In a business, ROI or return on investment is a familiar term, especially if the business operates in fields such as commercial, marketing and operations.

In simple terms, ROI is the return on an investment made in a business. ROI is a measure of success. Often this return on investment is a measure of the success of a business.

When you run a business, it is important to understand what return on investment is. To better understand ROI, here is a complete explanation of what ROI is, its benefits, and advantages and disadvantages.

Understanding ROI (Return of Investment)

Quoted by Investopedia, ROI is a performance measure or tool for measuring the performance and efficiency of a company's investment.

ROI can also be a comparison of the level of efficiency of several investments that have been used by the company.

Whether from different types of projects or assets, ROI can be used to compare investments to see other investment opportunities.

ROI tries to directly measure the return/profit from an investment relative to the investment costs itself.

In a more general and simple sense, ROI is the financial return from an investment. For example, company A invests Z amount of money, then ROI is a benchmark that shows how much profit from investment Z.

It is important to understand this ROI benchmark to form the right business strategy to get returns/profits from the investment.

ROI is calculated by reducing total sales by the nominal investment at the start, then dividing by the nominal investment and multiplying by 100%. That's the ROI number you're looking for.

The ROI figures show that the greater the percentage, the greater the profit the company will get.

Benefits and Importance of ROI (Return of Investment)

As previously explained, ROI is a benchmark used to compare the level of efficiency of an investment. Here are some benefits of ROI:

1. Business Strategy Planning

When you get investment, ROI will be a benchmark in determining business strategy. Why is that?

This business strategy will be used to measure how much costs must be spent for, for example, making a product, carrying out promotions and selling it.

ROI is a benchmark for business strategy planning to increase the efficiency of each department that plays a role in the company to increase profits from the investment results.

Apart from that, by using ROI, the company/business will also know whether a particular business strategy can be implemented or not.

2. More efficient use of funds

One of the main benefits of ROI is that it helps measure efficiency in the use of capital.

In line with business strategy planning, when you use ROI analysis it will be easier to see what parts of the company need optimization.

From this analysis, the use of funds will be more targeted, for example for efficiency in adding workers, or production or sales efficiency. That way, there is no use of funds that is in vain and cannot be measured or causes losses.

3. Measuring profits

The use of ROI analysis in determining the use of funds/costs for production for a business or company can also help to measure the company's profits.

In some areas, ROI is used as a tool to measure the profits from an investment plan.

That is why ROI is also a comparison between one investment and another. This is because the availability of existing investment also needs to be seen whether it can be done or not and what the benefits will be.

A company's ROI is often looked at to determine investment. Usually investors who accept a low ROI ratio prefer businesses with high sustainability, whereas investors who accept higher risk will also choose companies with a high ROI ratio.

4. Measuring New Product Performance

When your business has a new product, ROI can be used as a measure of the product's success both in terms of profits and financial expenditure. What is the profit of the new product compared to the production and promotion costs that must be incurred.

Advantages and Disadvantages of ROI (Return of Investment)

The following are some of the advantages and disadvantages of ROI or return of investment according to Poems:

Advantages:

• ROI provides precise measurement results related to the effectiveness and success of investments. This will help investors to evaluate the efficiency of the use of capital they will provide and what returns will be generated from the investment.
• ROI is the main consideration before continuing to invest, expand the company, or allocate resources. This provides a measurable basis for companies to assess the feasibility of using funds as a solution.
• ROI is also used to analyze whether an investment is in line with its profit target or not as well as determining the time period needed to achieve these profits.
• ROI is also used to assess the risk of an investment. Through this ROI analysis, investors can determine the investment value and profit prospects, thereby helping to make the right assessment.

Disadvantages:

• ROI usually only emphasizes financial benefits and ignores other important elements such as social, environmental and long-term impacts. That means ROI analysis fails to consider the non-financial risks/dangers of an investment.
• ROI usually measures the return/profit of investment in a certain period only according to a predetermined time, making it difficult to evaluate long-term investments.
• ROI does not consider the timing of cash flow or cash flow. Not all investments that have fast returns have stable cash flows, there are also investments with slow returns but stable cash flows.

There is no risk analysis in ROI, even though this needs to be taken into account in ROI because high investments also have high and unpredictable risks.

In running a business, the main elements that need to be considered are not far from financial analysis and other financial terms such as ROI.

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Financial risk has become part of running a business. Every business person must have the best ways and strategies to gain profits. Every company leader or those who run a business must have knowledge in managing this risk.

Financial risks can arise from various causes and this condition is very detrimental. You could experience decreased profitability, loss of capital, unstable cash flow, or the business goes out of business.

You need to identify things that might happen from internal and external factors to reduce the risk. That way, you can avoid all risks in business that could be detrimental.

How to Minimize Financial Risk

Steps that can be taken to minimize financial risk are reducing expenses, transferring assets, and increasing income. Here are a number of strategies to minimize financial risks in business.

1. Have insurance

Insurance is the best way to transfer risk to a third party when the company has to pay unexpected costs. There are many types of business insurance policies that can cover various risks that may arise. The company only needs to pay a certain amount of premium on a regular basis.

2. Build an emergency fund

Apart from insurance, companies also need to have emergency funds as a risk management strategy. Emergency funds are taken when the company makes a profit or sets aside some capital at the start of the business.

3. Investment diversification

Some of the business profits must be turned back into investment products. There is no harm in putting capital into shares of other companies that have more potential to generate profits. However, make sure the company also has liquid investments to be used suddenly.

4. Keep accounts receivable low

Accounts receivable (AR) or better known as trade receivables is one form of income that can maintain cash flow. Unfortunately, many companies ignore AR so that it is not collectible, reducing the company's income. Therefore, continue to monitor AR reports to always check payment reports from other companies.

5. Operational efficiency

The longer the procedure is carried out, of course the greater the production costs will be. If possible, make operational cuts for risk management. These funds can be diverted for other more profitable purposes.

6. Reduce unnecessary debt

Many businesses rely heavily on loans and debt. The greater the debt value will of course increase the financial risk as well. Moreover, if the debt comes from a financial institution that charges high loan interest. Therefore, make sure the loan value is as low as possible.

7. Invest in employees

Employees are assets and can determine the failure or success of a business. Companies must be braver in investing in employees, especially when running a service business. The best employees will reduce the risk of a company experiencing losses due to a bad reputation.

8. Give the job to a third party

Outsourcing could be a company's choice to reduce costs. However, choose responsibilities that can be given to people outside the company. Giving it to the wrong party can also create other risks.

9. Create a measurable matrix

You have to make a clear plan and measure the right level of success. Use the right matrix to support objective decision making. That way, your business journey will always be on the right track.

10. Create a cash flow management strategy

You must be able to estimate cash flows in and out in a period. Make a definite plan for each transaction, including risks and backup plans when the initial strategy doesn't work properly. The next step is to monitor each strategy implemented.

11. Make neat notes

A note can be the difference between a company that is doing well and one that is not. To reduce financial risk, make sure all transactions are recorded properly and neatly. That way, you can immediately find out where the mistakes in your financial management are. Apart from that, every company leader can create the latest strategy.

12. Create separation of duties

Giving responsibility to just a few people actually increases the risk of errors or embezzlement in financial reports. Therefore, companies must be able to control the duties of each employee and their respective responsibilities. This includes the responsibility for making plans, approvals, payments, and recording.

Equip yourself in carrying out financial analysis by following the Financial Analysis Program to carry out financial strategies in the company. That way, you can keep your business running longer and even potentially make a profit.