How to calculate and improve the return on your investment

A profitability measure that evaluates the performance of a business by dividing net profit by net worth. Return on investment, or ROI, is the most common profitability ratio. There are several ways to determine ROI, but the most frequently used method is to divide net profit by total assets. So if your net profit is $100,000 and your total assets are $300,000, your ROI would be .33 or 33 percent.

There are a number of benchmark business performance indicators. Your gross profit margin isn't primarily used as a measure of your business success. Gross Profit Margin is used to compare businesses to see how efficiently they can generate profits.

The net profit margin may be used to compare different businesses, but it's also used to benchmark a business against its own past performance. The operating margin, or return on sales, doesn't take into account financing structures. So it is a sensible measure to use when comparing businesses in different industries.

Return on Sales vs. Profit Margin

Return on sales may be considered to be your business profit margin but there are three common measures of your profit margin. Only one is the equivalent to your return on sales. Return on sales is the same thing as the operating profit margin, but it's different from the gross profit margin or net profit margin. Business owners should understand these differences when they are benchmarking their profit margins against other businesses or their past performance.

Gross Profit Margin

The gross profit margin is calculated by subtracting the cost of goods sold from the value of the sales and then dividing the difference by the sales value. Assume, for example that you had sales of $10,000, and the cost of goods sold was $6,000. You would subtract $6,000 from $10,000 to get $4,000; $4,000 would then be divided by your sales of $10,000 to get 0.4, or 40 percent.

Net Profit Margin

The net profit margin is a simple ratio, measuring net profits relative to sales. It's calculated by dividing the net profit after taxes by the total net value of the sales. For example, imagine that your business had after-tax net profits of $10,000 and net sales of $5,000. You would divide $10,000 by $5,000, and that would give you a net profit margin ratio of 2, or 200 percent.

Operating Profit Margin or Return on Sales

The operating profit margin is another name for the return on sales. It's a measure of earnings before interest and taxes, against sales. It's calculated by dividing the earnings before interest and taxes by net sales. If you had net sales of $20,000, for example, and earnings before interest and taxes of $25,000, then you'd divide $25,000 by $20,000. This gives you an operating profit margin or return on sales of 1.25, expressed as 125 percent.

Improving Profit by increasing Sales Revenue

You should prioritise the strategies you have chosen to improve your profit so you can focus on the most important ones. Here are some ideas from my business notebook

• Increase the productivity of your staff - recognise and reward staff contributions with staff performance reviews. Training and teaching them sales skills and how to up sell products so customers make multiple purchases at one time

• Develop new product lines - new products and services are essential for all businesses. It is crucial to business growth and profitability that you invest in their development. You can also survey your customers about their thoughts on new product and service ideas

• Find new customers - new customers can help grow your business. By consistently focusing on new business, you'll reduce your risk of failure and grow your business in a sustainable way.

• Find new markets - avoid the temptation of short term gains and try to focus on tapping into new markets whenever the opportunity arises. The additional revenue that a secondary market brings in will reduce the impact of any higher costs. Use market research to determine if you could expand your business into new areas

• Supplier relationships - build close relationships with your suppliers to get better trading terms and volume discounts and collaborate on joint promotions

• Customer service - improve your customer service and develop a staff training programme

• Increase your prices - check if you have priced your goods and services correctly and if you could increase prices without reducing sales

• Price discounts - consider price discounts and promotions to increase your customer base (e.g. 2-for-1 deals or happy hour)

• Retail displays - use effective retail displays to increase your sales

Gary Chamberlain is a business consultant to businesses across Asia. He works with clients to improve their business models. Better business comes from planning and strategic thinking.