You turned your dream of running your own business into a reality. You had to invest time, money, and effort. And after so much work, it’s’s only natural to expect great benefits.
But are you aware of how much you’ve earned after every investment you have made in your business?
Do you think your company could perform better by learning how to distribute your resources properly?
Have you ever considered using a loan to grow your business, but you don’t know how to measure its impact?
Here you’ll learn what the Return On Investment (ROI) is and how to use it to calculate the benefits of a loan for your small business.
What is Return On Investment?
The Return On Investment (or ROI) is an indicator of profitability. It’s’s used to measure your potential profit in relation to the cost of your investment.
In other words, by calculating the ROI, you can determine how profitable an investment, purchase, or expense is.
Return On Investment Formula
Calculating your Return On Investment is very easy. You just need to divide the net profit between the total of the investment. To obtain a percentage, just multiply the result by 100.
ROI = (Total profit – Investment / Investment) x 100
What is a Good ROI?
In business, it is considered that an investment with an average annual return of 5% to 12% is good. A Return On Investment lower than 5% is deemed bad, while one over 12% is considered outstanding.
Keep in mind that this might be slightly different between industries.
Why is Calculating ROI important for your business?
Measuring the ROI of your business will increase your chances of success in the long term because you can make better-informed business decisions. Thus, your goal should be to achieve maximum performance with a minimum investment.
The Return On Investment is the most common indicator to establish the overall profitability of any business, but it also has other applications. You can measure, for example, how effective can be a digital marketing campaign, or you can resolve if your prices are competitive. It also serves to calculate your monetary benefit when buying assets, such as equipment or inventory.
The return on investment will help you decide which purchase alternatives can generate profits or cost savings, increasing the net income of the business.
These are some advantages of the Return On Investment:
- It’s easy to calculate and easy to understand.
- It’s a standardized and universal measure of profitability, with the same meaning anywhere and, therefore, cannot be misinterpreted.
- It’s a versatile indicator that can be used to evaluate the efficiency of a single investment or to compare the returns of different investments.
But the best advantage is that it can help you understand if you should get a business loan or not.
Well, by understanding how much profits your loan will give you (and comparing it with the total cost), you’ll be able to decide if it is worth getting into debt.
How to calculate the Return On Investment of a loan?
A business loan can increase the chances your business has to grow. If you calculate your ROI, you can know how to invest your money better and how to get more benefits. This is what you need to know:
1. Plan what you are going to invest in and how much it will cost you
Before applying for a loan, make sure you know what the investment opportunities in your company are.
Hiring staff? Buying inventory? Purchasing equipment and machinery? Starting a digital marketing campaign? These are just some possibilities.
The idea of borrowing money and getting into debt sounds risky, but what other choice do you have when you want to expand your business? Also, moving forward with a company involves taking risks; the key is to anticipate what they could be. This is where the Return On Investment comes in.
The formula to calculate the return on investment is straightforward.
First, you must calculate the total cost of your investment and the potential benefit you expect to receive. That way you’ll know if the risk is worth it. The most challenging thing is to estimate the net benefit you can get from the investment. Expressed as a percentage, the ROI equals the gross profit of the investment, divided by the total cost of the investment. The result is a percentage of the initial investment.
Let’s look at the formula again:
ROI = (Net Profit / Investment) x 100
Keep in mind that Net Profit = Total profit – Investment.
2. Consider other variables and costs
To obtain accurate results when calculating your Return On Investment, you must consider certain variables.
First, you need to budget the cost of the investment: how much money will you invest? What are the rates and fees applied by the lender? How much will you pay in interest, and how much will be your monthly payments?
Also, time is a crucial factor. If you plan to make an investment that generates profitability for several years, calculating your ROI can be more complicated.
You can project a very positive return on investment in the long term, but have in mind this profit can vary over time. It can decrease or increase, depending on external factors (such as the demand for your goods or services) or internal factors (such as issues in the production line or an increase in sales due to the implementation of a virtual store, to name a few examples).
3. Consider applying for a business loan
Once you have decided in which areas you could invest money and how much money we are talking about, you should evaluate if a loan will help you make such investments.
If your answer is affirmative, we recommend you choose a lender who knows your industry and can help you identify those areas in your business that could benefit from a loan. Remember that on top of having favorable terms, the loan should generate a healthy return on investment.
Discover here 20 ways to grow your business with a business loan
Return On Investment: an Example
Let’s use a case study to illustrate better how to calculate the ROI of a business loan:
Let’s say Miguel has a food business, and he plans to buy a new industrial oven costing $20,000. Miguel thinks he could make 500 bread rolls daily with this oven.
If Miguel sells each roll for 20 cents, he will get a profit of $100 daily. Monthly, this would mean $3,000, and annually, $36,500. In other words, that would be the annual benefit of the investment made by Miguel after buying the oven. This amount of $36,500 doesn’t include Miguel’s current earnings. For the 2 years it will takehim to pay the oven, that’s $73,000 in profits.
If Miguel applies for a $20,000 business loan to buy the oven he needs, he should use a business loan calculator to make accurate calculations and make sure the cost of the loan is less than the potential benefit.
By using the calculator, Miguel will find out that a loan of $20,000, paid within 24 months, and with an interest rate of 1.5%, would cost $5,361.57. This amount includes interest and the closing fee of the loan. It becomes clear that for Miguel, it is worth assuming this cost because he could pay for it using the profits obtained from his new oven in just one month.
Now, having all the data, the calculation would look like this:
ROI = (Total profit – Investment / Investment) x 100
ROI = ($73,000-$25,361.57 / $25,361.57) x 100
ROI = ($47,638.43 / $25,361.57) x 100
ROI = $1.8783 x 100
ROI = 187.83%
The return on the investment made by Miguel would be almost 190%, which is an excellent percentage. He resolves to apply for the loan and make the investment a reality.
At Camino Financial we make your investment plans a reality
If, like Miguel, you do your own math and conclude that applying for a loan is a good option, consider a business loan from Camino Financial. With our loans, you can make the potential investment a reality, and you can use the funds in any way you consider to grow your business.
These are some of the features of our business loans:
- Amounts: ranging from $5,000 to $400,000, to adapt to any of your business needs
- Monthly interest rate: between 1% and 2.5%
- Loan term: between 24 and 60 months
- Frequency of payment: monthly
Our process is simple and fast. All you have to do to take the first step is submitting your online application, which will not impact your credit score. In less than 24 hours, one of our business loan specialists will contact you to guide you through the rest of the process. You could receive the funds you need to make your investment within 4 to 10 business days.
What are you waiting for? Turn your dream of growing your business into a reality!
Use our business loan calculator to see at a glance all the costs and payments involved in your loan. Use it to determine the loan amount and the monthly payments that you feel most comfortable with.