There’s never a shortage of opportunities for small business owners. But one thing that remains universal across both the start-up scene and established business is proving return on investment (ROI).
Put simply, ROI measures the return on funds invested in the business by you, the business owner, or the return on a particular marketing campaign. It gives you an idea of how successful your investment has been, as well as a guide to which strategies and tactics are more worthy of increased funds.
The higher the ROI, the greater the return and the more effective your business is in generating a profit.
Calculating Business ROI
The Queensland Government provides an online calculator for generating the ROI on investments. For example, if net profit before tax is $120,000 a year and total assets are $90,000, the ROI ratio is 1.33.
If you were looking to value your business, you could divide net profit by your expected ROI (e.g. 50%), in which case a business earning $120,000 in annual profits with a 50% ROI would be valued at $240,000.
Calculating Marketing ROI
When looking at boosting sales, marketing ROI measures the revenue to cost ratio: incremental revenue driven by a marketing campaign minus the marketing investment, divided by the marketing investment. It’s typically expressed as a percent, so multiply your result by 100. For example, if you spend $100 on Facebook ads and generate $1,100 in sales, the ROI for this spending is ten times or 1000%! ($1100-$100) divided by $100.
Here is another example. If your product costs $100 to make and sells for $200, and you sell 10 products after advertising with Google Adwords at a cost of $200, you have total revenue of $2,000 and total costs of $1,200. The ROI for this Google Adwords campaign would be calculated as ($2,000 – $1,200) divided by $1,200, which equals 66.6%.
Some people like to look at the Lifetime Value of a Customer instead of incremental revenue. Check out MarketingMo’s guide here.
In a recent article, Inc. magazine’s Victor Ho writes that for most campaigns a return of 5 times is “decent” and more than 10 times “a home run.” However, as long as you have a positive ROI and have taken all your costs into account, you are ahead. The ratio can be used to assess the value of future marketing campaigns, such as newspaper or online advertising or flyers, either by estimating the ratio in advance or doing a trial to see if it passes your own ROI hurdle, whatever that may be. You can then look at which marketing campaigns deliver the best ROI and focus your limited time and budget on those.
Improving Business ROI
Strategies to improve profitability – the “R” or “Return” part of the equation – include increasing sales revenue by up-selling more products to existing customers, identifying new markets and new customers; improving customer service; and considering price discounts and promotions.
For example, a hairdressing business might up-sell shampoo and shaving cream to customers, while a plumber could bring high end tapware to a job and show the customer an alternative, more expensive option. Gaining extra sales from existing customers is one of the easiest ways of increasing your business ROI.
Business profitability can also be enhanced by cutting costs, such as decreasing inventory, reducing supplier costs, saving energy, minimising waste and benchmarking your business costs, such as rent and utilities to similar businesses (check out the ATO’s benchmarking guide across more than 100 industries here).
For energy savings, the Australian Government’s “Energy Made Easy” website provides a comparison to electricity and gas offers as well as tips on reducing energy usage. A quick search of offers for electricity and gas for small businesses based in Sydney reveals more than 80 offers, which can be quickly compared to cut costs.
Proving ROI can make a big difference when deciding where to invest your hard-earned funds or valuing your business. And if you need funds for that exciting business opportunity, Prospa is here to help.