Measuring return on investment
Simple return on investment measures
Accountants will give you many methods of measuring return on investment. For most decisions in a smaller business, a few simple measures are sufficient to enable good decision making.
- Information needed:
- Length of project (usually measured in years)
- Initial Investment needed
- Annual Investment needed
- Cost of finance (the interest paid over the period + any admin costs)
- Annual cost savings
- Simple calculations to make:
- Total cost saving
- Return on investment
- Payback period
Total cost saving
To calculate the total cost savings of the project you multiply the annual cost savings by the length of the project.
Total cost saving = Annual cost savings X Length of project
Return on investment (ROI)
First calculate the Total Investment needed:
Total Investment = Initial Investment + Cost of finance + (Annual Investment X Length of project)
Then calculate the ROI by dividing the Total Cost Savings by the Total Investment and turning it into a percentage, as follows:
ROI = 100 X (Annual cost savings X Length of project) / Total Investment
The result is expressed as a percentage which gives an indication of the benefit you will receive compared to the investment needed. For example, if the ROI is 100% you stand to get back an amount exactly equal to your investment. If the ROI is 400%, you stand to get back 4 times the investment over the course of the project.
This gives you a useful indicator about whether the investment is “worth it” and is particularly useful when comparing one project against another. You will have to decide what level of return makes a project worthwhile. One thing to be aware of is that if the project period is lengthy, £1 in the future will be worth less than £1 today (due to inflation). This simple calculation does not take this into account so if you have a lengthy project and the ROI is close to 100% you need to be careful as the return in “real money” may be less than the amount invested.
Payback period
The Payback period helps you understand how long it will take to recoup your investment. To calculate it you divide the total Initial Investment by the Annual Cash Inflow as follows:
Payback period = (Initial Investment + Cost of finance) / (Annual Cost Saving – Annual Investment)
Again, this is useful when comparing projects. Generally, a shorter payback period is considered less risky than a longer one.
Written by Eoin McQuone
Eoin (pronounced like “Ian”) is the Chief Carbon Coach and founder of Go Climate Positive. He is a Practitioner member of IEMA (the Institute of Environmental Management) and a member of the Carbon Accounting Alliance.
Eoin says, “Sustainability is no longer a ‘nice to do’, it is business critical. My goal is to make it accessible and affordable for every business, however big or small , no matter their market sector.”
