TODAY we look at one of the vexing business concepts called return on investment (ROI) or return on capital (ROC).
Or in short, what a business can pay the business owners for having taken the initiative of putting together the resources of running it.
Looking at it from a business perspective and in this case referring to small and medium enterprises (SMEs), investment can be described as the capital outlay that an entrepreneur surrenders into a business venture.
This can be seen from the smallest business such as the marketeer starting a business with K100 as capital for buying and selling tomatoes at a market, to an entrepreneur investing in property worth thousands of Kwacha.
However, returns on investments are what matters in a business venture. For example, if tomato business can produce K40 on each day as profit then the business is profitable and there are more reasons to continue with such a business venture.
One of the major reasons of starting a business is to ensure that a business produces profits to reward the business owners.
Profits are the proceeds in terms of business assets that remain after all direct and indirect expenses are removed from the business earned income in a period, for instance it could be one day, one month, six months or one year.
Now these proceeds could be referred to as returns on capital.
The subject of this article is to look at the money invested into business and how that money can bring in the proceeds and at what rate.
One practical example is of a pensioner who retires early from work and is paid substantial amounts of money to enable him start a new life altogether.
His investment involves completing his house where he makes a provision for four tenants to enable him obtain rental income and the other remaining money he uses it to build the house where he is residing with his family.
The investment of K300,000 on a house with four tenants gives him only K2,800 per month in form of rental income and out of this
money he has to take care of family requirements and now the question is what is the return on investments?
I must not be misquoted here as discouraging people from investing in property such as building houses for rental income but I am looking at the rate of the return on the investments if such a move is taken as a business venture.
But the other man who has similar money risks it and starts a hardware business which is giving him an average of not less than K10,000 proceeds per month with the cash flow proceeds projection of increasing as the business grows in proportion.
Investing in a business like dealing in buying and selling hardware is risky because that business is volatile but with high percentage of returns while investing in property is guaranteed security the property remains at the value of investment or can increase in value.
The pensioner who invested in building the house for rentals has since gone back to employment to supplement his meagre resources while the one who started hardware has since employed five more persons.
It is true that property in terms of house investment in this case offers permanent security in form of value attached to it, but the returns on investments are not enough compared to a business of hardware which is a risk business but with high returns.
It is important for an entrepreneur to understand that returns on the capital initially invested into business should go above the capital invested over certain period if the investment is to be meaningful.
This must be traced by the increase in investments in fixed assets or the growth of working capital the business should have at the time of preparing its balance sheet.
In short a business growth is seen in the expansion of fixed assets such as motor vehicles, business premises, office equipment supported by strong working capital such as money at the bank, money in hand, money in fixed deposits, money locked up in stocks.
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