An investment is something you put time, energy, or money into because you expect to gain profit or satisfaction in return. When you start your own business, you are investing time and energy into the venture, as well as money. You do this because you believe that someday your business will return more than the value of the time, energy, and money you put into it. One way to express this idea mathematically is to calculate a return on investment (ROI), the net profit of a business divided by the start-up investment, expressed as a percentage of that investment.
Investors think in terms of wealth—the value of assets owned minus the value of liabilities owed at a particular point in time, rather than money, per se, because a business may own assets (such as equipment or real estate) that have value but are not actual cash. Return on investment measures how wealth changes over time. To measure ROI, you have to know these three things:
1. Net profit: The amount the business has earned beyond what it has spent to cover its costs.
2. Total investment in the business: This includes start-up investment (the amount of money that was required to open the business, plus all later additional funding).
3. The period of time for which you are calculating ROI: This is typically one month or one year.
There is an easy way to remember the ROI formula: What you made over what you paid in, times one hundred. Normally, ROI is calculated on an annual basis, although it can also be calculated for days, weeks, months or quarters.
Return on sales (ROS) on the other hand, is the percentage created when sales are divided into net income. This is an important measure of the profitability of a business.
Return on Sales (ROS) =Net Income\Sales
ROS is also called profit margin. To express this ratio as a percentage, multiply it by 100 (as you would to express any ratio as a percentage).
A high ROS ratio can help a company make money more easily; however, the amount of revenue will make a difference. The size of the sale will also make a difference. Hardware stores sell many inexpensive items, so they have to have a higher profit margin on each to make a profit. Auto dealers sell expensive items, so they can afford a smaller ROS on each car they sell. Learn more about return on investment and various other things related to business management at LSBF.