Is Your Business A Good Investment?
Entrepreneurs often become deeply absorbed in daily operations, leaving little room to assess their business from an investor's viewpoint. Yet every once in a while they step back and ask themselves, is my business a good investment? Should I sell the business and simply reinvest the money into the market? Should I distribute cash out of the business and invest it into other things or reinvest that money into the business? These are all great questions and are the foundation to looking at your business like an investor and understanding its performance compared to other investment alternatives. Regularly looking at your business as an investment can transform your strategic planning, refine your decision making and boost your company's overall value and growth potential.
Here are three ways we like to look at a business as an investment to help you gain clarity and make better decisions in your business.
Return on Invested Capital: Are Your Investments Paying Off?
In simple terms, Return on Invested Capital (ROIC) tells you what percent return the business is giving you on the total capital you have invested in the business. The total capital you have invested in the business would include capital you invested directly, money the business has made and not distributed to you, and any sweat equity you put into the business. ROIC helps you quickly see if the money invested into your business, including retained earnings, is generating sufficient profit.
Why It Matters:
ROIC tracks the performance of the business based upon the total amount of capital it is tying up.
ROIC will help prioritize operational improvements that directly impact profitability.
For example: Holding too much cash in the business will drive down the return on invested capital. In this case you need to deploy the capital in the business to drive greater net income, or distribute the cash out so that you can invest it in other investments.
How to Calculate ROIC: (Net Income) ÷ (Total Money You've Invested + Sweat Equity + Retained Earnings)
Return of Capital: How Quickly Are You Getting Your Money Back?
Return of Capital (ROC) measures how much money you have received back compared to your initial investment. The quicker your business returns cash the healthier and less risky your business is.
Why It Matters:
Shows you how quickly your cash is being returned to you.
Helps you decide when to reinvest or when to enjoy the rewards by taking money out.
How to Calculate ROC: Total Distributions You've Taken Out ÷ Total Cash You've Invested
Return on Investment (ROI): Are You Building Wealth?
This is the big-picture view. It shows if owning your business is making you wealthier, considering both how much your business has increased in enterprise value and the distributions you've taken out (not counting a reasonable salary). It helps you compare your business investment to other ways you could invest your money, such as the stock market, and is the best measure of true wealth creation over time.
Why It Matters:
Gives clarity on whether your business is truly worth your effort compared to alternatives.
Guides your biggest decisions like whether to expand, sell, or invest more by highlighting growth and wealth creation.
How to Calculate It: (How Much Your Business's Value Has Increased + Total Cash Taken Out) ÷ Total Money You've Put In
Be Truthful To Yourself:
One thing to note when looking at these metrics, it is easy to inflate some of these returns by not paying yourself a reasonable salary and inflating your profits or distributions. If this is the case you should adjust your profit and distributions numbers to reflect what a reasonable salary should be and rerun the calculations. Be truthful to yourself, pay yourself a reasonable salary, and get a true understanding of your business's health.
Why Thinking Like an Investor Really Helps:
Looking at your business through the eyes of an investor helps you clearly see what's working and what's not. Are you getting a return on your investment and is it worth the hassle you are putting in? It’s not about complicated numbers; it’s about making sure your efforts and money truly pay off, helping your business thrive and for you to build meaningful wealth.
Ready to start thinking like an investor? Reach out today and we’ll help you get started building a better future for you, your family, and your business.