Cash investments are critical to a company’s growth. Cash investments can lead to increased revenues
and/or decreased costs, leading to higher profits, and growth. So, decisions about what investments to make
are critical to your company’s future.
This blog suggests using a quantitative approach to making decisions
about how to invest cash for growth. Think
in terms of the affect that the investment will have on profit by increasing revenues
or decreasing costs. Quantify these
changes in revenues and costs in dollars and than divide these changes by the dollar
amount of the investment made. The result
will be the return on the investment.
Have in mind a minimum return on investment percent (e.g. 5%, 10%, or greater)
that you will required before you will make the decision to invest. Use your financial statements for support in
making investment decisions. Consider
each line item on the profit and loss statement for where increases or decreases
can result from investments. Accept
that too low a return is not worth the effort.
Rather look for other investments with sufficient returns.
Return on investment calculations need to be based on reasonably
accurate estimates of gains (the increased in revenues less costs) divided by reasonably
accurate estimated costs. Too often the
return on investment determination is flawed, because the estimated gains and
costs are incorrect, leading to a wrong rate of return. The return on investment
concept for decision making should only be used when there is a clear amount of
investment and a quantifiable gain and cost that clearly and unambiguously results
from the investment. Otherwise too much uncertainty
exists about how the investment correlates with the gain.
Accounting systems such as QuickBooks and QuickBooks Point
of Sale can be used to determine the return on the investment for each item of inventory
that is sold. Reports in these software
packages can show total costs (investments) and total profits (gains) form the inventory
item sales. From this data, investment returns
can be calculated showing those inventory items that are most profitable. Investment return percentages give a more pronounced
picture of the differences in gains from sales than gross profit margin
percentages and, in that respect, can be useful for decisions related to
inventory investments.
Besides inventory investments, investments in creating new
products or services, in marketing, in adding personnel (where the personnel
can be clearly tied to increased revenues, such as sales personnel), and projects
with clear, directly-related costs are likely investments for return on investment
decision-making analysis. Remember, be
as accurate as possible in estimating these gains (benefits) and the costs of
the gains. And implement only the investments with sufficient returns. Where limits on investments exist, choose the
investments with the best expected returns.
Other factors need to be considered in addition to the percentage
rate of return of an investment, not the least of which is the risk associated with
the investment failing to meet the expected gain.
Try to keep in mind that computing investment returns in
your business should be straight forward, not unduly complicated and complex, and fully understandable by you. Although good estimates of gains and costs
are important, absolute accuracies are not so critical such that determining the
estimates become a lengthy, complicated, painful, and costly exercise. Rely on good judgments and common sense in estimating
the gains and costs. Whether the return
is 15%, higher, or even lower, the decision to make the investment in your business
will help your business. What is important
is to be in the right ball park, e.g., the result that the return is above your
lower limit for a return, rather than in the wrong all park, meaning there is
no return, and therefore a bad decision.
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