Mar 31, 2023
This Podcast Is Episode Number 517, And It's About How To Weigh ROI Vs Cost When Making A Business Purchase
The cost is the money you spend making the purchase plus any indirect costs (such as training costs) related to the purchase. The ROI is a calculation of financial gains or benefits that you obtain due to that cost.
To determine ROI profitability, there is a simple formula you can use. If the purchase yields a positive return, it can be considered profitable. However, if the purchase does not earn back the money it costs, it would be considered a negative return on investment.
Return on Investment Formula
Using a formula to calculate the ROI only offers a rough initial estimate. Other factors might come into play, such as future work you will get because of the new asset or unforeseen expenses. The formula to determine ROI is:
ROI = (Net Profit / Cost of Investment) x 100
Let’s see an example:
Suppose you run a spec home building company. Three employees spend their time in the field gathering data and taking stock of how a proposed development project would affect the landscape. Vegetation, waterways, animals – everything is taken into consideration.
You have one client who would like you to survey very rugged terrain. They would pay $2500 if you could complete this work, but covering the landscape would be difficult and take time.
The only way to do it effectively would be to purchase a drone for $1000. It would cost $200 to train each employee how to use the drone. The new equipment would make taking on this work possible and save many hours spent physically in the field.
Additionally, having a drone would mean you could offer your new aerial surveying services to other clients who are undertaking more large-scale or complex projects.
Calculating the ROI of obtaining new equipment for this project:
First, you would tally your total expenses and expected revenue to decide whether this purchase would be profitable.
Expected Revenue = $2500
Total Expenses = $1000 + ($200 x 3) = $1600
Then, you would subtract the expenses from your expected revenue to determine the net profit.
Net Profit = $2500 – $1600 = $900
To calculate the expected return on investment, you would divide the net profit by the cost of the investment and multiply that number by 100.
ROI = ($900 / $1600) x 100 = 56.25%
Your return on investment would be 56.25%, a positive return. Not only that, but your new equipment may allow you to gain more work in the future, making your ROI even better.
What happens when you don’t put your investment to work
What if you purchase the drone but find the learning curve overwhelming, and it collects dust in a corner?
In this case, your client may not hire you, or the hours required to do the work on foot may make taking on the project cost prohibitive. Your ROI would be zero, plus you would be down $1600 from the initial expense and training. This would result in a negative return on investment, mainly if you have already performed the employee training.
On the other hand, how many places can you find with a strong chance Of 100% Return on Investment? Let me say - If something seems too good to be true, it probably is, and you should stay far away from it.
We Do Like Managed Risks
This is anything we can control the input and have a more remarkable than the breakeven chance of making a profit. We pay close attention to the higher levels of math and how it is used to predict probable outcomes accurately.
Decision Modeling
Decision modeling uses reliable QuickBooks reports to generate predictions of profit and loss based upon re-allocating resources and aligning your Business Process Management system processes to present to you a variety of possible outcomes. It offers you a way to attach knowledge, expertise, and analytic insights. As possible results are analyzed, decisions become easy because the goals, processes, and data come together.
As contractors like you move away from gut-level decisions and begin relying on your construction accounting systems to provide helpful financial and job costing reports, it will open a treasure chest busting at the seams with practical knowledge which can lead you to earn massive profits and, by extension, increase your wealth exponentially.
Knowledge Leads To Profits And Cash Flow
What Makes Knowledge Powerful?
Use Of Knowledge!
If you could harness and truly understand even half of the information in your existing QuickBooks company file and truly understand it, you could quickly become wealthy, debt free, and live the lifestyle you deserve in five years or less.
Final thoughts
While making a large purchase to benefit your business can be daunting, significant rewards often come with taking the plunge. Do your research, calculate if the investment is worth it, and then move ahead confidently. If you calculate correctly, you will find that your purchase takes your construction business to new heights.
About The Author:
Sharie DeHart, QPA, is the co-founder of
Business Consulting And Accounting in Lynnwood, Washington. She is
the leading expert in managing outsourced construction bookkeeping
and accounting services companies and cash management accounting
for small construction companies across the USA. She encourages
Contractors and Construction Company Owners to stay current on
their tax obligations and offers insights on managing the remaining
cash flow to operate and grow their construction company sales and
profits so they can put more money in the bank. Call 1-800-361-1770
or sharie@fasteasyaccounting.com