SO, YOU’RE LOOKING to reinvest in your business. Whether it’s purchasing a new piece of equipment that can yield a good return or opening a brand-new store, the principles of investing will still need to apply to your decision. Today, we’re going to look at what you need to consider before you go ahead.
Often, it’s the emotional factors that take precedence, but ultimately, any investment comes back to the return it can generate, and it’s important we run the numbers before making a final decision.
The world of finance can come up with all sorts of complex mathematical equations for calculating your return based on different variables, but for simplicity’s sake, just consider three key factors:
- The return on investment
- What you might earn deploying that money somewhere else
- The risk
Let’s look at an example. Sid is considering an expansion in the size of his standalone store. He knows it will cost him $100,000 to complete the job but believes it can add $10,000 per year to his profitability. The annual return using a rough back-of-the-envelope concept would be $10,000/$100,000 or 10 percent.
The question is, what else could Sid do with this money? Bank deposits and bond yields are almost negligible these days, so the same money offering a 1 percent payout would only give $1,000 profit per year — nothing to get excited about. At this point, the investment in the business looks to give the better return.
The third question is risk. What are the chances of a) not earning the predicted return, or b) losing some or all of Sid’s initial $100,000 investment?
This is where things start to get a little more subjective. Sid doesn’t have a crystal ball and can’t be certain of the profit he will make. He will possibly have a better idea of the value of his investment if he was forced to sell or quit it (the new and improved value of the building). He will need to compare the risk of not achieving his return, or the risk of losing some or all his investment, against the risk and return he would get from deploying the money elsewhere.
There’s a lot for Sid to think about, but the important thing is to review the numbers and consider the possibly of them not being achieved.