Do You Get A Return On Investment On Your Sales Dollars?
Do you even measure return on investment for sales or other normal business functions? Many companies only look at ROI on capital expenditures and other large dollar investments. The bulk of the money companies spend are spent on normal daily activities, but few look at justifying ROI on anything other than one-time major investments.
Why should you worry about ROI on normal expenses, doesnt your P & L cover that? The real answer is the P & L will tell you many things but its telling you about them after they occur. In my recent book I gave the example of using the P & L as a problem solving tool is like steering a huge ship by looking at the wake. What you see has already happened, and corrections take time.
So how do you measure ROI on sales, and why bother?
Lets take a hypothetical company as an example. You run a $10MM dollar manufacturing company, sales are flat and margins are declining. You have a current net margin of 2% and high fixed costs. You feel you need additional sales to offset the high fixed costs, and improve margins.
You are currently making $200,000 annually, (2% of $10MM), and you want to double your net margin to 4% in order to attract new capital. How much do you need to increase sales and how much can you afford to invest to get those sales?
Well first you need to understand what return you get from a $1.00 sales increase. At 2% net margin you are only getting .02 cents. That is before any additional costs are added to increase sales. Based on an assumption that you cant grow sales at your present level since they are declining, lets assume you need to invest $100,000 dollars to increase grow the business and margins to where you want to be. How much new business would you need to get in order to accomplish your goal?
Adding 100K in new cost has effectively cut your current margin in half to 1%, so you are already starting in the hole.
Lets further assume fixed cost are $2.8MM annually. The chart below shows if all support and production functions remained the same you would need to grow sales by $1.1MM in order to achieve your goal of a 300K net profit increase.
So an investment of 100K in sales would get you an increase of 319K in net profit assuming you were able to execute.
Current Needed
Sales $10,000,000 $11,100,000
Labor10% $1,000,000 $1,110,000
Material50% $5,000,000 $5,550,000
Total Direct $6,000,000 $6,660,000
Gross margin $4,000,000 $4,440,000
Overhead11% $1,100,000 $1,221,000
Fixed costs $2,800,000 $2,800,000
Total Indirect $3,900,000 $4,021,000
Total Costs $9,900,000 $10,681,000
Net $100,000 $419,000
Net Margin1.00%3.77%
You would need to increase sales by about 400K just to cover the cost of the additional sales expenses.
Initially the return looks great, invest 100k and get 319K back in profits, the question becomes one of time and execution. The longer it takes to develop the needed sales increase the lower the ROI.
Understanding the numbers makes it easier to make a decision initially, but it also makes it easier to understand the costs of delay and nonperformance.
Why should you worry about ROI on normal expenses, doesnt your P & L cover that? The real answer is the P & L will tell you many things but its telling you about them after they occur. In my recent book I gave the example of using the P & L as a problem solving tool is like steering a huge ship by looking at the wake. What you see has already happened, and corrections take time.
So how do you measure ROI on sales, and why bother?
Lets take a hypothetical company as an example. You run a $10MM dollar manufacturing company, sales are flat and margins are declining. You have a current net margin of 2% and high fixed costs. You feel you need additional sales to offset the high fixed costs, and improve margins.
You are currently making $200,000 annually, (2% of $10MM), and you want to double your net margin to 4% in order to attract new capital. How much do you need to increase sales and how much can you afford to invest to get those sales?
Well first you need to understand what return you get from a $1.00 sales increase. At 2% net margin you are only getting .02 cents. That is before any additional costs are added to increase sales. Based on an assumption that you cant grow sales at your present level since they are declining, lets assume you need to invest $100,000 dollars to increase grow the business and margins to where you want to be. How much new business would you need to get in order to accomplish your goal?
Adding 100K in new cost has effectively cut your current margin in half to 1%, so you are already starting in the hole.
Lets further assume fixed cost are $2.8MM annually. The chart below shows if all support and production functions remained the same you would need to grow sales by $1.1MM in order to achieve your goal of a 300K net profit increase.
So an investment of 100K in sales would get you an increase of 319K in net profit assuming you were able to execute.
Current Needed
Sales $10,000,000 $11,100,000
Labor10% $1,000,000 $1,110,000
Material50% $5,000,000 $5,550,000
Total Direct $6,000,000 $6,660,000
Gross margin $4,000,000 $4,440,000
Overhead11% $1,100,000 $1,221,000
Fixed costs $2,800,000 $2,800,000
Total Indirect $3,900,000 $4,021,000
Total Costs $9,900,000 $10,681,000
Net $100,000 $419,000
Net Margin1.00%3.77%
You would need to increase sales by about 400K just to cover the cost of the additional sales expenses.
Initially the return looks great, invest 100k and get 319K back in profits, the question becomes one of time and execution. The longer it takes to develop the needed sales increase the lower the ROI.
Understanding the numbers makes it easier to make a decision initially, but it also makes it easier to understand the costs of delay and nonperformance.
Source...