What is a return on investment (ROI)?

Return on investment (ROI) is a financial metric that investors or businesses use to measure their level of financial success. ROI refers to comparing the ratio of the net profit from the investment to its cost.

Depending on the total return on the investment, the company receives information on how well it is managed. “Total return” refers to all returns on an investment, including capital gains and other financial rewards.

Although ROI is a ratio, it is usually expressed as a percentage and there are many ways to calculate it.

How to calculate ROI?

One of the ways to calculate ROI is investment gain divided by investment base, or ROI = Investment gain / Investment base.

But the most common way to calculate ROI is net income divided by the total cost of the investment, or ROI = Net income / Cost of investment x 100.

For example, if a person invested $80 into a business purpose and spent another $20 researching this purpose, the total cost would be $100. If that business purpose generated $300 in revenue but had $100 in personnel costs, then the net profits would be $200.

By using the formula above the net income which is $200 divided by the cost of investment which is $100, the answer is 2. But ROI is often expressed as a percentage so the result needs to be multiplied by 100. Therefore, this particular investment’s ROI is 2 multiplied by 100, or 200%.

Measuring the ROI of numerous metrics helps determine how profitable the business is each one of them.

However, some disadvantages are important to pay attention to.

What are the disadvantages of ROI?

• Different calculation methods – Due to the existence of different equations for calculating ROI, each business may use a different method, making the comparison between investments irrelevant.
• ROI does not consider time period – For example, comparing two investments. The one has a high ROI and the other has a low ROI, it does not mean that the investment with a higher ROI is better than the other. Since ROI does not consider the period of each investment, it is possible that it was different for the two investments.
• Only considers the financial benefits – When estimating the return on investment, ROI does not consider the non-financial benefits of the investment.

Despite the drawbacks of ROI, it has also its benefits.

What are the advantages of ROI?

• One of the biggest advantages of ROI is its ease of use. Thanks to the easy calculation, it enables analysis of the performance of an investment.
• Another benefit of ROI is the possibility of comparing returns from different investments.

Conclusion

For a business to be profitable, it needs to have a positive rate of return on investment. This means that the rate of return must be greater than the total cost. If the percentage is negative and the indicator against which the ROI is measured is less than the total costs, it means that it generates a loss.

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Customer loyalty is when the customer and the business have a continuous positive relationship. If clients keep buying again and again, this means that you are doing the right things in your business. You won their trust and they will choose your company over a competitor that offers similar products. To understand how well the product affects the auditory there is a metric called Customer lifetime value (CLV).

What is a customer lifetime value (CLV)?

Customer Lifetime Value (CLV or CLTV) is the total revenue a business will receive from a single customer over the lifetime of their relationship. The longer the customer continues to buy from the company, the greater this revenue becomes.

Why is customer lifetime value important?

As mentioned earlier in the article, CLV not only shows the value a company can expect from individual transactions but also across their entire relationship, calculating the specific revenue from each customer. With that said, increased CLV will lead to increased revenue over time.

Also, CLV helps you understand how the product affects your consumers and which areas need improvement. By looking at your customer’s feedback and behavior you can change your product to their needs and strengthen their loyalty.

This will help you differentiate your company from the competitors.

In order to measure customer lifetime value, companies use two main models.

What are the CLV models?

There are two CLV modules and these are predictive CLV and historical CLV module. Each one of them leads to different results.

This depends on whether a business wants to understand the future behavior of its customers or whether to look at existing data.

What is a predictive customer lifetime value module?

By using regression or machine learning the predictive CLV model can predict the customer’s behavior. With this module, companies can better identify the product or service that brings in the most sales and identify the most valuable customers.

What is a historical customer lifetime value module?

The historical CLV module represents the amount of gross profit that the customer has made from all previous purchases.

This model looks at past data to predict the value of a consumer based on previous transactions alone. Without considering whether the customer will still purchase from the company or not.

How to calculate the customer’s lifetime value?

The customer lifetime value formula will tell you how much it’s worth investing in the customer experience in order to see a positive return on investment.

The formula used to calculate the CLV is as follows:

Customer lifetime value = customer value x average customer lifespan.

Customer value is the average purchase value multiplied by the average frequency rate.

