Business owners require a net return on their investment to motivate them to continue to invest.  While there are several measurements used in evaluating performance, Pointguard relies on two primary measurements of return. 

Return on Sales (Net Income)

This measurement evaluates the financial return on every dollar of sales revenue earned during the period after deducting all costs of providing for or manufacturing of the product or service; and the costs of infrastructure – also known as general and administrative expenses or overhead.  Pointguard refers to these as infrastructure costs, which are dependent on what is required to support the level of sales volume the Company is able to generate.   In our experience, a company will require a 5% return on sales in order to survive.  This 5% return on sales will pay for minimum debt service, minimal fixed asset purchases, and income taxes, but will not provide a cash return to the equity owner.  A company that does not earn above a 5% return will require outside debt or equity to fund its working capital needs in order to operate.

Companies producing or reselling a product can achieve a return of 8-12% depending on whether the product is a commodity or unique to the market, while companies that primarily sell services can achieve a return on sales of up to 30% based on maximizing the return on their labor.  If your company is on the lower end of the scale, you can expect to leave more of your return in your company for operating capital and growth.  Removing capital from the business will slow your growth and cause a heavy reliance on debt.

Return on Equity

This measurement evaluates the financial return on every dollar of equity the owner continues to invest in the business.  This return has nothing to do with the owner’s compensation for working in the business, but rather, the return on the investment of the owner’s capital in the company.  It is measured as the net income earned on the beginning of year equity.

This return should be evaluated based on the comparison of relative risk of an investment of money in the equity markets.  Investments in small closely held businesses are higher in risk due to several factors including dependence on key personnel, higher concentration of sales with one or a few customers, and regional economic or industry limitations.  For this reason, we have observed a minimum return of 20-25% on owner’s equity to be required to pay for this level of risk. 

Every business owner must evaluate the return they expect to achieve each year by forecasting the Company’s operations in advance.  The result of the forecast should determine if the plan will achieve the desired results, and if not, changes to the plan are necessary.  Make sure you have a plan that pays you for your risk.