Return on investment—commonly called “ROI”—describes the performance of an investment in financial terms. Specifically, ROI represents the amount of profit as a percentage of the invested amount. When ROI is positive rather than negative, it means you will get back more money than you originally invested.
ROI is a key indicator of the likelihood that a small business will be successful long term. Moreover, ROI provides investors in your business with important insight into the potential for a return on the capital they risked. With positive ROI, it’s more likely that investors will continue to invest in your business because they expect to continue to get a return on their money.
In this article, we take a closer look at how to calculate ROI when financing new projects and we also discuss what a good ROI is for a small business.
How to Calculate ROI Using Small Business Examples
In order to calculate ROI, you must first estimate the net profit you expect to make from your investment. Once you determine the net profit, plug it into the formula as follows:
- ROI (%) = (Net profit / Investment) x 100
As you can see, ROI is expressed as a percentage of your investment.
Let’s take our understanding of ROI a step further by reviewing some common project financing examples for small businesses.
Inventory Financing Project
You have the opportunity to buy more inventory at a 30% discount for a total of $100,000. You estimate that you can resell this inventory for $200,000. Idea Financial loans you $100,000 on a 12-month term. The total cost of the loan for the inventory, including interest and fees, is $114,870. With this information, we can compute the ROI on the financing of this project as follows:
- 74% = (($200,000 - $114,870) / $114,870) x 100
With a net profit of $85,130.00, the ROI of this inventory financing project comes out to be 74%.
Advertising Financing Project
You need to boost your sales with an aggressive advertising campaign that you estimate will cost $100,000. Based on your marketing analytics and business intelligence data, you estimate that the lifetime revenue value of one of your customers is $4,000. Moreover, you expect that this advertising campaign will bring in 100 new customers. Idea Financial loans you $100,000 on a 9-month term, which brings the total cost of the loan for the advertising campaign to $111,100. With this information, we can compute the ROI on the financing of this project as follows:
- 260% = (($400,000 - $111,100) / $111,100) x 100
With a net profit of $288,900, the ROI of this advertising financing project comes out to be 260%.
Fleet Expansion Financing Project
You’re expanding your fleet of service trucks by buying two new ones. Each truck costs $70,000 and has an estimated useful life of 5 years. With these two additional trucks, you expect to be able to service more customers and increase annual sales by $300,000. Idea Financial loans you $140,000 on a 18-month term, which brings the total cost of the loan for the trucks to $171,706. With this information, we can compute the ROI on the financing of this project as follows:
- 75% = (($300,000 - $171,706) / $171,706) x 100
With a net profit of $128,294 the ROI of this truck financing project comes out to be 75%.
What is a Good ROI for a Business?
Determining the definition of a good ROI has quite a bit of variability depending on the nature of your business, your industry, and other key factors. Many business owners and investors strive for double-digit ROI—often between 15%-30%. However, there are other businesses where a lower ROI (5%-10%) or a higher ROI (over 30%) is considered good.
As you work to define whether a projected ROI is good for your business, it’s helpful to take into account the length of time it will take before you become profitable from the proceeds of the loan. Moreover, it’s vital that you carefully consider how the infusion of capital will affect the long-term growth of your business and your ability to service the loan payments from your cash flow. If the projected ROI is high enough and you have the cash flow to make the payments, you can move forward confidently knowing that financing your next project will help take your business to the next level of success.