You can get the average purchase value when dividing the total revenue over a set time frame and the total number of purchases over the same time frame.

The average frequency rate is obtained when the total number of purchases over a period is divided by the total number of customers during that same period.

And the average customer lifespan is the average number of years a customer stays active dividing by the total number of customers.

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You can use the organic search. This is an unpaid process known as search engine optimization (SEO). Or choosing another method that focuses on getting traffic from organic and paid searches. This process is known as search engine marketing (SEM).

There is another advertising strategy that is only paid and it’s called cost per click or CPC.

What is CPC (cost-per-click)?

As the name suggests CPC is a financial metric that measures the cost that the advertisers pay every time their ad is clicked. CPC applies to ads that appear on the results pages of search engines, display ads, and ads that appear on social media.

In the case of SEM, is the cost they pay every time their ad is clicked from a search engine such as Google.

This is a metric that applies to all types of ads no matter if they have text, images, or videos.

Often advertisers use CPC with a daily budget. When this budget is reached the ad is automatically removed from the website.

There is a formula that is used to determine the rate you pay per click.

How is calculated?

One of the most popular ways to calculate CPC is:

Advertising Campaign Cost / Number of Clicks

In order for ads to be displayed next to search results on search engines like Google and social networks like Facebook. Advertisers use a bidding process to determine the rates by choosing the maximum amount they are willing to pay for a click. Since advertisers only pay for clicks, they spend money on consumers interested in the product. And these paid clicks have the potential to turn into sales.

There is one more pricing option that defines the cost that the advertiser will pay for an ad campaign on a website. This metric is called cost per mille or CPM.

What is CPM (cost per mille)?

CPM is a paid advertising option where companies pay a price for every 1,000 impressions their campaign receives. This is why CPM is also called cost per thousand. An impression is when someone sees an ad on social media, search engines, or another marketing platform.

What is the difference between CPM and CPC?

The CPM model is a great choice for advertisers looking to build brand awareness. Because a CPM campaign is focused on putting the ads on as many screens as possible. This will help companies to know their audiences better. Then, once the brand’s visibility reaches a certain point, companies may transition to an action-based campaign. For example a PPC campaign.

PPC or pay-per-click is an advertising model in which the CPC metric represents the amount that the advertisers have to pay for every click. When the visitor clicks on the ad, they are taken directly to the publisher’s website and he has to pay the cost for that click. If this click leads to a sale then the investment has been valuable.

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What is the click-through rate (CTR)?

Click-through rate (CTR) is a metric that measures the number of people who click on a specific advertisement, webpage, or email per the number of people who see it (impressions). This is expressed as a percentage.

What are Impressions?

An impression is when the user only sees the advert without clicking on it. It’s also known as view-through. The impression shows us the number of people who are seeing ads within a particular channel. Calculating this number of impressions that the campaign makes will help us to understand how far the advertising channel really reaches. And also helps us generate other marketing metrics such as click-through rate.

If you want to generate CTR you also need to know how to measure it.

How is CTR measured?

You can calculate the click-through rate with the formula  – CTR is (clicks/impressions) x 100.

CTR can be measured depending on the different areas of practice. For example, if it’s an email CTR can be measured in a call-to-action link. On the website is the hyperlink on a landing page. It can be a PPC (pay-per-click) ad on the Google search results page or an ad on a social media site such as LinkedIn, Instagram, or Facebook.

PPC or pay-per-click as the name suggests is when you pay for every click the user makes on your ad. A higher click-through rate will generate better Quality Scores. In turn, the high-quality score predicts a successful PPC campaign. But apart from that CTR is important for other reasons as well.

Low CTR

As we mentioned above higher CTR leads to success in PPC ads. But also CTR will show you if there are any areas that need improvement.

For example, low CTR indicates that something is wrong and needs to be fixed. Because the users are finding your ad to be less relevant. Therefore you can improve it and increase the chance of getting a higher CTR.

High CTR

High CTR indicates that your ads effectively capture the interests of your target audience. But not always Higher CTR is good for the business. If your keyword is not suitable it will not generate sales, leads, etc. So it’s important to have high CTR on the relevant and affordable keywords for your business.

