Small Business Talk By Jason Arsenault, CPA
Return on Investment (ROI) This is a business term that we use to evaluate the profitability of an investment. For a small business owner that investment could be inventory. Let’s say that we own a tire shop and sell a set of four tires for $1000 and those tires cost us $500, that creates an ROI of 1 or 100%. It is a quick calculation of taking the profit of $500 and dividing it by the cost of $500. I imagine most small business owners aren’t spending a lot of time calculating ROI because it just doesn’t mean much.
the huge savings. These extra costs are not part of the ROI calculation, but they are an important consideration of whether offering a price of $650 is worth it in the long run. As a small business owner, it is important to see the whole picture of your operation, it can be the difference between success and failure.
Net Income Formula
ROI is a great tool to evaluate a specific investment like inventory, but it falls short in giving us a better understanding of how your business is doing overall. You might have heard the term the bottom line. The net income formula gives you that very important bottom line and is often referred What is important to a small business owner to as being in the black (positive income) or is cash flow. What if it took our tire shop the red (negative income). two months to sell that set of four tires? Our competitor on the other side of the street It is an easy calculation. You get a revenue sells that same set of tires for $650, giving number from all your sales and then subtract them a much worse ROI of .3 or 30%. an expense number. Those expenses are However, they are selling four sets of those your operating expenses like turning on the tires a month, meaning eight sales to our lights, payroll costs and a number of other one sale. That gives our competition a profit costs. For an inventory business this number of $1200 every two months compared to will also include the cost of goods sold. our $500. In business more money always means better, doesn’t it? Calculating this number is very important because it is going to tell us how we are The tire shop across the street had to hire doing financially. Do we have extra monies an extra hand to help with the demand for to put into marketing in an attempt to have their low-cost tire. They also are running even more sales next month? Or, do we need an advertisement in the local paper and to really focus on cutting operating expenses radio station so everyone will know about because we are spending way to much
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November 2021
