Determining how you are doing in your business
The television commercial begins with someone asking if you know what your score is. He quickly points out he is asking if you know what your credit rating score is. Most people don’t know it.
There is a question that could, and should be asked of every business owner. “Do you know what your return on investment is for your business?”
Most business owners do not know what their rate of return is. They do not know how to calculate it, and most importantly they do not know what to do to improve the rate of return. Yet, if they took the total amount invested in their business and were looking for a way to invest that money, one of the first questions the business owner would ask would be with regard to the rate of return.
Yet, as compared to investing in the stock market where the riskier shares often have the chance for a higher return, the better you perform the task of operating the business, the higher the return you will receive.
You can utilize a free return on investment calculator on the website profitsplus.org where you will need your year-end balance sheet, your last twelve profit and loss statements, and what your income tax rate was. As you input various bits of information from these documents, the website calculator will quickly analyze your business and likely tell you more about your business than any accountant has.
You will learn how well you are collecting your accounts receivable, how fast you are turning your investor, your return on the total investments of your business, and the final answer of your return on investment. Looking at this last number, it would be reasonable for you to hold this number up in comparison to any other investment you are making. Which one is performing better?
Of course, in this calculation the assumption has to be made that if you own the building, you are paying yourself a competitive rate for rent. And, the assumption is that you are paying yourself a reasonable salary as the owner/manager of the business. The suggestion would be that the business should be paying you a salary comparable with that of a person you would hire to perform the same tasks.
After having completed this calculation, you will have to decide if the return on investment you have calculated is acceptable to you. Again, the best comparison would be to ask yourself what kind of return your money would earn if it were invested elsewhere.
Whether you are or are not pleased with the calculated return, the important lesson to be learned is what you can do to maintain the current rate, or even to improve it.
One of the first areas to review would be your in-house charge accounts and your rate of collection. While in-house charge accounts can be a great way to develop and maintain customer loyalty, having that money uncollected is akin to loaning money to someone at a zero interest rate. As you use this calculator and determine your A/R collection days, the desirable answer is anything less than 1.5 times your terms. As an example, if your terms are net 30, anything less than 45 is desirable.
Another aspect of improving your return on investment (ROI) is controlling the cost of goods sold. This can be achieved by increasing your gross margin. Doing this requires that you either lower your inventory costs by doing a better job of buying or by increasing your prices on the goods and services you sell. Either way, you have increased your gross margin.
A third way of improving the ROI is by increasing your inventory turnover. Many people think that by lowering their prices they will increase sales. However, increased sales do not necessarily lead to an increase in inventory turnover. The key to increased inventory turnover lies in better inventory control.
Better inventory control begins by properly anticipating the seasonal needs of inventory. If inventory remains in your business from one season to another, your turnover will greatly decrease. The phrase, “just in time” inventory comes into play here. Unless there is a substantial savings in the cost of the merchandise, it doesn’t make sense to have a month’s worth of inventory on hand when you can get by with weekly reordering. Just don’t cut it so close that you are missing sales.
Operating expenses is the fourth way that stands out. Simply stated, if you don’t spend the money in expenses, then it falls to the bottom line as profit. And the higher the profit, the higher the return on investment your business will have.
One last observation, the return on investment calculation will also show that the fewer current and long term assets the business has, and the more current and long term debt the business has, the higher the return on investment. However, those two factors are cancelled out as you can’t operate your business without cash, and having debt will require additional interest expense. None of these are desirable.
Hey friend, want to get a great return on your money with a sure thing? It’s right there inside your business. And the return will be even more with some of these specific efforts by you.