You run a small business, things are going well and now you want to make some big investments, perhaps a costly new piece of equipment to provide a new service or a bigger van.
But the big question is “will you get a good return” from spending this extra money, and how much extra income do you need to generate not just to cover the costs but to bring in enough extra income to make the risk worthwhile through extra profits too.
Before splashing the cash you first need to work out the expected return on investment (ROI) by comparing the expected benefits with the costs.
What is the biggest mistake to avoid when calculating ROI?
The most common mistake I come across is confusing is people confusing income with profit. If you rely solely on your income figure when calculating ROI then you will end up with a figure that looks much better than reality.
Let me tell you about Lee, for instance, a tradesman who, after 5 years of driving around in a clapped-out van, wanted to figure out whether he could afford a replacement vehicle.
Lee came to Ozlop to discuss the financial merits of upgrading his van and we worked with him to identify that there were lots of positives including:
- Significantly lower fuel costs
- Lower road tax
- No repair bills thanks to a comprehensive warranty
- An improved image that supports an increase in fees
- Much improved reliability – allowing him to keep the van on the road and secure more work
When we did the sums at Ozlop we discovered that compared with the previous 3 years, the reduced fuel costs, lower road tax and removal of repair bills more than covered the additional costs of leasing a new van.
In fact, the figures showed that the new van could boost revenue by as much as 5%, which coupled with his lower operating costs showed a much-improved return.
Fortunately, Lee’s business was able to carry the weight of the investment. We meet many more business owners who have made big investments only for it to erode profits and ultimately cause cashflow problems from over-optimistic assumptions about potential returns.
It is absolutely vital when you’re deciding how and when to spend on your business, you are armed with the right financial information to help you make the right decision.
This is where Ozlop can help.
Ozlop helps people who have limited time for business admin by helping get on top of your books so that you can make spending decisions. Get in touch to find out how we can help you sort out your finances quickly.
David Vine – small business specialist and Managing Director at Ozlop, the bookkeeping specialists for owner-managed businesses