The first step for improving the relevance of your advert and getting those desired actions is good CTR.

What is a good CTR?

A good CTR depends on the industry. For arts and entertainment, a good CTR is between 11% and 12%. But most industries have a good Google Ads click-through rate is around 6 and 7%+. Then the average CTR is between 4 to 6%.

A good CTR also depends on the running campaign, the target keywords, and the channel. So there are a lot of factors.

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What is a cash flow?

The cash flow is a financial metric that shows the cash and cash equivalents (CCE) that move in and out of the company. CCE is the financial assets that the business could convert into cash.

To know the profitability of the company it’s important to understand the differences between profit and cash flow. These terms can inform business owners of the best way to pursue growth by making important decisions.

How is used?

Cash flow shows how well you’re using your money. This includes all sources and uses of cash from business activities that are important to the company’s finances. A cash flow analysis can show whether the company can pay its bills and whether it has enough cash to carry out operations in the future.

For example, the seasonal business can experience significant cash inflows during peak season and cash outflows during off-peak times. It’s important for businesses to better manage their finances, ensuring that they have enough cash reserves during their off-peak seasons.

Cash flow can be positive and negative. Positive cash flow means that more cash is moving in than spending out. Negative cash flow means that more money is moving out than coming in.

What are the different types?

Cash flow activities are classified into three categories:

• Operating – Operating activities are the revenues and expenses incurred by the company’s core business operations. It’s important to remember that in order to sustain business growth in actively growing companies is to have a positive cash flow.
• Investing – Investing activities are all net cash made by the company’s investing activities. In healthy companies that invest frequently, the number can be negative.
• Financing – Financing activities refer to the moving of the cash between the investor, owner, or creditor and the company. This is the net cash made to finance the company and may include debt, equity, and dividend payments.

Now that you know the three types of cash flow activities, a company can determine its free cash flow.

What is free cash flow?

The free cash flow represents the true amount of cash that the business has available and can use.

This is the net amount of the cash after operating all expenses, taxes, reinvestments, etc.

Here is a formula for how to calculate it:

Free Cash Flow = Cash Flow from Operations – Capital Expenditures

This is a metric that indicates the company’s financial health in its truest form.

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Net profit is also called the bottom line because this is the final measure of profitability after all expenses have been taken out. To understand the meaning of net profit you must understand what is the definition of profit, the types it is divided into and what is a profitable business.

What is profit?

The profit is a measure that determines a business’s financial growth. For this reason, it’s important for businesses to make a profit. The profit is the amount of money that the business earns after accounting for all expenses. This can be accomplished if the product is better than the competitor’s or if it’s innovative or so-called unique.

What are the different types of profit?

To understand the business’s true financial standing, the profit is separated into three categories:

Gross profits, operating profit, and net profit (bottom line). These metrics help entrepreneurs understand the profit their business is generating and which areas are earning the most revenue.

What is gross profit?

Gross profit is also known as gross income or total revenue. This metric shows the direct income that a company receives from the products after deducting all the direct expenses. The total costs incurred to produce the required goods are called “cost of goods sold (COGS)”. Gross profit helps entrepreneurs by showing them how well the business is performing and the aspects of the business that are most valuable.

What is operating profit?

This is the total income after paying all business costs, but before paying taxes. For many startup businesses, this is a very important metric for profitability. Operating profit shows if the entrepreneur is spending more money to manage the business than he is earning.

Net Profit

Net profit is also known as net income or net earnings. This is the total amount of money that the company receives after all expenses and taxes are paid for a certain period of time. This metric shows the financial health of the company. If the business doesn’t make a profit, the entrepreneurs can assess for how long the losses are sustainable. The ones who make a profit can make a plan for growing their business further. Monitoring the net profit in the individual periods allows the entrepreneur to see if things in the company are going well. Here is a formula to calculate net profit:

Net Profit = Total revenue – Total expenses

In the formula above we can see that the net profit is the total revenue (gross profit) minus the total expenses.

What are expenses?

An expense is the cost of business operations that a company incurs to generate revenue. Total expenses are the sum of the costs spent toward running the business. There are two types of expenses that a business can incur: overhead and operating expenses.

