There may be a reason why “ROI” is both the French word for king and a very important financial acronym that stands for Return On Investment. Understanding ROI in your small business can make the difference between failure and success as a business owner. You might have heard the term before; now let’s explore it in depth.
Spending Money in Our Businesses
Tracking ROI can help us measure how profitable a past expenditure has been. It can also help us objectively evaluate the potential profit of an expenditure we may be considering.
As entrepreneurs, we often get good at running our businesses with our hearts and by a “gut feeling” we all have. We know our business intuitively, and we often have to make a spending decision without all of the information we’d like to have.
Marketing ROI Example
Using ROI, we can learn from past purchases to get smarter about future ones. Let’s say that we joined a networking group a year ago that cost $500 in annual dues plus $50 per meeting. We’ve attended eight meetings, taking two hours each, and our hourly rate is $150 per hour. Let’s add up the costs:
|Annual fee||$ 500|
|8 meetings x $50||$ 400|
|Time: 8 meetings x 2 hours x $150||$2400|
Although our time may not be something we normally think about in conjunction with a cash expenditure, it should be included to determine the total business cost of the networking group. If you weren’t using those two hours for networking, you could have been doing another business activity that generated actual revenue.
On the revenue side of this example, we found three clients from this networking group, and each will bring in $1,000 per year for several years. However, one of them is a troublemaker that you may need to fire:
|Revenue this year||$3000|
|Revenue less costs for current year||-$300|
|Revenue in 2nd year, assuming you pick up 3 additional new clients||$5000|
|Revenue less costs for 2nd year||$1700|
In the first year, we lose $300 to this marketing source. However, in the second year—assuming we keep the clients we picked up the first year, fire the troublemaker and acquire three more in the second year—we begin to gain from the cumulative effects of the clients we’ve found through the group.
Lessons From the King
There are a couple of things to learn from this ROI example. First, this networking investment might be a good marketing source, and it might not be. Wouldn’t it be nice if we knew which marketing expenditure had the highest ROI? Then we can begin to make some really smart decisions about our marketing spend.
Second, your time is limited, and there are always choices in how to spend it. If there are more profitable ways to spend your time besides networking, then you may be holding back your company’s profits.
ROI should measure not only hard costs and revenue, but also any intangibles. What if your reputation from being in the networking group was key to you winning an award? That award has helped you reduce your sales cycle and has tremendously boosted the community’s view of your business.
In that case, a line should be added to the revenue side that reflects the sales time saved and the value of the award. This is an intangible, which is harder to put a dollar value on, but it is undoubtedly a huge benefit to your business. Any intangible like this should be added to your ROI worksheet and listed with or without a value when you evaluate any type of expenditure.
On the opposite side, what if you hate networking, and it causes you a huge amount of stress? That item should then be added to the costs side, and while you don’t have to put it in terms of dollars lost, your heart and gut will help you assess it.
Numbers for Your Heart
ROI should not replace your heart and your gut, but it should be used in addition to all the other tools you utilize when making decisions. Applying ROI can help us choose wisely when we have so many spending options for our businesses.
Managing and tracking ROI will help us avoid purchases that may be influenced by unwarranted optimism. As entrepreneurs, we tend to be very positive, hopeful people. ROI can help us make decisions that are more grounded for our businesses, so that we are not purchasing every “bright and shiny” object that comes along and promises to make our lives and businesses better.
Getting Your Money’s Worth
Think of ROI as a fancy way of asking whether or not you are getting your money’s worth when you make a business purchase or spend. As a summary, here are the steps to follow:
- List all costs, including time spent.
- List the revenue that you can directly attribute to the item you are evaluating.
- List intangible benefits and costs.
- Compare your revenue to your costs. Are you in the black or in the red?
- Consider future years to see if it turns around in Years 2 or 3.
- Add your heart and your gut to make the spending decision.
Using ROI can clearly make your business more profitable in a shorter amount of time. Try adding ROI to your business toolbox, and watch your company grow.