How To Forecast Small Business Return on Investment (ROI)...

The return on investment ratio (ROI), also known as the return on assets ratio, is a profitability measure that evaluates the performance or potential return from a business or investment. The ROI formula looks at the benefit received from an investment, or its gain, divided by the investment's original cost. it is a critical part of basic accounting. Investors may want you to demonstrate realistic ROI predictions before they invest. You will need realistic ROI for deciding how you will grow your business. Realistic ROI predictions are needed by both of you to make sound business decisions.

The ROI Formula Is Simple

The basic idea of ROI is to express the additional money or value you have received -- the benefit or return you gained -- as a percentage of your initial investment. The formula is simple just add all the revenue a project or item will generate. Then subtract all the probable cost you will incur for producing that project or item. The balance is the likely ROI for the opportunity. A good opportunity will generate a profit and a bad opportunity will generate a loss.

How To Predict ROI

At least three contributing factors come from high market share; economies of scale, market power, and better access to quality management and talent. The latter can increase your ROI as high-performing managers are most often successful at achieving large portions of their respective markets. To make a realistic ROI prediction, you must set aside your biases (what you want to be true) and conduct research (what is true). You must also balance the science and the art of ROI. You can only guess at market changes that impact your predictions and the costs you will incur to adapt to those changes. You will need to consider direct revenues, indirect revenues, and residual revenues that will be generated by the project or item. then you need to consider the direct cost, the indirect cost, and your time and energy spent on this project. All these must be considered to produce an accurate ROI prediction. Looking into the future is the most tricky part of making a realistic prediction for each of these factors.

Interpreting the Return on Investment (ROI)

When interpreting ROI calculations, it's important to keep a few things in mind. First, ROI is typically expressed as a percentage because it is intuitively easier to understand (as opposed to when expressed as a ratio). Second, the ROI calculation includes the net return in the numerator because returns from an investment can be either positive or negative. When ROI calculations yield a positive figure, it means that net returns are in the black. Alternatively, when ROI calculations yield a negative figure, it means that net returns are in the red because total costs exceed total returns. Finally, to calculate ROI with the highest degree of accuracy, total returns and total costs should be considered. For an apples-to-apples comparison between competing investments, annualized ROI should be considered.

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