Using ROI To Make The Best Business Decision

ROI, Return On Investment is a widely used tool to measure the performance or efficiency of an investment. Expressed as a ratio of net profit over the cost of investment, it helps shorten and simplify the decision-making process by owners or management of businesses when it comes to critical decisions involving large investments. The higher the ROI, the shorter the time it takes to recover the investment cost.

According to a market survey among some 200 managers, the majority of them (about 77 per cent) found ROI concept useful in their work. In fact, the concept is so popular that it has also been adopted by scientific agencies like National Science Foundation to evaluate their research projects. ROI is a widely used concept taught by economics tutor Mr Edmund Quek in his economics tuition. One may sign up for his economics tuition class to learn about ROI and many other useful economics concepts. You can visit this economics tutor’s website at www.economicscafe.com.sg to check his economics tuition class timetable.

Advantages of ROI Concept

As a decision-making tool, the concept of ROI is very easy to understand. The simplicity of its formula allows all to use it freely with pre-determined variables. One point to note is that when we choose what variables to take into consideration, we must try to capture all key factors that affect the cost and return of an investment. For example, an investment in infrastructural development will not only bring about financial returns, but also environmental and social benefits which are often neglected in the past but given heightened attention by political leaders across the globe in recent years.

A typical case study that I have come across recently is the evaluation of the HRIS (Human Resource Information System). With a projected lifespan of 5 years, the total cost of this investment is about half a million Singapore dollars, including one-time investment such as license fee, software development cost, hardware cost as well as recurring cost like annual maintenance. HRIS, an electronic system to replace manual system to process all documents by hand, will result in cost savings in various areas. First of all, staff who used to manually process all physical documents can be freed up to perform other tasks. Secondly, the electronic system removes the need to print out and deliver all the physical documents, resulting saving in paper, printing and delivery cost. Thirdly, HRIS also leads to higher accuracy and efficiency. However, the improved accuracy and efficiency is hard to be quantified. In reality, when we calculate the ROI, we will simply compare the total cost with the quantifiable returns/benefits to make a decision, bearing in mind the non-quantifiable returns/benefits. With guidance from your economics tutor in your economics tuition class, calculate the ROI of economics tuition over 2 years. Discuss with your economics tutor to identify some of the limitations of this concept. A good economics tutor will be able to demonstrate to you how to use economics concepts to solve real-life problems. Mr Edmund Quek is an experienced economics tutor renowned for incorporating real-life events into his economics tuition. His economics tuition centre, Economics Cafe Learning Centre is conveniently located within walking distance from Bishan MRT Station.

Disadvantages of ROI Concept

One of the greatest disadvantages of ROI concept is that ROI calculation does not capture the time factor which may be of pivotal value to decision makers. For long-term investments, there is a need to make the present value adjustment for accurate calculation of ROI. In addition, it may encourage myopic behavior as decisions based on ROI tend to sacrifice long term benefits for short term gains.

The traditional ROI concept also fails to account for the various environmental, social and political benefits which are usually hard to quantify. Another limitation of this concept is the lack of standard formulas, which may cause confusion in the event that different formulas are chosen purposely by different people to draw completely different conclusions.

Linda Geng

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