Will the Real ROI Please Stand Up? - Variations on a Theme
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While the power of the ROI equation may lie in its simplicity, that same simplicity can cause some issues when it comes to collecting all the necessary data to provide the most accurate results. For instance, finding the true Profit of an activity can prove difficult in some instances due to a lack of data on other aspects of the business. Omissions in this data can, as previously mentioned, provide inaccurate and costly results. With this in mind, I will present a collection of variations on the ROI equation that may prove useful.
To begin with, the equation itself can be broken into two separate parts that incorporate Sales (a.k.a. Revenue) into the equation without undermining the quality of the results.
If you remember back to your algebra days, this equation is made possible by the fact that since the Sales variable is both above and below, it cancels itself out and therefore simplifies the equation down to the previously discussed form. However, for now, let’s concentrate on the expanded version above.
As you might have noticed, the right half of the equation (Profit over Sales) is the same equation that provides you with the Net Profit Margin (or just Profit Margin) percentage. This rate can often be found in all public companies’ annual reports and on the balance sheets of most private companies, if they’re into sharing the information with the rest of their employees. (It should be noted that the left side of the expanded equation, Sales over Invested Capital, is another metric known as Turnover. This metric is also often found in most annual reports, however, its use would only complicate things here, so we won’t present any versions of the ROI equation with it in place.)
Once you convert the right side of the equation to just Profit Margin, the above equation can be simplified further to:
In this form, it is much easier to use the company’s overall Profit Margin in your ROI calculations, rather than just what you can dig up as expenses used in a particular instance, such as just the cost of goods or advertising. Some may argue that this variation places an undue burden on the Sales Revenue by multiplying the Profit Margin for the entire company against the Sales from this one activity. Conversely, not using this number in place of a more lenient Profit estimate may produce an ROI result that keeps a money losing activity alive. When this decision is up to me, I tend to lean towards a more conservative answer that could save the company money. However, if you feel you can stand the risk, feel free to use a broader Profit variable in the equation, such as Sales less the Cost of Goods, etc.
Next: ROI meets CPC >>
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