Getting the most out of the money you spend is at the top of any business's priority list. This requirement is doubly the case for small businesses, where every investment you make needs to contribute to your growth and financial success. Whether you have a head for numbers or you're not so good with figures, ROI is a necessary way to measure the worth of the money you spend on anything.
If you want to know how to calculate ROI, why ROI is so important, and what data you need to capture in the first place, we've covered all you need to know. Read on for our complete guide to ROI.
What is ROI?
Return On Investment, typically known as ROI, is a key metric that any business can use to indicate the profitability of an action or investment they take. ROIs are often used alongside Key Performance Indicators, or KPIs, to quantify how successful a particular investment is. By calculating ROI and understanding the process, you're able to reduce the risk and guesswork in important business and marketing decisions.
ROI is simply a calculation based on specific data you provide. It's what you do with that information that can have a direct impact on your business. ROI provides a window into how your business is doing and allows you to see how likely it is that an investment will be profitable for you.
Why is ROI important?
ROI is important for several reasons. Firstly, it gives you the foresight to decide whether an investment is worthwhile for your business. For example, calculating the ROI of marketing activity, such as a specific brand campaign, can be an excellent way to determine whether it's worth investing the money or considering other options. The outcome of ROI calculations can make or break a future project or marketing activity and is an important consideration in business planning and strategy.
Secondly, ROI can help you to make decisions where you have multiple concepts and ideas in mind. By calculating the ROI of individual activities or investments, you can figure out which is the most likely to be profitable for your business. As part of a strategy to grow your business, ROI is an invaluable resource that is easy to use and practical to complete; provided you have the correct data captured.
How to calculate ROI
Calculating ROI may initially sound complex, as a specific formula is needed to measure the data you input to figure out a final percentage. The average small business can quickly calculate ROI using this easy formula:
ROI = (Net Profit ÷ Cost of Initial Investment) x 100
Using this formula, it's possible to get a quick and easy answer to whether a particular investment is worth it for your business. When ROI is calculated following an activity, this uses the facts and data you've gained throughout the year. If you are calculating a speculative ROI for an activity you're planning, you'll either want to use data from existing, similar activities or use forecasting to figure out the profit.
Say your local business has been solely word-of-mouth before now, with a single-page website that doesn't do much for your brand. Now, you'd like to invest in a brand-new platform with an investment of $3,000 overall, inclusive of everything you need to get your brand in front of local potential customers.
Once your website is launched, you see an income of in the first month of $1,500.
The net profit is calculated by taking away the monthly costs of website maintenance and any other payments you have to cover. Once you've figured out these costs, you're left with $1,000 in net profit.
In this example, you have all the data available to you, and you can calculate your ROI as follows:
($1,000 ÷ $3,000) x 100 = 33.3%
As your business grows, you plan to invest in social media marketing activities that drive traffic to your website. Before you invest, you want to figure out whether the ROI is worth an investment of $2,000 for advert creation.
In this case, you're not using data that already exists for your ROI. However, you have run a similar marketing campaign in the past, which has shown an immediate increase in income of $10,000 for the year following the campaign launch.
Minus the annual costs of paid advertising and seasonal advert alterations, this leaves a yearly net profit of $6,000 for your past campaign.
To calculate the potential ROI in this case, the formula will be as follows:
($6,000 ÷ $2,000) x 100 = 300%
What data do I need for ROI?
For ROI to be calculated successfully, you'll either need access to captured data or the ability to forecast the likely outcome of future activity. At the very least, you'll need figures for the cost of your initial investment, as well as the net profit of your investment.
When you are first planning on a marketing activity or business investment, speculative ROIs can give you a general idea of what you're likely to see. But if you want your ROI to be pinpoint accurate, you'll need precise figures for both initial investment and net profit for formal reporting and specific information.
Net profit is the data that you'll need to capture the most information for. You'll want to have clear information on what money you've made from a marketing activity or investment, and you'll need to have the necessary details to subtract any costs from that amount.
How do I know if my ROI is good?
Any ROI that's in the green is good news for your business. It indicates you've turned a profit, and therefore you have a good return on the money you put in. However, it's worth considering other factors alongside ROI. As percentages, ROI can look very impressive on paper, even if it isn't as impactful on your business. For example, a 200% ROI on a $100 spend isn't nearly as impactful as a 75% ROI on a $100,000 investment.
As a valuable tool, ROI can help you make important decisions about your business. Whether you're looking to grow or you want to figure out the best way to invest your marketing spend, calculating ROI gives you the foundations to figure out what might work best for your business.
For more small business tips and tricks, check out the rest of our Limecube articles and guides. We're here to take the mystery out of marketing for small businesses across Australia.