Estimated reading time: 5 minutes
When you’re trying to propose a new idea or project, one of the questions that regularly comes up is “What’s the ROI?” Return on investment (ROI) is a calculation that reflects the benefit of an investment versus its cost. The basic calculation is:
ROI = Program Benefit – Cost / Program Cost
Once you calculate ROI, you can also multiply the result by 100 and turn it into a percentage. An example would be if a program cost $1000 to implement and would result in $10,000 of profit, then the ROI is 0.9 or 90%. While it’s important to understand the formula for calculating ROI, there are ROI calculators available, just do a search in your favorite internet browser.
Sometimes instead of calculating ROI, organizations will simply look at the relationship between the benefits and cost of a program.
Benefit-Cost Ratio (BCR) = Program Benefit / Program Cost
When using this calculation, if the BCR is more than one, then the benefits exceed the cost. And if the BCR is less than one, then the costs exceed the benefits. If we use the same example above, $10,000 profit / $1000 cost = BCR is 10.
Regardless of whether you use ROI or BCR, the value doesn’t necessarily come in simply calculating the number. It comes in evaluating the result. Here are three questions that need to be answered before calculating ROI.
- How will a benefit be defined and calculated?
Let’s say you’re proposing a new step in the recruiting process that will result in a better quality of hire. How will the benefit be calculated (i.e., quality of hire)? Do all the key stakeholders agree with this calculation?
Side note: I don’t want to get off track here but, one of the great things about HR metrics is that we can be flexible with our formulas. This can also be a downside. For example, when I worked at the theme park, we calculated turnover for our regular full-time employees separate from our seasonal employees. Because, if we calculated them together, the numbers would be skewed. This was great because we had better data and insights. But it could be challenging if managers didn’t remember that we had two separate turnover calculations. So having stakeholders reach consensus on the calculation could be necessary.
Back to our quality of hire example. Once everyone agrees on the benefit calculation, now we must figure out how to turn it into a dollar amount. And everyone needs to agree on that too. I know this might sound very obvious, but there are lots of organizations that don’t take the time to do this. And if the organization doesn’t know the answer, then how will they know the true benefit of the proposal they’re considering?
- What is the program cost and how will it be calculated?
The same principles we used for determining benefits also apply to costs. What are the costs that will be included? It may or may not be simply the program being proposed. For instance, let’s say that we’re proposing a new software program for our reskilling program and the cost is $1,000. We know that the cost of the software will be a part of the calculation.
But what about implementation costs? Should we include recruiter pay and benefits since they will be overseeing the implementation? And will there be an expense for training on the new software program? Some organizations might want all those additional expenses included. Other organizations might think of them as a regular operating expense that they would need to incur anyway and not include them.
Like the program benefits, if organizations don’t define what costs will be included, then they run the risk of not calculating ROI completely. Which brings us to the third question.
- What’s an acceptable ROI?
At the beginning of this article, we talked about the relationship between benefits and cost. It’s important to realize that a project might have an ROI of 90% and the organization might say, “That’s not enough. We need a ROI of 110% to proceed.” OR the organization might say the BCR on a project is 0.75 and give the project the green light because the cost isn’t as large as expected.
Companies need to define what acceptable ROI looks like. And realize it could vary based on the project. It becomes difficult to proceed with a proposal or measure the impact of a project if an acceptable ROI isn’t defined.
Return on investment is an important business calculation. It can help organizations make good decisions and it can help organizations measure the results of decisions they’ve made. But the value in ROI isn’t in just calculating the number. It’s in making sure you calculate the number completely. Using the right information. Because that allows the organization to gain the proper insights.
Regardless of what’s happening with the economy, organizations want need to make fiscally responsible decisions. Knowing how to calculate ROI helps them do that.
Image captured by Sharlyn Lauby while exploring the streets of Washington, DC
