to spend to do something - anything, really, like buying a truck or a building, starting a new product line, hiring another employee, or even deciding whether or not to spend your valuable time on some project. This investment can be cash that you have on hand, or money that you borrow.

* Return: The income, or cash stream that you expect to receive over some reasonable, predefined time period, because you made the investment.

* ROI: The average interest rate that you will earn over your predefined time period for trading the money you have today for the income you will earn in the future.

* A Good Deal: The present value of the income you get in the future exceeds the investment you make today.

When you think about ROI, it's important to remember that you have to equate the value of the investment you are making today with the value of the cash you will receive in the future. In other words, you have to think about the present value of those future cash flows, because they are not worth as much in the future as they would be if you had them today - if you had them today, you could invest them and earn interest. So, in ROI calculations, the discount rate is the assumed interest rate you have to earn on those future cash flows to equal the investment you are making today.

Think for just a moment about what the discount rate in the ROI calculation really means. Assume that you have $100,000 to invest and that you have three investment alternatives. You c

an invest the money in government bonds and get a "risk free" return of about 4.5%. If you prefer to invest the $100,000 in the stock market, you're taking on more risk, so you need a higher return - maybe 8% to 10% to compensate you fairly. Now, what if you want to invest the money in a new product line? If you can get 4% with no risk and 10% by going into the stock market, what return do you need to risk losing all of your $100,000 - maybe 15% to 20%?

ROI represents a very useful thought process that should be applied to a lot of the decisions small businesses have to make. Doing the calculations and knowing the numbers is not nearly as important as just thinking in terms of ROI. Investments are not always those big deals where we actually write a check. Sometimes they are as simple as how people are going to spend their time, or the additional income you might realize from selling more of your product or service. We have choices about what people do, how they spend their time, and what things we are going to emphasize; applying the ROI thought process makes it easier and more efficient to choose between the alternatives that you have. And, if you invest ten more minutes looking quickly at the two examples below, you'll see that there is an easy way to get a handle on the ROI of virtually anything you do.

Every business has a different tolerance for risk and will make different assumptions about what the investment potential of different choices might be. The point, though, is that we too often don't think about ROI and quite often don't look at the actual numbers. Don't allow your business to be one that doesn't take the time to look at this appropriately.

 Previous      Next