DOWN TO BUSINESS
A look at small business questions from the Southwestern Oregon Community College Small Business Development Center (SBDC).
By Arlene M. Soto CMA, CGBP, Southwestern SBDC Director
How do I calculate return on investment in my business?
Return on investment (ROI) is a financial concept that measures the profitability of an investment. There are several methods to determine ROI but the most common is to divide net profit by total assets. For instance, if your net profit is $50,000 and your total assets are $200,000 your ROI would be 25%. A common definition of ROI is “a profitability measure that evaluates the performance of a business by dividing net profit by net worth”.
In a small business uses of ROI could be to measure the performance of pricing policies or an investment in capital equipment or an inventory investment. When purchasing assets in a business such as inventory or equipment you expect to get a financial benefit from the purchase. Return on investment is a tool to help decide between purchase alternatives that will either generate revenue or result in cost savings that benefit the net income of the business. Investors look at return on investment when choosing whether to fund a business venture.
Return on investment may also be measured unconventionally such as in terms of social responsibility, environmental benefits or societal benefits. This is more difficult to measure. In determining the social return on investment, the payback would need to be quantified to calculate the cost versus the benefit. A network of practitioners was formed in 2006 to facilitate the evolution of calculating social return on investment.
While return on investment is a useful tool to look at profitability, calculations are complicated by other factors such as time, maintenance costs, financing costs, other investment considerations and the overall goals of the company. For instance, with the purchase of capital equipment it is expected that equipment will provide a benefit to the company for several years so the net income will need to be estimated for future time periods to determine the overall ROI. Maintenance costs over the life of the equipment will reduce the overall ROI. An accountant can assist with the formulas to determine more complex ROI calculations.
The SBDC is a partnership of the U.S. Small Business Administration, the Oregon Small Business Development Center Network, the Oregon Business Development Department and Southwestern Oregon Community College. Arlene M. Soto has been the Director of the Southwestern Small Business Development Center since July 2007. To ask a question call 541-756-6445, e-mail firstname.lastname@example.org, or write 2455 Maple Leaf, North Bend, OR 97459. Additional help is available at the OSBDCN Web page www.bizcenter.org.