Return on investment, or ROI, is a way to measure how profitable a business investment is. It can be a good indicator of how your business is doing as you can see how much you get back compared to how much money you put in.
If you’re stuck wondering what financial decisions make business sense, then it’s a good idea to measure return on investment. But how exactly do you do that? Read on to understand the ROI definition, how to calculate it, and what you can use it for as a small business owner.
ROI is a metric used to see how much you’re getting back for every pound you put into something. And it can be used to measure past, present and future investments.
If you’re making more than you put in, then that’s a good return on investment. If you’re making less, then you’ll be losing money and impacting your profit margins.
You’ll usually look at ROI as a ratio or percentage.
But first, you need to work out net return. To do that, subtract the amount of money you put in from the amount of money you get back.
The return on investment formula is:
ROI = Net return ÷ Total investment value x 100
You can use ROI to understand the success of marketing campaigns or to estimate the profitability of business decisions like buying a new tool, upgrading equipment, hiring staff or changing sales tactics.
To work out ROI here would be a little different as you’d need to consider ‘time’ as an investment. You’d need to think about the cost of the new software and attribute a financial value to the amount of time you’d save by using it.
ROI in marketing is an important performance metric to understand if your marketing campaigns are successful. This could be social media advertising, paid ad campaigns, promotional events, or a free trial of your latest product.
However, it’s more challenging to measure ROI on content marketing like blog posts and videos as you can’t directly link these outputs to a customer that goes on to buy your product or service.
Return on investment example
You have an online shop and you invest £500 in Facebook ads as part of the launch of your new home gym equipment range. You make £800 on sales directly from the campaign (that’s £300 profit). To work out the return on investment you divide profit and total investment:
£300 ÷ £500 = 0.6 or 60 per cent
This means for every pound you spent on the campaign, you’d make 60p in profit.
Return on investment can vary depending on your business and the many variables involved, so it’s hard to say what makes a good return on investment. It can also change over time, so it’s a good idea to calculate ROI regularly and make sure you’re not losing money on your investments.
You should also consider:
Do you want to know more about calculating ROI? Ask us a question in the comments below.
Photograph 1: Wutzkoh/stock.adobe.com
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