Updated: Dec 11, 2019
Every small business owner can employ multiple strategies to promote growth, but the path(s) chosen will have a significant impact on the long-term success of the business. Whether you’re contemplating a physical expansion or planning to enter a new market, it is important to accurately gauge the dividends that will ensue from investing time and money in that venture. Conducting a ROI analysis of the growth opportunity can help you decide if it’s the right move.
In the simplest terms, ROI (Return on Investment), is a measure of the gain accrued from a specific investment, relative to its cost; it is the value a growth opportunity adds to your business. If you’re starting a loyalty program to expand your customer base, for example, value lies in the revenue generated from the newly acquired customers, relative to the cost of acquisition. If your plan for growth centers on the introduction of a new product line, value is easily captured by sales volume, relative to the cost of production.
Evaluating the ROI of an investment opportunity is critical, particularly when you’re operating on a limited budget. Using ROI as a guide can help you pinpoint those opportunities that offer the highest potential return, based on the amount you’re able to invest.
Calculating ROI can also help you determine whether a growth opportunity offers any net benefit from a savings standpoint. Upgrading equipment, for example, may enable the expansion of your product line. At the same time, new equipment may also make your business more efficient and reduce your overhead costs, saving you money in the process.
ROI is measured as the ratio of net profits to total amount invested. Net profit refers to the total earnings from a venture over a defined period of time. It is the difference between the revenue generated by the venture, and the total cost of undertaking the venture.
For a growth opportunity which generates $500,000 in revenue, at a cost of $425,000 for example, ROI is: [500,000 – 425,000] / 425,000 i.e. 0.176 or 17.6%.
Make sure to factor loan interest and fees into your costs, if you’re financing an opportunity like the purchase of equipment or office space. Maintenance costs may also come into play if investing in equipment or other physical assets.
Time is also an important consideration. While the actual ROI calculation does not incorporate any data on time, it is important to review the timeline for generating returns. Make sure it fits with your business goals.
The standard ROI calculation, offers a measure of an investment opportunity’s value in financial terms, but other benefits may be just as important to consider. Recognizing the intangible payoffs of a particular investment, may help you develop a more comprehensive growth strategy. Hiring new employees, for example, may reduce workplace stress for your existing staff and increase employee satisfaction. That in turn could boost productivity, which would make the investment required to recruit and train them well worth it.
Thinking beyond dollars and cents is also important if your focus is the enhancement of your business’ reputation. Switching your product packaging to environmentally friendly materials, for example, sends the message that social responsibility is a priority for your business. That can improve your relationship with your existing customer base and also attract new customers who support the same cause.
Before you begin calculating the ROI for a growth venture, be clear on what your hurdle rate is. This represents the minimum rate of return you’re willing to accept for a particular investment. Keeping this base rate in mind as you perform ROI calculations, allows you to eliminate those opportunities that do not fit your criteria.