Return on investment (ROI) is a fiscal and strategic business concept--and a critical part of basic accounting. On the one hand, many investors want you to demonstrate realistic ROI predictions before they invest in your business. On the other hand, you need to make realistic ROI predictions when deciding how you will grow your business. Both hands rely on realistic ROI predictions to make sound business decisions.
ROI Basics
ROI calculations are simple. Add up all the probable revenues a specific opportunity will generate. Then, subtract all the probable costs you will incur for pursuing that opportunity. The remainder is the likely ROI for this opportunity. A good opportunity from an ROI perspective is one that generates a positive ROI or a profit. A bad opportunity is one that generates a negative ROI or a loss. The best opportunity is the one that generates the most profit.
ROI Factors
When predicting revenues, you need to consider:
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Direct revenues that will be generated by the opportunity
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Indirect revenues that will be generated by the opportunity
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Residual revenues that will be generated by the opportunity
When predicting expenses, you need to consider:
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Direct costs incurred by pursuing the opportunity
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Indirect costs that will be incurred if you pursue the opportunity
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Opportunity costs for not using your energy, time, and resources to pursue other opportunities
All of these factors must be considered to produce an accurate ROI prediction. The really tricky part, however, is looking into the future and making a realistic prediction for each of these factors.
Predicting ROI
You must set aside your biases (what you want to be true) and conduct research (what is true) to make a realistic ROI prediction. You must also balance the science and the art of ROI. You can research the number of people who use a product or service, the percentage of users who want a better experience, the effort required to convert them, and your penetration rate. You can only guess at market changes that impact your predictions and the costs you will incur to adapt to those changes.
Predicting ROI requires research and honest calculations. It also requires having a feel for your market and its upcoming changes. On the one hand, there’s a lot of business science involved. On the other hand, there’s a lot of artistic, intuitive guesswork involved. You need both hands to make realistic, accurate ROI predictions.
If you're struggling to predict ROI and need help with small business accounting strategies, our experts can help.