• Operating expenses (OPEX) are costs that a business is spending for its management, such as rent, utilities, marketing, and payroll.
• Overhead expenses are all costs on the income statement except for direct labor, direct materials, and direct expenses. By taking your gross profit and subtracting all expenses you can determine net profit. It’s important to know your overhead costs because they always go up regardless of whether the business is making any revenue. Then you will be able to find solutions to reduce them.

After paying operating expenses and taxes from the total sales revenue what is left is the net profit margin.

What is the net profit margin?

Net profit margin (also known as profit margin or net profit margin ratio) is a financial ratio that reveals the company’s financial health. Net profit margin measures the amount of net income that the business makes from sales revenue. The moment where the total business income is greater than the total business cost is when the business is profitable.

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What is market share?

Market Share basically means the percentage of an industry’s sales that belong to a particular company. Think about it as if one cake represents the market share of a whole industry. The goal of every company in this market share is to get a slice. As the industry grows companies need to expand with it to keep their sales percentage. The company with the largest market share in the industry is called market leader.

How is calculated?

Market share is calculated by dividing a single company’s sales for a particular period by the total sales of its industry during the same period. The result can be expressed as a percentage.

Here is a formula for calculating the market share of the company:

Market Share = Total Company Sales / Total Industry Sales x 100

There are several ways to increase your company’s market share.

• Find a specific target audience and build a reputation.
• Create a personality for the brand. You need to stand out from competitors and do something different.
• Create a marketing strategy and engage with the customers. This way you can turn your target users into loyal customers.
• Offer new technologies to users that the competitors can’t provide. This way the consumers would wish to buy this technology and become loyal customers.
• Expand the product even if the product itself doesn’t change.
• Keep the prices at a standard level by always comparing them with competitors.
• Win users trust. Ask customers for opinions about your brand, what they like, and what they don’t. And try to turn the negative reviews into positive ones.
• Another way to boost the business is by adding discounts or other benefits.

Example:

A good example of increasing the company’s market share would be Apple Inc. This technology company not only offers new products to its users but also upgrades their devices. Apple Inc. evolves according to users’ needs and gains their loyalty.

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What is a bounce rate?

A bounce rate is a metric that shows the percentage of visitors that land on a page of a website and then leave without taking action. This action could be clicking on a link, making a purchase or even visiting a second page of the website. The metric only counts visits to one page and that is the landing page (the page that led the users to the website).

How is calculated?

The bounce rate is calculated by dividing bounced visitors by the total number of users that arrived on the website. But in order to track the website visits, every page’s code on the website should have a Google Analytics tracking ID.

When someone visits the website this code triggers a session. If the visitor leaves the site without taking action the session expires and their visit counts as a “bounce”. But if the user interacts within the website and takes an action that triggers an event. Then the code fires and Google Analytics considers it as not a bounce.

This metric measures how effective is one website relative to the viewers. The bounce rate can be high or low. If the purpose of the website is for users to take a detailed look at it, then a high bounce rate indicates a problem.

What is a high bounce rate?

A high bounce rate might indicate that the page didn’t meet the user’s expectations or the content is not relevant to the viewers.

Some other issues for high levels of this metric could be the navigation, site speed, or a site error. It is important for businesses to pay attention to the bounce rate. Over time a high bounce rate negatively impacts search ranking because it indicates poor user experience of the website. To reduce the high levels we could improve the content of the site, copywriting, or user experience.

The only exception for a high bounce rate is if the purpose of the website is only to visit one page. If the purpose of the site is to leave a review or send a message then is normal for users to click away after completing an action.

What is a low bounce rate?

A low bounce rate means that users are not leaving after reading only one page. Most of the time lower bounce rate means better user engagement. But if the bounce rate is too low it might be a problem. For example, it could be a technical issue with how the analytics tracking code is integrated into the site.

Often bounce rate is misunderstood as exit rate, but they are different metrics.

What is Exit Rate?

Exit rate is a metric that measures the percentage of visitors that exit from a page after viewing several pages on the website.

Bounce rate and exit rate are important indicators of how satisfied the users are with the website’s content. And both of them are highlighting the problems that are causing users to leave the website. Once you are aware of what the potential problems are, you can start investigating further.

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