Every businessman wants his/her company to grow and flourish, for which one has to apply various growth strategies. But the path chosen to reach the goal has a significant role to play in the long-term success of the firm. Before planning for expansion or entering a new market it is very important to contemplate if the time and money invested in this venture will yield good returns or not.
Return on Investment (ROI) analysis is conducted to analyse the growth opportunity which helps in deciding the efficiency of strategies and business loan prospects.
What is Return on Investment (ROI)?
ROI is the measure used to evaluate gain accrued from a specific investment relative to the amount invested (cost incurred). It is the value a growth opportunity adds to the business. For example, if there is a business expansion planned then the ROI is measured with the revenue generated as against the cost incurred to acquire the new customers and the cost of acquisition.
If the plan is to introduce a new product in the market then ROI will be measured by the sales volume relative to the cost of production. ROI is used as a guide that points out opportunity which offers the best returns for the amount invested. It is critical to evaluate the ROI of investment especially when the budget for a business is limited.
Calculation of ROI
ROI is the ratio of net profits to total investments. Net profit is the difference between the total income generated and the total costs incurred by the business over a period of time. For example, getting new equipment expands the product line, makes the business more competent and reduces overhead costs, which in result saves money for the business.
It is important to ensure that factors like business loan interests and fees are also included in the total costs if the financing opportunity is for acquiring new equipment or office space. Maintenance costs and depreciation values are also to be included in costs if the investment is on equipment or any other physical assets.
It is also vital to review the time period for calculating ROI, although it does not include any data on time. The timeline considered for generating returns must fit in with the business goals.
ROI calculations measure the financial benefit of investment however there are other intangible benefits also which should be considered before making the decision on investment. It also aids in developing a more comprehensive growth strategy. Many times, entrepreneurs lack funds to accentuate intangible benefits, but for which a business loan can come to the rescue.
For example, simple things like eco-friendly packaging material used for products are very impressive to a lot of people as it projects a sense of social responsibility and invites more customers who think along the same lines. Another example is investing in creating a stress-free work environment (enough people) increases productivity and employee satisfaction which in turn will result in the business earning profits.
While calculating ROI it is important to set a minimum percentage of return expected/accepted from an investment. Having this minimum rate set helps eliminate the investment opportunities that do not fit the criteria or take an unnecessary amounts of business loans.