Let’s talk about return on investment (ROI)
It doesn’t matter what type of business you run, numbers matter.
Understanding how decisions affect your bottom line is important because you want to stay in business as long as possible.
That’s why entrepreneurs focus heavily on having a healthy return on investment with the decisions they make.
We wrote an article recently about opportunity cost. Quick reminder, it’s the cost of the opportunities we don’t take.
A return on investment is the potential value for the decisions that we make for our business.
In this article we’re covering:
- What is a return on investment (ROI)
- How to calculate it
- Why it’s important
- How to apply it to your business
Let’s start with defining it.
What is ROI (Return on Investment)
A common phrase for business owners, ROI calculates the financial benefit of a decision made. It’s mainly associated with making a financial investment back but it can be measured in different ways.
The idea is that you get back what you put in and that can be different for everyone. For example, if you decided to go to a networking happy hour and you met 3 people who gave you their number and one of them becomes a client in your business.
You can make the argument that the networking event had a positive ROI for you even though you may have “lost” money being out of the office not working.
As a retail business owner one of the best ways to measure return on investment is in the marketing department. It’s not the only area you can do it in but it’s the easiest. Spending money on advertisements will quickly tell you if there’s a positive or negative return on your money.
The perfect situation is to get the most return for your investment. But barely breaking even is still technically a positive ROI.
Let’s talk about calculating ROI…
How to Calculate ROI vs ROAS
Return on investment deals with the cost of an entire project, including expenses. While return on ad spend (ROAS) is specifically how much revenue is produced directly from the marketing campaign.
The reason we need to separate the two is because you can have a profitable ad campaign but the expenses can eat away at any of the revenue so you need to know both numbers.
ROAS (Return on Ad Spend) Example:
You spend $10,000 USD on Facebook Ads and make $20,000 in revenue from the ads.
(Revenue)/(Ad Spend) = $ROAS
($20,000)/($10,000) = $2
This means that for every $1 in ad spend you make $2 in revenue. Sounds good right?
Let’s say you’re selling a yoga mat for $35. After the costs, expenses and overhead the margin left over is $7. That’s a 20% margin rate (amount left over).
We can calculate the return on investment like this:
(((Revenue x Margin Rate) – Ad Expenses) / Expenses) x 100 = ROI
((($20,000 x 0.20) – $10,000) / $10,000) x 100 = -60%
So what does this mean? It means that you’re going to lose money for every product you sell using that specific Ad campaign.
Here are a few ways to fix this:
- Test multiple ad campaigns (With A/B testing)
- Cut production costs (Analyze supply chain)
- Cut overhead expenses
- Increase order value with upsells
Why ROI Is Important
Calculating ROI helps you understand what projects are profitable and which ones are not worth going after. So much about business can feel like you’re shooting from the hip but an ROI calculation can help you make better choices without emotions.
If an ad campaign you like isn’t profitable then raw numbers can help you make more informed decisions. You have options when you know exactly what’s working and what’s not working. Most businesses run marketing campaigns and pray that things improve, that shouldn’t be you.
You can use rough ROI calculations on your time as a business owner as well. If you’re worth $100 per hour, does it make sense for you to spend your whole day putting numbers into a spreadsheet? No! Pay someone to do it.
Focus on the decisions that will grow your business and move it forward.
How to Use ROI in Your Online Business
It’s not always straightforward to calculate a return on investment. What about all the activities you can’t assign a dollar value to?
As a business owner you need to break up activities that directly produce revenue and ones that indirectly produce revenue. Most of your day needs to be income producing activities that a potential customer can see.
For activities that don’t directly generate revenue but you know are necessary for your business you need a system:
- Perform the task yourself
- Record yourself performing the task
- Hire a virtual assistant
- Pass that task off to them
Do this, and not only will your business grow but you’ll save time and money. You will no longer be stuck doing tasks that don’t make money for the business.
And I know those tasks are important but it doesn’t need to be you doing them. The more you get off your plate the bigger return your actions will have on your business.
Wrapping This Up
Whenever you invest money, time or resources into your business you need to have a goal you’d like to achieve. You also want to find a definitive way to measure it.
The goal doesn’t need to be profit, it needs to be growth centered. Did you grow your business by making this decision or was it a lateral move?
Outsourcing work is one of the best ways to immediately see a positive return on your money because you’re taking tasks off your own plate. That way the only tasks left are the ones used to grow your business.
Your time and your money is valuable and if you’re not continually finding ways to test and improve your return on those resources then you already lost. There’s always a way to improve and there’s always a way to make more profit for your business.
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