Calculating how your money is working in your business
How do you make a small fortune in a business? Start five years earlier with a large fortune.
It is an old story told in the business. Hopefully it is not true for anyone reading this column, but the question of making a small fortune could still be asked. And the answer would be to maximize the return on the investment you have in your business.
Explaining how to maximize the return on investment may sound simple in this column, and we will do our best to help you decide the necessary steps to achieve this maximization in your business.
We begin by explaining that the investment in your business is found on your balance sheet in the top section where assets are listed. Every asset, regardless of whether or not it has been paid for is an investment. Maximizing the investment requires an examination of each asset to make sure you are getting the most return.
In assets, cash is usually listed as the first asset. In most situations, cash is the least productive asset you have. To confirm this statement, look at the interest rate any bank pays, and you will see it will be difficult to have a poorer performing asset.
A second poor performing asset is accounts receivable. For many businesses, when you are sending a statement to a customer for their purchases of the previous month, you are in effect giving that customer an interest free loan. This is not to imply you should eliminate receivables; you can gain customer loyalty because you offer the option to a customer of paying at the end of the month. However, you will want to closely monitor just how much you are willing to have sitting on the balance sheet as a non-productive asset.
There is a series of assets that are commonly depreciated over a period of time. These include delivery vehicles, computers, fixtures, and other equipment used to carry on the daily transactions of business. While at first look you might think these are not wise investments, quite the contrary can be true.
It may require a bit of calculation, but the purpose of each of these assets is to increase business. While depreciation can make the purchase of one of these assets even more attractive, envision your purchasing a display that could greatly increase the sales per square foot. When you calculate that increase in sales and extend it for the life of the fixture, you will be able to compare the sales increase to the investment in the fixture to determine the return on investment.
The category of assets that can make the biggest difference in the return on investment of your business is that of inventory. Stating earlier that cash was a poor investment was a lead in as to where you should be investing. However, purchasing inventory just for the sake of putting the cash into action is not going to increase your return on investment.
Where should you be making that inventory investment? One place to consider is adding new categories of products that your current customers are likely to purchase. The reason for this is that you want to cause the customer to be more reliant on your business. Research has shown that the more a customer depends on a business, the harder it is for the customer to decide to do business somewhere else.
Another consideration for increased ROI is the quantity of each item you keep on hand. One school of thought for inventory control is that you want just enough of an item on hand so that new inventory arrives just before you sell the last of what is sitting on your shelf.
To the other extreme, some will look at special buys, seasonal offerings and other promotions as they decide to buy inventory in quantity. The question asked is which of the two is correct. The answer is that the two answers can both be right and they can both be wrong.
To make the determination that maximizes your return on investment, you have to give consideration to several factors; how many do you have to purchase at a time, whether or not freight is to be paid, when the invoice for the inventory is due, how fast you sell the inventory and how long it takes an order to arrive.
All of these examinations of your assets can make a big difference in the return on investment in your business. Take a close look at how you can better control the assets, implement a strategy, and watch your return on investment increase. It sure beats letting the cash sit on the shelf and in your checking account.