Before buying, determine profit potential, how a tool can grow your business or if renting might be a better option.
ROI, or return on investment, is sometimes tricky to calculate. The term refers to the potential future profit an investment such as new equipment, tools or machinery can provide over time. For example, imagine an estimate on a job that requires a specific doohickey. You don’t own this equipment and would have to purchase it to complete the job. Questions, such as the initial expense and whether you’ll ever use it again, drive the decision to accept or turn down that job and buy the equipment.
Not only can that, but the right equipment and tools be a game-changer for job efficiency. The speed and safety at which your team performs has a real dollar impact on your business. “Time is money”; true enough, and fatigued employees can result in serious expenses.
Tools and equipment often translate to working smarter rather than harder, saving your team from expensive slow-downs, burnout and injury.
In a perfect world, we could justify buying every newfangled tool that might make our jobs easier. But that way can lead to madness and a never-ending, profit-sucking black hole. Instead, new purchases should be prioritized and carefully considered for profitability and growth potential.
The formula for ROI is deceptively simple. But first, let’s consider what questions should play into the data:
How fast can I get my money back and turn a profit?
Equipment can pay for itself in one job or in 50. Obviously, the faster your company can recoup the cost of that investment and start profiting, the better. If you are well acquainted with your financials, you can do some quick-and-dirty math to figure out your ROI period and potential future gains.
In the case of job efficiency, this estimate can sometimes be extremely difficult to decipher. You are talking about some serious math equations and the application of lean manufacturing principles. I’m not suggesting your small business worry about time studies and the calculations of employee productivity down to the tenth of a second. Just start with some estimated round numbers. For example, is it worth it if it saves your employee 10 minutes every day?
Where ROI is most easily calculated is when you can bill the equipment directly to the customer. Don’t make the mistake of absorbing every new equipment purchase into your overhead. If you would charge a customer for the use of rented equipment, don’t stop charging for the use of the same machine once you own it. Don’t undervalue the risk and expense that your company is taking on. Not every tool or machine can be billed directly, but be cognizant of when this is appropriate and take advantage of it for a faster ROI.
What is the true cost of ownership?
Many times, the cost of equipment lies more in ownership than in the initial purchase price. Employee training, storage, insurance, maintenance and repair are all vitally important ongoing expenditures. Real-world ROI takes these complex matters into consideration.
If the monthly ownership cost of the equipment is higher than the profit it is earning, then the initial purchase price doesn’t matter – it’s a bad decision.
Is there another way to proceed?
For the times when the line between need-to-have and nice-to-have is blurred, a little ingenuity can go a long way in saving you some serious cash. Don’t be afraid to borrow, build or rent your way to getting the job done. Renting is one way of trying out a tool for future purchasing decisions and is well suited to one-off situations.
How much risk can you tolerate?
If you are worried about the ROI on a piece of equipment, it is probably because you consider it expensive. The definition of expensive fluctuates depending on the size of your business, its age, cash flow and credit rating. A new opportunity is great, but not if it over-leverages you to the point that you can’t meet payroll. Risk is perhaps the greatest thing to consider for ROI, because it is all moot if you can’t pay the bill. Paying yourself, your employees and your current creditors should take priority. Taking carefully evaluated risk can make a strong company stronger, but it can make a weak one crumble.
The textbook formula for calculating return on investment is gains minus cost, divided by cost. Make sure that the cost and gains values are true and reflect your unique situation. And sometimes, you just have to follow your gut and take a leap of faith. Just make sure it is a calculated one.