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Why is Return On Investment important?

You may have heard ROI being talked about in the business sector and wondered what are they talking about? Why is ROI so important to investors and the finance department? Let us look at what ROI is and why it can help you greatly when make business decisions.

What is ROI?

ROI stands for “return on investment”. This means what do you make when you put money into a certain project or equipment. To work out ROI, you can use a simple equation. Let us take a look at what this would look for an investment into a piece of equipment for your business.

ROI = ((profit made – cost of equipment)/ cost of equipment) X 100

If our profit was R100 000 and the equipment cost R20 000 then the equation would look as follows:

ROI = ((100 000 – 20 0000)/ 20 000) X 100
ROI = 40%

So you have made quite a good return on the investment which you made. When calculating the return on investment, it is also important to include the hidden costs, fees and time. You may want to consider the emotional factors as well. One thing to consider about ROI is that it often does not take time into consideration and you may have a negative return on investment in the first year of your purchase. So you need to keep this in mind when doing your calculations.

Why is ROI important?

Now, that we have an idea of what return on investment is, why is it important? What value does it offer to the business owner? ROI is important to all types of business and function areas no matter how big or small you are. It will help you to make more accurate business decisions and you will be able to change course on an investment if you see that it is performing badly. Here are some areas where ROI can be used:

  • Purchasing of new equipment: When considering buying new equipment for the company you can do an ROI comparison and ensure that you purchase the right piece of equipment for your business. Ensure when you work out the return on investment for each piece of equipment you use the same parameters to measure it by.
  • Hiring of employees: Are you employees helping to increase or decrease your profits? By doing a ROI calculation who can see who is worth their weight in gold, and who is dead weight and needs to be removed. The same can be done for when you are considering adding a department to your business.
  • Marketing strategies: You can assess what the profitability will be for a marketing strategy. Furthermore, you can assess the strategy after its implementation and see if it is still profitable and if not you can review your strategy and make adjustments before you have lost too much money.

Finally, it can be said that ROI is important to assist in making critical business decisions. By evaluating what the return on investment will be for your next purchase or strategy you will be able to make a more informed decision.

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