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Calculating Return On Investment
Calculating Return On Investment
Businesses of every size are concerned about their return on investment. All investments, whether time or money, must generate a positive return on the investment in order to remain in business. The return on investment for advertising is often the hardest to calculate due to intangible evidence used in the equation. Pay-per-click (PPC) advertising offers a unique opportunity to more accurately calculate the return on investment. To understand how PPC advertising returns can more accurately be determined one must understand how ROI is calculated, where the equation is wrong and how the equation should be adjusted for greater accuracy.
ROI = (Revenue Investment) / Investment * 100 ROI = (100,000 15,000) / 15,000 * 100 ROI = 85,000 / 15,000 * 100 ROI = 5.67 * 100 ROI = 567% The second method allows us to see a totally different picture based upon how the revenue changed from the baseline comparison. It is every business owners hope that the revenue change will be positive. A negative change can be easily seen, but a minor increase may not always be noticeable using the first model. The first model assumes the entire revenue is generated from the advertising campaign. Using the second method with the following numbers one can assert that the ROI of the advertising campaign is Rev1 = $80,000 Rev2 = $100,000 ROI = ( Revenue Investment) / Investment * 100 ROI = ((100,000 80,000) 15,000) / 15,000 * 100 ROI = (20,000 15,000) / 15,000 * 100 ROI = 5,000 / 15,000 * 100 ROI = .333 * 100 ROI = 33.3% Each of these methods is accurate for its general purposes. However, they do not properly represent an accurate picture of return on investment.
Notice this equation is now giving us a better picture of how the cost to make or purchase the product, shipping costs (if any), labor, and overhead are now subtracted from the revenue to get an idea of how much profit was truly generated. Using the ROIt example below one can now see how important it is to include COD in the equation. ROIt = ((Revenue COD) Investment) / Investment * 100 ROIt = ((18,936 13,255) 9,172) / 9,172 * 100 ROIt = (5,681 9,172) / 9,172 * 100 ROIt = -3,491 / 9,172 * 100 ROIt = -.38 * 100 ROIt = -38% While the traditional ROI equation would represent a positive profit, the reality is the entire advertising campaign was a loss. While it is sometimes hard to come up with the real COD value, one can estimate it based upon the business desired net margin profit. For example, a desired net margin profit of 30% would be subtracted from the revenue to get the desired or expected COD. Of course, the COD value would be an estimation. The Revenue ROIt equation, as represented below, can be used to evaluate the increase or decrease in revenue compared to the investment. ROIt = (( Revenue COD) Investment) / Investment * 100 In this equation the COD should be estimated using the Revenue versus the revenue as in the first method.
In Conclusion
Accurately calculating and evaluating a business return on investment is essential to the success of the business. The traditional ROI equations fail to identify short-comings or false beliefs unless the revenue for the period is less than a comparable baseline. Both the traditional and true ROI methods inaccurately assume that all revenue is generated from the advertising campaign. However, the true ROI method helps gain a better understanding of the business profitability.