In one episode I welcomed the co-founder of Wheelhouse 20/20 and discussed Return-on-Investment.
What is ROI, why is it important, and why should an entrepreneur care?
ROI is a key performance indicator that is often used by businesses to determine profitability of an expenditure. In truth – ROI is a formula: (net profit/cost of investment) x 100 which gives us return-on-investment as a precent.
Using the ROI formula is a wonderful way to determine the percentage used to compare investment options or evaluate a business plan. However, it is also important to understand this fact: management of time, floor space, quality upgrades, delivery capacity or scarce skills – these are difficult to quantify in financial terms.
In addition to that, ROI is not always cash. ROI can also be market share, increased competitiveness, brand awareness, or gaining first mover advantaged are a few examples ROI.
A notable example of ROI is buying shares in a company. Let us go through this example together: let us say we buy 100 shares in a corporation. When we buy the shares, the cost is $20 each share, so our total investment is $2000.
After we buy the shares, the corporation’s stock rises. When it reaches $30 each share, we decide to sell it. Our profit on the investment is $3000 subtracted from $2000, which is $1000 – that is our profit, not our return-on-investment because as you may recall, ROI is a percentage and not a whole number.
To determine our ROI, we need to take $1000 and divide it by our initial investment ($2000). That calculation gives us .5, or 50%.
Our ROI is 50%.
Considering it took little time to calculate our ROI, we could say that our ROI has a great ROI!
In fact, we could take our business to a new level by identifying which investments help our business the most and making better financial decisions because of it.
We do not have to be a math whiz; we just must remember: (net profit/cost of investment) x 100 = ROI (%)