Measuring return on investment (ROI) is one of the smartest ways a small business owner can understand what’s working—and what isn’t.
In this guide, you’ll learn what ROI means, why it matters for the health and growth of your business, and how to calculate it yourself using a simple formula.
By the end, you’ll have the tools to evaluate your efforts with confidence. Even better, you’ll be able to make smart, informed decisions that help your business thrive.
Read on to learn more!
What Is ROI and Why Small Businesses Need It
Return on investment (ROI) is a financial ratio that measures the profit generated by an investment in relation to its cost.
Several factors impact ROI, including the initial investment cost, ongoing maintenance (if applicable), and cash flow generation.
So why do ROI calculations matter to small businesses? They can be crucial for several reasons, including:
- ROI evaluates performance and enables you to compare investments.
- The metric can help you make more informed decisions about whether to continue with the investment or halt it.
- Understanding the ROI allows for the prioritization of resources when they are limited.
- ROI can provide a competitive advantage, ensuring more sustainable growth.
- Small businesses can use ROI to mitigate financial risks.
- ROI could also be something that entices investors to your business.
- It’s versatile and straightforward. You can use it across many investments using the same formula.
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How to Calculate ROI (With the ROI Formula)
Let’s review how to measure ROI, starting with the formula.
ROI = Current Value of Investment (or Net Income) − Cost of Investment / Cost of Investment × 100
Here is an explanation for each number:
- Current value of investment: What the investment is worth currently.
- Net income: The total profit from the investment.
- Cost of investment: The complete amount your business invested in a project or initiative.
Note: You would use the current investment value when measuring the ROI of a specific investment that can increase. Whereas, net income makes sense for those things you invest in, like marketing campaigns, that should generate revenue.
Let’s use an example to calculate ROI with the formula: Current Value of Investment (or Net Income) − Cost of Investment / Cost of Investment × 100
Let’s say the total investment cost was $5,000, and the current value/net income is $8,000.
Then the ROI formula would be $5,000 − $8,000 / $5,000 × 100.
So, you subtract 5,000 from 8,000, equaling 3k.
Then you divide 3,000 by 8,000, equaling .6.
Finally, you multiply .6 by 100, equaling 60.
And that’s it! Your ROI is 60%.
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Benefits of Using the ROI Calculation
How can your business benefit from using the ROI calculation? It can apply to almost any initiative within your company, so there’s no shortage of advantages.
Here are the most valuable benefits:
ROI is Easy to Calculate
It won’t require much work, as the ROI formula is straightforward. You only need two numbers. Also, you can measure it over time to understand the investment’s trends with little friction.
Comparative Analysis is Consistent
You can easily compare the ROI of several similar projects or investments. This practice enables you to prioritize the one with the best returns.
ROI is a Reliable Way to Gauge Profitability
With ROI, you’re seeing net numbers (after expenses), so it accurately shows what you’ve earned. As we all know, maintaining a healthy profit is critical to any business.
Not sure how much profit your small business needs? Check out our free Profit Margin Calculator. It does the math for you!
ROI Calculations Set Benchmarks
Over time, you can use ROI numbers as benchmarks for future projects that are similar in nature. These previous measurements can be useful in goal setting and forecasting.
ROI is an Excellent Performance Measurement
ROI is objective and deals with defined numbers. That makes it good for assessing the success of things like marketing campaigns. If you do this over time, trends will emerge. This empowers you to spot what’s working and what needs adjustment.
Limitations of Using the ROI Calculation
ROI has many applications and use cases, but it’s not a “perfect” metric. Like anything, it does have limitations, such as:
There’s No Timeframe Consideration
Comparing two investments can be misleading if the time frames differ. For example, a three-year investment may look more profitable than a five-year one unless you account for the time difference. The ROI formula does not factor in investment time periods.
Calculations Can Differ Between Businesses
There are variations of the ROI formula, such as using net income versus current value. This makes it tricky to benchmark against other companies.
ROI Leaves Out Nonfinancial Benefits
Investing in things like computers and software doesn’t necessarily generate income, nor do they increase in value. However, they deliver many things needed for a company to be successful by improving efficiency. ROI calculations don’t cover the full yields of an investment.
ROI Percentages Leave Out Important Things
These calculations do not address risk, longevity, or other factors not represented by numbers. The ROI percentage, therefore, isn’t the complete story on what your business gained from the investment.
The ROI is Only One Metric for Profitability
You should think of ROI as one data point on a bigger map. To understand true profitability, you also need information about cash flow, aging reports, sales pipelines, and other relevant financial data related to your business.
What Is a Good ROI? 5 Factors to Consider
The question of what a good ROI is depends on multiple factors, including:
1. Risk Tolerance
Each investment comes with some level of risk, some more than others. If you’re more risk-averse, a lower ROI would be good for you. If you have a higher tolerance, then expectations will be greater.
2. Investment Duration
The duration of an investment or project influences its ROI. If the investment is long-term and involves a significant amount of capital, you’ll want to see higher ROI percentages. For something that’s short-term, you will have more flexibility and be content with a lower ROI value.
3. Industry Norms
You can also look at industry benchmarks to gauge the performance of ROI. If available, these give you more insight into how your competitors are faring.
4. Company Goals
Your organization may have specific objectives for investments around profitability or an expected return. Those are typically set before the investment and will inform whether your final ROI is good or poor.
5. Your Business Stage
Another factor is the maturity of your company. If you’ve been in business a long time, you may find a lower ROI to be in line with sustainable growth. Start-ups may have more aggressive ROI goals, as they need to see returns on their initial investments or risk failure.
Which factors will be most essential to you?
The type of investment or project will certainly determine which components carry the most weight in your analysis. Also, ROI has a narrow meaning. It should be one part of a total investment in the performance of a campaign or initiative.
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6 Pro Tips on How to Measure ROI for Your Business
Learning how to measure ROI is only the first step. It’s a valuable metric that can lead to taking action.
Here are some strategies to assist you:
1. Use Digital Tools
There may be interactive calculators available for these calculations. Digital tools would also be necessary for measuring ROI related to any type of advertising spending.
2. Stick to the Same Method of Calculation
Being consistent matters; otherwise, your calculations would have different interpretations.
3. Compare Investments Based on ROI Numbers
ROI serves as a very effective comparison tool. However, remember that factors like the length of the investment need to be considered in your comparisons.
4. Have an Objective in Mind From the Start
Calculating ROI without a clear goal means the results won’t drive action or meet a need.
5. Focus on Factors That Are Relevant
A project or investment can have multiple goals or outcomes. Decide what’s most essential and use those in your interpretation.
6. Consider Long-Term Value
Just because an investment isn’t delivering substantial ROI today, it doesn’t mean that it never will. Keep this in mind for those longer-term projects.
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Key Takeaways for Measuring Small Business ROI
- Determine the best ROI formulas you should be using and how often you’ll do this measurement.
- Define the types of projects or investments you want to measure the ROI of and begin measuring monthly.
- Find an ROI calculator that fits your needs and use it for calculations.
- Develop a standard operating procedure for interpreting ROI results in terms of monitoring profitability and comparing assets or projects.
- Be sure to include context in your analysis for more accurate projections and comparisons.
