ROI, or return on investment, is the golden rule of business. At the end of the day, business decisions are made because of ROI. Are you getting the correct return on your investment?
Broadly speaking, ROI is all things earned divided by all things spent. People put these resulting calculation in percent or as a decimal. Either way is fine as long as you understand it. Every business decision has an ROI. Most are very hard to calculate. However, you can use your accounting software to make things easier. I’m a fan of QuickBooks (<- Paid Affiliate Link), and I’ve tried several different software suites. If you don’t want to commit to a paid product just yet, you can make some fancy spreadsheets to handle this as well.
That’s actually what I did. I made spreadsheets until my data became too much. Then I moved to a custom piece of software I built. Finally, I switched to QuickBooks plus a little bit of Excel.
The Math of ROI
Firstly, Excel is your friend. Get well acquainted with your spreadsheets or hire someone who can do these kinds of analyses for you. Business analysts and CPAs do these things all the time.
If you have different products, product categories, or departments, you can separate all of your costs and revenue into those categories. This will make the calculations much easier.
As stated above, ROI is all things earned divided by all things spent. If you’ve properly divided your revenue and expenses, that’s an easy calculation. In the real world, it’s actually never that easy. For example, if you’re selling all your products on your website, how do you determine which product covers the cost of the website? That’s called overhead, and you should allocate a portion of that to each product in some fair ratio. Accountants have rules for that allocation, if you’d like to do it 100% correct. In my opinion, we just need it accurate enough to make simple decisions.
Here’s an easy example. Let’s say you spent $10,000 on PPC ads that take customers to a landing page. Those customers then either fill out a contact us form or don’t. From those who fill out that form, X% buy a $400 product. To calculate your ROI, you take the total revenue from this campaign (New Customers from this form x $400) divided by $10,000. Let’s say I got 40 new customers from this campaign. That’s $16,000. My ROI is $16,000/$10,000 or 1.6. In these calculations, you always subtract 1, so it ends up a .6 or 60% ROI. That’s a great ROI. However, you should have this calculation for all your campaigns. If 60% is lower than others, you prioritize those others. Mathematically speaking, you should always go for the highest ROI.
If I got 20 new customers instead of 40, I would have had a negative ROI and I shouldn’t do that campaign anymore.
Not all things can be measured. That’s just the truth. Some things can be measured, but they’re hard to measure or the results are delayed. The example I gave above was easy because the return should be instantaneous. Things that bolster your public image or health and wellbeing of yourself or your employees yield positive results, but they’re hard to measure from an ROI standpoint. There are actually numerous studies that do look at the ROI for these things, but as a small business owner, we don’t have the data necessary to do that.
The biggest myth I keep seeing is that you can resolve a negative ROI with volume. If you’re losing money on a product, selling more of it means you’re just going to lose more money. Unless something else changes, that’s how it goes. I unfortunately see this all the time. Revenue looks great, but if it costs you more than you’re making, that product is losing you money no matter what volume you do.
I actually had one client cut half of his business because that half was losing him money. He was bringing in about $500,000 from the B2B business, but supplies and labor cost him about $600,000. On the other hand, his B2C was costing around $425,000 but bringing in about $500,000. It is incredibly hard to lose half of your revenue, but when he did, suddenly, we went from losing $25,000/year to profiting $75,000. We actually did a lot more than this, but these numbers were simplified for this example.