Defining ROI for Your Small Business
Return on Investment (ROI) is one of the most important tools in a business leader's tool kit. By understanding ROI or return on investment, business owners and project managers can make more effective decisions for a business. From deciding whether to offer a specific new product or service line to determine how to utilize the marketing tools at your disposal best, ROI metrics can guide informed decision-making.
Do you need to better evaluate your ROI and how your latest investments have impacted your business?
ROI Defined
A company's ROI is the return on investment. Think of this as the amount of money made or saved due to a specific decision. It determines the profitability of specific decisions made for the business. It could be the profit related to the return on hiring a new employee, investing in new business equipment, or the money your business can save based on a specific decision.
Typically, ROI is calculated by comparing the amount of money that will be spent on a project to the amount the company is able to save or make from that project. For example, consider the following: if the activities of a $500 marketing campaign result in a $10,000 return on your investment, but a separate $100 marketing campaign nets $8,000, a business owner should choose the latter marketing campaign for its higher-percentage return.
Although this example is straightforward for the purpose of demonstrating what ROI is, defining it usually is not as simple. One aspect that makes measuring it simpler is to create a project plan.
Project planning to measure ROI
Project planning involves a more complex process than many business owners realize. A project plan and breakdown of associated costs are critical to measuring ROI. Project plans should include the following information:
- Identify activities and tasks for the project.
- Identify the resources or people needed to accomplish each task.
- Estimate how long it will take to complete each task.
- Estimate the cost of each task, using an average hourly rate for each resource.
- Determine which tasks are dependent on other tasks and develop a critical path.
- Develop a schedule of all the tasks and cost estimates. The schedule can be organized by a chosen time period (week, month, quarter, or year) and by which task is scheduled to begin and end.
- Develop the cost baseline, which is a time-phased budget or cost-by-time period.
The project planning process is not a one-time effort. Throughout the project, business owners will most likely be repeating some or all of these steps. In order to measure ROI, business owners must also ask the right questions. They must define the components, record upfront and ongoing costs as well as estimate projected revenues. It's important to understand the "why" behind all of it.
Related reading: Why resource allocation is more important than ever
When to measure ROI
These are just a few examples of when ROI calculations and metrics could be insightful in determining profitability or return for a business.
Hiring a new employee
Adding a new team member is one of the largest costs or investments that a small or medium-sized business makes. It is also true that every new employee or resource has the potential to add a large amount of value and significant return. Here is a situation when it is important to create a project plan. The plan should break down the costs and potential revenue for the specific department that is considering adding a new team member. It is important to calculate and ensure the value of the contributions made by that new team member before investing in hiring. Remember to include the time associated with training new staff in your cost considerations.
Buying new business assets
Most small and medium-sized growing businesses need to purchase assets to scale. These include land, office or building space, equipment, inventory, or machines. Whether a business is looking at a new computer or adding a new truck to the fleet, assets are usually high-cost investments. Calculate the potential ROI of this new asset before making the purchase. This will help to gauge if it’s a good purchase for the business at the time and if it will support profitability in the future.
Marketing
Marketing and advertising can be extremely mercurial in determining ROI. Some marketing programs have high, measurable return, while others end up costing more money than they generate. Marketing specifically has many intangible, difficult to measure, as well as long-term returns on value. Certain forms such as online advertising can be much simpler to track and gather data on. Online tools can help in measuring costs as well as conversions that lead to revenue. Businesses that use traditional marketing avenues such as newspaper, radio, or television advertising often find it difficult to measure effectiveness. When the data is available, using an ROI calculation gives a clear picture of marketing results.
The benefits of defining ROI
The obvious benefit of determining ROI is that it can help make informed decisions for the business. When it comes to marketing, for example, you may choose the avenue or plan that has a higher return to help you better focus your marketing efforts. Defining ROI, however, also has some other advantages.
It's a metric used by many business investors
If there are investors considering investing capital into the business, many will evaluate the projected ROI for the project before deciding whether they want to invest.
It's very flexible
It's a recognizable metric that can be understood by people in a wide range of situations. It's important to note, however, that ROI can be calculated and manipulated based on the factors you use to determine it, so it's important to clearly define your factors before attempting to display ROI of a particular investment or project.
It helps determine the viability of an investment
Before a business owner dives in with a new project, whether a marketing initiative or a new offering for the company, it may be necessary to see if it will work for the business, calculating ROI is a quick and effective way to determine that viability.
It can demonstrate which tools are working most effectively
ROI isn't just a projected measurement. Business owners can also use it to determine which tools are currently working for the business and, therefore, which ones they should continue to use in the future.
It gauges which products or services perform best
Are there some products that aren't selling as well as they should -or that, worse, fail to sell enough to justify the investment in them? When business owners keep an eye on ROI, they can better determine which products are actually working for the business and which ones need to be moved out to make more room for better products in the future.
Related reading: are you chasing deadlines rather than working on your business?
