What is ROI?
3-minute read
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.
<br />A small business guide to return on investment
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 meaning
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.
It's important to consider ROI when pricing a product – and to review your pricing if you're not making enough money. Remember that your time is also an investment, so consider that when looking at how much effort you're putting in and the reward you're getting back.
How to calculate ROI?
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
What would you use ROI for – and why’s it important?
You can use ROI to understand business growth, 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.
For example, you might be considering new accounting software or investing in an invoice app to make your business admin a little easier.
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.
Or you might be thinking of trying a new sales approach by cross-selling one product with another related product you've just launched. ROI can help you work out if this strategy is working for you.
When thinking about ROI and profitability, it's also a good idea to do some competitor analysis to see how similar businesses are pricing their products or services.
What is ROI in marketing?
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.
Related guides
- create a marketing plan
- understand your unique selling points
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.
What is a good ROI?
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:
- time is also an investment – but it can be hard to quantify
- it’s challenging to attribute everything – such as blog posts and videos
- the difficulty of comparing different ROIs – it doesn’t take into account how long an investment takes to generate results
- using a combination of metrics – don’t just rely on ROI to make business decisions, you can also calculate EBITDA and do a SWOT analysis
Do you want to know more about calculating ROI? Ask us a question in the comments below.
Small business guides
Photograph 1: Wutzkoh/stock.adobe.com
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Written by
Catriona Smith
Catriona Smith is a content and marketing professional with 12 years’ experience across the financial services, higher education, and insurance sectors. She’s also a trained NCTJ Gold Standard journalist. As a Senior Copywriter at Simply Business, Catriona has in-depth knowledge of small business concerns and specialises in tax, marketing, and business operations. Catriona lives in the seaside city of Brighton where she’s also a freelance yoga teacher.
We create this content for general information purposes and it should not be taken as advice. Always take professional advice. Read our full disclaimer
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