Check your ROI often

By Sandra Taylor-Sawyer: Everybody’s Business

In previous columns, I’ve discussed how business owners can use financial ratios to assist in making management decisions.

Another important financial ratio in determining success is the return on investment ratio. Business owners should set an ROI goal and review the ratio regularly.

A business owner’s desire is to make money. It is expected that the owner will be compensated through owners’ draw (sole proprietorship) or salary (corporation).

Many businesses are accomplishing this, but owners fail to consider earning an additional return on their monetary investment in the business. A prudent business owner will consider the ROI when preparing a business plan and reviewing year-end financial statements.

What is ROI? Let’s say an individual has $5,000 to invest in a business. A pragmatic owner should consider what return can be received by taking the $5,000 and placing it in a certificate of deposit (CD). Currently, market rates for a one-year CD average about 4.83 percent. This rate should be used as the minimum ROI goal for the business.

ROI is determined by dividing net profits (sales minus expenses) by the total assets (items the business owns).

The return on investment should be higher than the average CD rate for one year. Of course, other items such as the current industry and level of risk will be considered in determining the ROI a “fair return.”

The ROI is a goal that can be used to measure the success of the business. After all, taking the $5,000 and investing it in a CD provides a guarantee. Running a business does not.

The ROI can be used along with other financial tools to make management decisions dealing with employees, a new or second location, or new product lines, to name a few. The return on investment calculation is important in determining business success as part of the annual goal setting.

Jim Casey, a retired business counselor from Tillamook, Ore., contributed to this article.

Sandra Taylor-Sawyer is director of the Small Business Development Center at Clovis Community College. Call the center at 769-4136 or visit
www.nmsbdc.org/clovis