Why should a business count ROI and how to use it? What ROI is good and what to do if ROI is less than 100%? What tools to use for calculations? Here are the most important things about the key metric of business financial performance.
For example, you promote this bookmaker. You spend a lot of money on Instagram ads and want to optimize the business: increase the number of bettors and reduce unnecessary costs. ROI will help you in this: it will show how much your investment pays off together with the costs of advertising and adding new features.
Knowing how profitable or unprofitable the project is, it is easier to make management decisions: to expand or stop the production of a particular product, close the project, direction, advertising campaign or continue their investment.
What Is ROI
ROI (Return On Investment) is a measure of return on investment in business. Simply put, it shows the return on investment of a project. ROI will show how much money you were able to get back, whether you managed to make a profit, what can really make money.
ROI is calculated as a percentage. To do this, the result of the calculation is multiplied by 100.
The Difference Between ROI, ROMI, and ROAS
ROI is often confused with ROMI and ROMI with ROAS. This is due to the similarity of indicators – in all cases we consider the return on investment. To understand the difference, let’s look at how the numbers differ and compare the formulas.
ROI shows the level of return on all investments. The indicator helps to determine how profitable the project is, taking into account all investments. It is a global indicator of business payback.
The formula for ROI is as follows:
ROI = (income – investment) ÷ investment × 100
To calculate ROI, take into account all the costs of the project and the income received from it.
ROMI is a measure of return on investment in marketing. That is, when calculating the figures you need to consider only marketing costs: advertising budget, labor costs of specialists and organization of events and other related costs. In contrast to ROI, this calculation does not take into account the costs of producing the product.
Here is the ROMI formula:
ROMI = (marketing revenue – marketing investment) ÷ marketing investment × 100
ROMI has a narrower focus than ROI. It is used to determine the effectiveness of the marketing strategy.
ROAS = advertising revenue ÷ advertising costs × 100
When calculating ROAS, only the cost of a specific advertising tool or channel is counted.
When to Calculate ROI
ROI calculation is useful for management decision making. With ROI it is possible to assess the current profitability of a project, thus avoiding costly mistakes when investing in unprofitable projects. ROI helps in choosing the direction of company development when it is necessary to determine profitable ways.
ROI shows the profit received from the project as a percentage. Here are the possible results of the calculation and their meaning:
- > 100% – the investment has paid off and the project is profitable.
- = 100% – the investment is paid off.
- < 100% – the investment is only partially paid off.
Knowing the result, you can determine what percentage of return each unit of money invested provided.
The calculation of ROI is useful if you need to:
- Evaluate the overall profitability of the project.
- Evaluate the results of the project over a certain period.
- Identify profitable and unprofitable products.
- Make a decision about continuing to invest in the project.
Applying ROI as one of the performance indicators is appropriate for most types of business, in which it is possible to accurately calculate costs and revenues. From a manicurist to fixing car windshields, to manufacturing metal tiles to selling radio communication systems.
When ROI Doesn’t Work
ROI may seem like a universal tool for measuring performance. But it isn’t. In particular, there are situations where calculating ROI won’t help you figure out your actual return on investment.
Long Deal Cycle
When selling premium goods or high-value services, the deal stretches over time and is divided into many stages, making it difficult to objectively calculate ROI. Often, long sales cycles are common in the B2B industry.
If it takes weeks, months or even years to make a decision, then focusing on ROI is ineffective. It turns out that in some period of time huge investments in marketing are accompanied by almost total absence of transactions, and the ROI shows losses. And in the other period there is a significant income along with minimal investments and ROI shows profit. If you are guided by the ROI figure, then you should shut down unprofitable marketing activities. But in fact, they were the ones that drove the profits, but with a time lag.
Working in Challenging Markets
In some areas it is difficult to calculate the average check, because the amounts can vary greatly even within the cooperation with one client.
For example, one month a customer made a $100 purchase and another month a $5,000 purchase. Or a client buys a product once and then periodically buys more goods/services. If you are only guided by costs and revenues for the period, ROI will show a loss and a profit.
Predicting an average check and calculating ROI is difficult and inefficient, for example for manufacturers of industrial equipment, as well as some construction companies and organizations that produce and service components for complex markets and projects.
Lack of Monetary Goals
If a company’s goal is to promote its brand and increase its visibility, it doesn’t set out to directly generate revenue. In the absence of monetary revenue, ROI cannot be calculated.
For example, the goal of a campaign is to build a loyal community. A lot of money is spent on various events and promotions, but the ROI will show a loss due to the lack of monetary revenue. Logically the campaign should be terminated, but in this case the effectiveness should be measured by completely different metrics.
Dependence of Sales on Other Conditions
In the service industry, profits are highly dependent on service and customer support features.
For example, a small company employs two managers on a rotating basis. Assume that marketing, advertising, and product production costs are static. The first manager worked for a month, processed requests perfectly, made a lot of deals, and the ROI was very high. But in the next month a second manager worked, who processed requests “with his hands down” and had few completed deals – the ROI was a loss. But if in the next period two of these managers work together, ROI can be anything, it all depends on the volume of high quality processed orders.
How to Calculate ROI on Your Own
Choose the Right Attribution Model for Accurate Calculations
An attribution model is the principle of distributing value across all the efforts that achieved it. For example, by the campaigns and advertising channels that helped attract users.
The attribution model used should be credible and transparent, that is, objectively consider the contribution of each effort and ensure that the results of the calculation can be verified.
Consider All External Factors That Affect Revenue Generation
Factors that affect revenue can vary widely. For example, product sales can be affected by seasonality, and with an equal investment, ROI will vary greatly from period to period. Profits may also be influenced by the activities of competitors in the evaluation period. Therefore with the probability of strong influence of external factors it is better to calculate ROI in dynamics and to analyze the reasons of profit or loss in different periods.
Focus on the Full Sales Cycle
For spheres with a long sales cycle it is more logical to count ROI for the full period, starting from the customer’s acquaintance with the product and up to the purchase.
Count Revenues and Expenses
A common mistake is ignoring some costs in the cost of production or accounting for unnecessary costs. In this case, income may be calculated incorrectly. The gross profit should be taken for the calculations.