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ROI - How to choose a business.

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Posted 29th January 2009 at 06:20 PM by jwhagarty

Hi everyone. In this article I will discuss the process my wife and I went through recently when we were looking for a business to buy or start. I hope you will learn from our process and be able to apply it in your own life.

We were on the hunt for a solid business that would produce a positive monthly cashflow (profit) to help us with a short term income goal.

We took a close look at a number of different businesses including a tanning parlor, a day spa, a beauty salon, and a network marketing company. The deciding factor for us was return on investment (ROI). The closest the average person gets to thinking about ROI is when they compare rates at their bank for savings or CDs. On a good day, you might get a 4% return from your bank.

ROI is traditionally measured as a straight dollars in, dollars out equation, without taking into account the time involved. There are three ways to evaluate your return. 1. If I don’t do anything but keep doing what the previous owner did, what is my return? 2. If I improve the business, what is my return? This is also known as pro-forma. 3. It always helps to take a very conservative view as well, and consider what will the return be if the business does worse than it did for the previous owner?

The math is relatively simple. Let’s say for example you can purchase a Day Spa that shows a net annual profit of $36,000 on a total sales volume of $94,000. The seller is willing to sell the business for $36,000.

In this case, your ROI will be 100% right? ROI is always measured on an annual basis, so assuming you do as well as the previous seller did, you will earn $36,000 the first year on your $36,000 investment.

That 100% ROI has to look pretty good right about now! But we haven’t taken into account the time factor involved. In this case the business is run by the owner. There are many, many, did I mention many (!) small businesses for sale that fall into this category. So the $36,000 return includes spending 40-50 hours a week running the business. This is also based on a total sales revenue of $94,000 for the year.

If you were to buy this business you would have to either run it yourself, or increase profit to the point where you can hire a business manager, and odds are you are still going to take home at most $3000 per month.

Compare this to a network marketing business. In this case, you are starting from scratch, so there is no current revenue or profit. Let’s say you can start your business for $5,000 including all start up costs and a healthy advertising budget. If all you managed to do was generate one sale per month, you would clear $1,000 per month, or $12,000 per year. What would your ROI be? In this case, your projected ROI is 240% ! Keep in mind that again, this does not take into account your time factor, and that this would be considered a "pro forma" (projected) ROI. Most people who work from home are disorganized, scattered, and put in maybe a couple of good hours of work each day. Let’s say that you are the exception to this rule. You are focused, dedicated, work on a schedule, and put in a good solid 4 hours a day on your business, five days a week.

Now, remember what I said earlier. Look at the current, the best, and the worst case scenario. Then decide which business to buy, if any.

Day Spa.
Capital Investment $36,000
Time Investment 40-50 hours per week
Current ROI 100%
Pro forma 100%
Worst case 50% ?

Network Marketing
Capital Investment $5,000
Time Investment 20 hours per week
Current ROI 0%
Pro forma 240% +
Worst case 0% (no sales made ever!)

There are many factors to consider when choosing a business. There is the time, the money, and what I can call the “hassle factor.” For us, the reasonable initial investment, huge ROI potential, and low hassle factor, made the network marketing business the winner by a mile!

Have fun, and good luck!
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  1. New Comment
    Thanks, J. W.,
    As my first official post, I appreciate your guidance. As a business owner in the real estate industry, I had guessed that internet marketing might give a more attractive ROI. Your formulas may help me dramatically down the road.
    Good luck to you, as well!
    Posted 29th January 2009 at 10:05 PM by Victor Sedinger Victor Sedinger is offline

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