If you have ever spent money in a business, you will know you need good returns, otherwise why would you spend the money in the first place? And it’s the word “returns” that is interesting to us.
ROI is a way for us to measure these “returns” in the right business language.
ROI stands for Return On Investment. In business we use this to measure the benefits from an opportunity/project and compare them to the costs involved. This lets us know for sure that we will get more back than we put in and who wouldn’t want to know that?
So, this is the tricky bit. We need to decide where to spend money and, using the same set of numbers (costs and benefits) there are three ways to help us do that:
Time - A simple measure known as Payback tells you when you get your money back. It compares all costs against all benefits and lets you know at what point in time you get your money back. For example – “If I spend X today then I will get my money back after 12 months”.
Rate Of Return - This percentage measure is a little more complicated and is known as Internal Rate Of Return (IRR). It compares money spent upfront against future benefits and gives you an annual returns percentage. For example – “If I spend X then I will create a return that pays for the money I spent upfront but will also create an extra 15% per year”.
Extra Value - The final measure is a profit one known as Net Present Value (NPV). It looks at all benefits minus all costs and shows a result as a money profit. Now we all know what a profit is, but this measure shows how much it’s worth in today’s terms, or how much our business value has increased because of our decision.
Remember, these are globally recognised financial measures that are commonly used together by both Private and Public sector organisations to explain the financial returns on and investment.
If you are still unsure, don’t worry, our software will do these calculations for you. However, if you would like to gain a deeper understanding of Payback, IRR and NPV then have a look at the following: