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Return On Investment

November 22, 2009

Fundamentally all management decisions boil down to return on investment decisions. What’s the cost of this program and what’s the expected benefit? What’s the monetary payback of this decision in relationship to the resources invested? How much time will I have to spend on this project and are the anticipated results worth the effort?

Return on investment (ROI) analysis is often thought to be a formal decision making tool for the larger company and the financial analyst. In actuality, ROI analysis should be a central part of every manager’s decision making process.

A typical ROI is computed by dividing a return, such as net income, by an input, such as total assets. Similar analysis can be done with most all resources and results.

Return on investment is an indicator of the productivity of your investment decision. Manager’s investments are not strictly financial. Time and other resources are equally important. An ROI is a measure of output for a given level of input.

You may not be able to compute an ROI as accurately for some management decisions as for some financial decisions. However, if the process forces you to focus on the relationship between the inputs and the outputs for each decision, you will make better decisions.

When you look at the ROI of any enterprise, there are two obvious ways to improve the equation. You can increase the numerator (output) or you can decrease the denominator (input). A third and less obvious way is to increase the denominator (input), in such a manner that it effects a proportionally greater increase in the numerator (output).

Simply because a return on investment analysis yields a quantified answer, does not mean that you have to make your decisions solely on the numbers. There is still room, and in fact need for, qualitative inputs in the decision making process.

Experienced decision makers are always searching for numbers that can measure their performance. Good decision making, however, doesn’t rely exclusively on numbers. As a manager you have a responsibility to recognize when the numbers don’t make sense or when the direction that the numbers indicate is incompatible with the character and philosophy of your organization.

Complacency is not an uncommon characteristic for the management of successful private business. Owners of small businesses can become complacent because they have achieved an adequate personal income, they have reasonable security, and they are relaxant to examine the alternatives to a formula that is already working well.

Because of this natural bias towards complacency for the owners of successful enterprises, they should more closely scrutinize each of their decisions for its ROI. The owners of a well established firm owned valuable property that had a low depreciated cost basis. Because the owners drew a reasonable salary and the business had been profitable, they had not examined the potential return from selling the property and investing the proceeds elsewhere. A return on investment analysis indicated that the sale and reinvestment of proceeds would nearly double their total return.

Managers make decisions to invest in people. They recruit, select, train, and work with their employees. If your output, or the return that you are getting from your people, is insufficient, perhaps you need to invest more to get a better result.

For example, suppose that one of your operations commands an inordinate amount of your time because one of your managers is weak. Despite the drain on your time, the results of that operation are still below average. It’s time to look at your ROI for this manager and determine if a higher level of investment on the front end would yield a higher return on the output end.

The extra time and money that you may spend on recruiting and selecting a truly qualified person to manage your operation, would be a bargain when compared to the current drain on your time. Time and effort spent training your manager would have avoided many costly problems. The cost of retaining a really good manager would be small when compared to the opportunities that may have been lost

Experienced managers have a certain “business sense” that enables them to make good decisions. They also have a tendency to become complacent in a smooth running operation. Opportunities can be lost. Because it’s your business, develop the discipline to subject major decisions to a return on investment analysis.

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