Last week we talked about calculating a return on investment (ROI) from your recruiting costs, whether you are recruiting customers for your product or resellers. Of course our return on investment calculation is just an estimate based on less than all the facts. It is still an important calculation, though, and worth the exercise even if ultimately it is way off. Why? Because ultimately you want to know what your real return on investment is and you can’t wait for all the facts to come in. So, you make an estimate based on what you believe, then you revise your number as reality sets in.
Why do you even care what return on investment is? Return on investment is an important measurement for deciding if you time and money are being spent in the right way. As a rule of thumb, a 20% return on investment is good for investments with substantial risks. You can consider a business investment a substantial risk because there will be good times and bad times, and you might now be in a good time (in fact I think now is a great time). So today your real ROI may be 20% and tomorrow it might be -5%. So 20% is a good rule of thumb for ROI.
You might want to adjust this ROI for your risk level. Let’s say that your ROI for new resellers is 18% but it’s likely their business will grow. So 18% may be a very good ROI. If your ROI is 8% instead, it might be a good ROI if your investment is US Treasuries that will always pay 8% (i.e. ultra safe). But it would be an extremely poor ROI if your investment had any risk at all. So risk is a factor in whether your ROI is a good number or not.
Your ROI is an important number to determine how much money you’ll need before your business begins making a profit. For instance, you invest $100 per month for a year and your ROI is 20%, meaning you’ll make $20 per month or so. It will take 5 years to begin making a profit if you never increase your investment. If instead you sink your profits back into your business, you will earn $100 in revenue before hitting the 5 year mark but you’ll always lose $1200 per year. You’ll need to back off on your investment to earn a profit.
If you do want to invest $100 per month in your business and reinvest the revenues for 5 years, how much money will you need? $1200 per year X 5 years or $6000. Do you have $6000 or can you get it over 5 years? If not, you will need to borrow the money or find investors. So the ROI is also important to determine if you’ll do it all by yourself or if you’ll need to seek help from others. It’ll do this before you actually need the money, giving you time to work with your bank or pitching your relatives on your new business (to drum up investors).
So your return on investment number is important to estimate, then correct, as you initially grow your business. What other calculations are important?