When it comes to making business decisions there are only two real approaches. The first school of thought is the school of the gut. Those who glance at the decision looming before them, consult their gut and hope for the best. The second are those who run their businesses by facts numbers and statistics. One key number in any entrepreneurs arsenal is Return On Investment or ROI.
Now I’m not suggesting you need to spend hours each day deciding what toothpaste you should use. That would of course lead to Analysis Paralysis, a common ailment for left-brained analytical entrepreneurs. What I am saying, is that when it comes to the key business decisions we need to take a moment to analyze our choices to ensure we select the option with the most potential for our business.
Times when you will want to employ this extra measure of analysis include:
– Which marketing campaigns to continue, and which to cancel.
– Split Testing offers and other opt-ins.
– Deciding which new product to bring to market.
– Determining if you need to hire additional staff.
– Reviewing customer feedback to adjust company policy and procedures.
What can we expect from our Facts, Numbers and Statistics
Analyzing our numbers allows us to determine which course of action will be most profitable for us to take. In essence we are looking for the option that will yield the greatest Return On Investment of either our time, our money or both.
I have often found that Entrepreneurs waste vital cash flow that could be better put to use growing their business. Every entrepreneur knows that they need to grow their business in order to succeed but unfortunately they are missing a few essential decision making tools to ensure they choose the right course of action.
Most entrepreneurs are so driven to grow their business, that they don’t stop to ensure that the money being spent is actually generating a return. Often this is because they are not quite sure how to crunch the numbers. One common mistake business owners make is to compensate for this lack of knowledge by throwing more money at it.
The problem is, if the money being spent isn’t generating profit the business will begin leaking cash.
The solution is easier than you would think. It all comes down to working out your Return On Investment or ROI. It is one of the most valuable tools for decision making you have at your disposal.
What is Return On Investment (ROI)?
ROI is what you are expecting to get back out of the money you are spending. ROI is essentially the ‘What’s in it for me’ for your business.
The formula is as follows:
ROI % = Net Profit / Total Investment X 100
It’s important to remember Net Profit is what you make after all the costs of delivering that product or service. If you sell something for $100 and it costs you $30 to manufacture and deliver it, then your Net Profit is $70
Let’s look at a few common decisions every entrepreneur must face.
To Advertise Or Not to Advertise – USing roi to make smarter decisions
Of course you need to advertise, but it’s more important that you do so profitably.
Advertising ROI = Net Profit on the sale of your products / Total Ad Spend used to generate the sales X 100
Eg. Our latest campaign on Facebook cost us $2400 but bought in $8750 in sales. On those sales we made $4300 in Net Profit.
Advertising ROI = $4300 / 2300 X 100
An advertising ROI of greater than 100% means that you have made back everything you have spent. In the above example we made back every thing we spent plus 86%. We almost doubled our money. We should continue that campaign.
If the ROI % was less than 100% we should either stop the campaign (as it’s sending us backwards) or adjust it’s messaging or offer to improve its effectiveness.
Launching a New Product – USING ROI to measure potential results
Products and services can be expensive to develop. Performing some preliminary calculations can help us work out whether or not it is worth our time and resources, or whether we should devote the resources to more profitable products and services.
If a new product is going to cost us $100,000 to develop we can use other numbers in our business to determine what it will take for us to break-even on this launch. We simply turn our formula around.
Let’s say our product retails for $250 and our costs are $75, we know that we make a Net Profit of $175 on each unit.
Break-even would be a ROI of 100%. Everything above is profit. Anything below is a loss.
Break-even = $100,000 / $175
So we know that we would need to sell at least 572 units to make back our investment. Knowing our break-even point allows us to work out how viable our new product or service might be. It also helps us choose between several potentially profitable new products and services.
What about other choices?
You can use ROI to assist you in making just about any decision you face in business. You may not have all the information you require at first, if that is the case ask yourself, “What number in my business can I use to measure how well or poorly this decision goes?”
Then analyse your problem periodically over time. Based on the increase or decrease in your key indicator you will be able to see the ROI on your incremental decision making.
Using these simple tools any entrepreneur can ensure their hard earned cash goes back into building their business and their future. Remember a wise entrepreneur learns from their mistakes and a genius learns from the mistakes of others. 90% of businesses fail for good reason. Building a great business grows out of good governance. It comes down to you and your decision making. When it comes to making decisions in your business, don’t follow the boulevard of broken businesses of the past. Invest the time required to check your numbers, then make informed decisions that will build your profits.
If you have any questions, let us know down below or join us at the MYB community.
You can also find an article with our 7 essentials to starting a new business here.