Growth is the goal of every business, and growth requires investment. But just like any other investment, strategy is the key to success. Investing in the right areas of your business and in the right activities can help provide a good annual return on investment. Making other investments at the right time can also provide a profit boost for a business.
But as a business owner, you likely have many questions about investments and their returns. What are two things a good investment might do? What is a good investment return? To clear things up, let’s look at three important things to consider when investing and analyzing your returns.
Before we go any further, let’s answer an important question, “What are investment returns?”
Investment returns are the amount of money earned relative to the amount spent on the investment. It’s the difference between the ending investment value and the starting investment value.
When it comes to returns, one question that many business owners ask is, “What's a good return on investment?” But this question is only one piece of the puzzle.
Let’s look at three things you should know about investment returns.
What is a good percent return on investment? Unfortunately, the answer isn’t as clear-cut as you might think. A good return on an investment for one person may not be a good return for another. It all comes down to a few things:
Of course, the question “whats a good rate of return on investments for business” will have a different answer from “what is a good annual return on stocks” or “what is the average real estate investment return.”
So, what is a reasonable rate of return on investments in general? Conventional wisdom says that a good investment return rate is anything over 7%.
So, how do you calculate the return an investment is giving? What is the average investment return?
To calculate your average annual investment return:
Let’s look at an example of an average investment rate of return:
A 130% return is fantastic for any business investment.
To get a better idea of ROI calculations, let’s look at a more detailed example. Let’s say that you want to redesign your website. The total investment for the redesign is $20,000, and it includes:
After one month, your new online shop generates a net profit of $6,000. The profit is what’s left after deducting your costs for shipping, website hosting fees and other costs associated with the site’s maintenance.
Here’s how to calculate the ROI in this scenario:
A 30% return is a great start, and your website will likely continue to grow in sales over the coming months. In this case, the investment paid off and will probably continue giving you a good ROI.
It’s helpful to ask, “What is average return on investment?” But it’s also important to remember that returns mean different things for different investments.
Average rates of return on investments can vary from one type of investment to another.
Investment in growth isn’t the only type of investment that a business can make. Corporations often make investments in securities, which include:
There are several reasons why a business may invest in securities:
Trading securities are considered a current asset and are placed on the asset side of a balance sheet.
If your business decides to make securities investments a part of its strategy, then it’s important to know how to calculate the ROI on them.
Calculating ROI on securities is a simple process and not unlike calculating the return on an investment in your business.
Here’s how it works:
Here’s an example:
In this case, the investment is providing a great return that’s just over 7%.
Whether you’re making an investment in your business or securities, you should know how to interpret your ROI calculations to determine whether your investment was worthwhile.
Now that we’ve answered the question, “what is a good investment return percentage,” let’s talk about another important thing to consider when investing: interpreting the annual return on investment.
ROI can be used to gauge a variety of metrics, each of which can help determine the profitability of a business. But in order to properly interpret the results, your ROI calculations must be accurate. To have accurate calculations, you must have your actual total returns and total costs.
If your ROI calculations have a positive percentage, this means that your investment has been profitable. How profitable the investment is will, of course, depend on the percentage. A negative percentage is an indication that the investment isn’t bringing a good return and is generating a loss.
Businesses often have an idea or an estimate of the returns an investment will bring. Calculating ROI can help determine whether the investment paid off and if it met the business’s goals.
ROI is an important gauge for business investments for a number of reasons, but most importantly, it lets you know whether an investment is paying off.
Businesses will use ROI as a benchmark to shape future strategies. And calculating ROI is important for determining which investment will make the most sense for your operation. For example:
Each of these types of investments can provide great returns for a business, but calculating the ROI for each one will help you determine which one will give you the most bang for your buck.
While ROI is important when analyzing investments, it’s just one of many things to consider. There are limitations of ROI. Here are some things to keep in mind:
ROI calculations do not consider time. For example, an investment may provide a great return, but if it took 10 years to get there, was it worthwhile? Another investment may provide a slightly lower return in a year, making it the better investment.
Here's the bottom line: it’s important not to rely just on ROI when considering your investments. ROI is just one piece of the puzzle.
When you only consider ROI, you overlook the nonfinancial benefits an investment may bring. For example, investing in new equipment may not provide an impressive ROI. However, it may improve worker morale significantly, which increases productivity and reduces turnover. It’s difficult to measure this nonfinancial benefit.
As you can see, it’s important to look at more than just returns when considering the average yearly return on investment.
When investing, it’s important to remember that your investment activities will affect your cash flow. These activities will be included in your cash flow statements under Cash Flow From Investing Activities (CFI).
CFI reports how much cash has been generated or spent on investing activities during the reporting period.
Remember that investing activities can include:
Negative cash flow in these activities isn’t always an indicator of poor performance or financial health. A business can have negative cash flow from investing activities if it’s investing a significant amount of money into research and development. Research and development will ultimately improve the long-term health of the company.
To clarify things, let’s look at some examples of CFIs and whether they generate positive or negative cash flow.
This section of a cash flow statement will also include capital expenditures, which is something that is considered when valuating stocks.
Cash flow from investing activities is important because it indicates how a business is allocating its cash over the long term.
For example, a business may invest in new property or equipment to grow the business. While this may show up as negative cash flow, these investments will provide a good ROI and ultimately generate more cash flow over the long term.
Alternatively, a business may invest in securities to boost its profit over the short term.
When business owners consider investing, they have a laundry list of questions.
It’s important to take a holistic view of any investment you’re considering and look at more than just the ROI. For example, will the investment improve worker morale or improve cash flow in the short or long term? If the answer is yes to either or both of these questions, then the investment is worth considering even if it has a lower ROI compared to other investments.
Investments are essential for growth, but they must be done strategically to achieve the best results. Taking the big-picture approach and looking at all of the data can help you determine which route to take when investing. The right one will be the one that helps you reach your goals in a timely manner.
Tools like Cash Flow Frog can help you keep track of the long term ROI of your investments and take a closer look at how they are impacting your overall cash flow. With tools like ours, you can gauge whether the investment is worthwhile or if it’s time to tweak your strategy and allocate your investment cash elsewhere.
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