The Cost of Opportunity and ROI on Small Business Investments
What can your company afford to invest in?
What can’t you afford to invest in?
And, importantly: what can’t you afford NOT to invest in?
If I could wave a magic wand, these are the questions I would answer for every entrepreneur.
(Fortunately, this is why CFOs and finance departments exist. :))
From my perspective (and I admit there are other takes out there), the answers to these questions are all about two things.
First: money. How much of it do you have? How much of it are you willing to spend?
Second: goals. What are yours? How ambitious are they? How much will you need to spend to reach them?
Let’s start with money. We all have some amount of it; many of us want more of it. Whether you’re funded or bootstrapped, you have a certain amount of cash inside your company. You can take that cash out of the company as the business owner for your personal use, or you can reinvest it back into the company in some way.
If you decide to reinvest, you must earn back more than what you spent to make it worthwhile (the caveman version of ROI).
How much more?
For a simple rule of thumb, I like 20%. (This is based on double the average return I can expect if I invested the money personally in the stock market and is a very simple, very general principle).
But things aren’t quite that easy. You can’t empty your entire piggybank into investments that will, someday, get you a good return.
Because you have expenses NOW, and you have to maintain enough cash flow to keep paying those expenses.
There is some range of dollars that you can spend on longer-term investments that should (but could not) end up garnering a return.
That range is determined by your financial projections. When you look 3 months, one year, 3 years out, where will your revenue realistically be? What about your cash? And profit?
How many of those dollars you end up spending should be determined by what you want to accomplish inside your business.
If you’re building a lifestyle company that supports you with a great salary, you may be more conservative with your investments.
On the other hand, you hit a tipping point where you must spend cash if you want to expand (spend money to make money).
If you want to double your revenue? You probably need to invest in that highly qualified CRO.
If you want to open a new business line? Better shore up your operations team.
If you’re making a play as a thought leader in your industry? You’ll need to spend dollars developing content.
One approach is not better than another. All are worth considering. The best path forward is ultimately based on four factors:
- how good the investment is
- the cash you have in the bank
- your appetite for growth
- your tolerance for risk
With the threat of recession looming, it might seem like an odd time to talk about spending money and making investments. And it’s true that some of you should batten down the hatches and make your organizations as lean as possible to prep for the coming months.
But some companies (and you may be one of them) should plan to invest now or in the near future. There is always potential during economic times, and the markets shift to favor some industries more than others. (I always use my former student painting company as an example; a low-cost alternative to professional painting is a booming business during hard times.)
Know your options; make smart choices. And if you need help thinking through them, we’re just an email away.