Calculating the return on investment (ROI) in business is one of the most important calculations a business performs. This calculation allows businesses to determine the amount of business received from investing a certain amount of money and resources. For example, the ABC Company invested $100,000 in an advertising campaign to promote a new service. The ABC Company received 150 phone calls from the campaign and 50 of the callers bought the new service. The amount of new business sold totaled $500,000. The equation to calculate ROI is: ROI = (return on investment – initial investment)/investment * (100)
1. The first bit of information you need to have to calculate ROI is the return on investment. In this example, the return is $500,000.
2. Next, you need to know what the initial investment was. In this scenario, the ABC Company invested $100,000 in the marketing campaign.
3. Now it is time to set up the equation. ROI = ($500,000 – $100,000) divided by $100,000 multiplied by 100.
4. Once the equation is set up, you can calculate the ROI. In this case, the answer is 400 percent, meaning that ABC Company has a 400 percent return on its investment.
Note: The initial investment includes money spent and employee time.
Yesterday I was chatting with a young friend who was incredibly excited about a new marketing program she’d launched for her company. She’d spent about $65,000 and brought in almost $130,000 in new revenue.
She proclaimed, “My campaign generated 100% ROI!”
Whoops. I hated to rain on her parade, but she was making a major mistake – she was comparing her investment ($65,000) to her gross revenue ($130,000). In her mind she had earned the company another $65,000, or 100% of her initial investment. She thought she’d doubled their money.
In poker, her calculation would be accurate. But in business, you have to consider what it costs to produce whatever it is that you’re selling and subtract that cost from your gross revenue.
In other words, it’s a good idea to calculate your marketing ROI based on your GROSS PROFIT for the product/service you’re selling, not on your GROSS REVENUE.
ROI calculations for marketing campaigns can be complex — you can have many variables on both the profit side and the investment (cost) side. But understanding the formula is essential if you need to produce the best possible results with your marketing investments.
In simple terms, the best formula for marketing ROI is
(Gross Profit – Marketing Investment) ____________________________________ Marketing Investment
Here’s how this common mistake can get you into trouble. Let’s say that her company’s average profit margin for this type of product/service is 50%. That means that only 50% of that $130,000 in revenue was gross profit; the other 50% was spent to build the products she was selling.
In this scenario, her true ROI is actually 0:
($65,000 – $65,000) __________________ $65,000
Unfortunately, she would have been better off putting the $65,000 she spent on media buys in an interest-bearing checking account rather than spending it on this campaign. In fact, in this scenario, the company most likely lost money on this campaign, as the gross profit figure hasn’t yet accounted for other expenses.
Marketing campaigns are investments. And like any smart investment, they need to be measured, monitored and compared to other investments to ensure you’re spending your money wisely.
With solid ROI calculations, you can focus on campaigns that deliver the greatest return to your company regardless of which product or service you’re selling. After all, you probably earn more profit in some areas than in others.
Using ROI also helps you justify marketing investments. In tough times, companies often slash their marketing budgets – a dangerous move since marketing is an investment to produce revenue. By focusing on accurate ROI measurements, you can help your company move away from the idea that marketing is a fluffy expense that can be cut when times get tough.
If you’re not sure how to calculate your profit, here are two more formulas:
- Gross Profit = Gross Revenue – Cost of Goods Sold [here's an article that shows you how to calculate COGS] - Gross Profit = Gross Revenue * Profit Margin (the % of your revenue that is actually profit)