What's the return on your business investment?

What is ROI?

Is your business producing the best Return On your Investment (ROI)?
ROI is not the same as profit. 
Rather, it is a financial ratio that says how well the money you have invested in your business is producing returns to you.  In other words, the value created by your financial investment over time.
Think about it. You have sunk $200,000 of personal funds into a business. You find out that your business' ROI is 4% per year, but the yearly interest rate from a bank is 5.9%.  Maybe you think you could just have left your financial investment in the bank to make money with fewer headaches.
So "ROI is a useful measure to make decisions between alternative investment alternatives [1].  It's a very useful metric as you will see.

Measuring ROI

There are several ways to measure ROI.


a.  Entrepreneur.com [2] calculates ROI way. 
If your business' net profit is $100K and your equity (or net assets) of your business is $300K.  You ROI is then (net profit ÷ equity) is (100k ÷ 300k x 100) or 33%.


b. Author Forest Time in Chron [3] goes a further and states that this is not the best measure, because in almost all businesses, ROI may start negative, slowly become positive - and then grow over time.  We think this is more accurate than the Entrepreneur example in (a). 
To use the second formula, first add together all the money you have gained from your investment = retained earning in the business, over a period of say - 5 years.
Assume this is $30,000. Next, assume your equity (your "investment") in the business is $20,000.
Last, take (retained earnings - equity) ÷ equity x 100 = 50%.  Your ROI is 50 per cent. 
Most investors in an enterprise require a higher interest than if they were to have left their money in the bank because of the riskiness of running a business, compared with the relative safety of a bank.

DuPont Ratio

The Du Pont Ratio, invented by the DuPont Corporation, reportedly in 1912 is an even more sophisticated financial ratio that looks at three components of a company's financials:  (a) profit margin; (b) asset turnover (operational efficiency) and (c) financial leverage. 
The model shows that ROE can be raised by a higher profit margin, increasing asset turnover, or leveraging assets more effectively.  Each one of these figures can be found, quickly in either the income statement or the balance sheet.  
The analysis helps to pinpoint reasons for the ROE being the number it is.  For example, management can discover whether the problem area is a lower profit margin, asset turnover or poor financial leveraging.  Once the culprit is identified, you can attempt to correct it or address it with investors.  A fuller explanation and example can be found at Dupont Analysis [4].
The primary advantage of DuPont analysis is the full picture it provides of the company's overall financial health and performance.
The disadvantage of the DuPont analysis is that results are only as good as the accuracy of the data used from the company's income statement and balance sheet.  The truth is that nonsense input data produces nonsense information for financial decision-making.
What is the return on your business investment?  Isn't that something that you should know?  Get information to make better financial decisions for your business.


[1] Kaufman, Josh (n.d.) What is "Return on Investment (ROI)? Accessed from https://personalmba.com/return-on-investment/
[2] Entrepreneur (2018) "Return on Investment (ROI)" Entrepreneur Asia Pacific.  Accessed from https://www.entrepreneur.com/encyclopedia/return-on-investment-roi.  
[3] Time, Forest. "How to Calculate Return on Investment for Small Business Investors." Small Business - Chron.com, http://smallbusiness.chron.com/calculate-return-investment-small-business-investors-26351.html. Accessed 05 September 2018.
[4] myaccountingcourse (2018) DuPont Analysis.  Accessed from https://www.myaccountingcourse.com/financial-ratios/dupont-analysis