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Return on investment (ROI) is one of the least calculated and most important ratios for small businesses. It tells you what kind of return you are getting from the personal money that you have invested in your business.

For example, let’s say that when you started up the business, you took $7,500 from your savings account and used that money for start-up expenses. You could have taken that same money and invested it in a bond (where it would earn interest income) or in real estate (where it would earn rental income) or in one of many other investments. But you chose instead to invest in your own small business. Shouldn’t you be making a return on that investment? Absolutely!

In Chapter 12 we delve deeper into the issue of return on investment. For now, here’s how we calculate it:

ROI = Normalized net income ÷ Money invested

What do we mean by “normalized” net income? We want to calculate net income as if you are being properly compensated for the hours you work in the business. This is your “employee” or “manager” role. How do you know what you’re worth? Start by calculating how much you would have to pay someone else to step into your shoes as the manager of the business. For example, if you would have to hire a replacement for $47,000 and you are only paying yourself $25,000 in order to take it easy on cash flow, then you would subtract the difference ($22,000) from income to get to normalized net income.

ROI = Normalized net income ÷ Money invested

= ($22,475 – $22,000) ÷ $7,500 = 6.3%

This means that you are making a 6.3 percent return on your investment in the business. This is probably better than a savings account but not enough to compensate you for the risk of investing in a small business. On top of that, you’re getting paid $25,000 for a $47,000 job. You have a ball and chain around your ankle because you can never leave your business. You would have a difficult time finding someone to take over your business and make that kind of money. It is not a very cheery outlook!