Guide to Calculate ROI of a Small Business Loan

In this article:

• How to calculate ROI for a small business loan
• Strategies to maximize the benefits of a business loan
• What’s the difference between ROI and APR?
• Key Takeaways

Managing finances is a critical aspect of running a successful small business. But many entrepreneurs are inexperienced and uncomfortable when it comes to taking out their first loan and making a business investment. After all, taking out a loan does involve some risk, so when does that risk make sense? And when is the risk greater than the potential reward? The best way to answer these questions is to learn how to calculate the return on investment (ROI) of a small business loan.

In this guide, we’ll delve into the intricacies of calculating the ROI of a small business loan and explore strategies to maximize its benefits. Whether you’re seeking funding for expansion, equipment, real estate, or working capital, this article will provide you with valuable insights to make informed financial decisions.

Steps to Calculate ROI for a Small Business Loan

Calculating the return on investment (ROI) of a small business loan isn’t as simple as plugging numbers into a formula (although we’ll get to that). There are a few steps you need to take in order to get the right numbers for your calculation.

First, determine the total cost of the loan. This involves identifying the principal amount borrowed and the interest rate charged by the lender. Additionally, consider any extra fees or charges associated with the loan, such as origination fees or closing costs. By summing up these costs, you can determine the total amount that needs to be repaid over the loan term.

Next, assess the returns that you anticipate will be generated by the loan investment. Identify the revenue or income you can realistically anticipate as a result of utilizing the loan funds. Take into account any additional profits or cost savings resulting from the loan investment, such as increased sales, improved operational efficiency, or expanded product offerings. Summing up these returns will give you the total gains attributable to the loan (note: this is different than net profit).

It’s important to adjust for time and risk in the calculation. Consider the duration of the loan and the associated interest payments over time. Assess the risk factors associated with the loan, such as market volatility or changes in business conditions. To account for the time value of money and the level of risk involved, discount future returns to their present value using an appropriate discount rate.

Now it’s finally time to calculate the ROI! Apply the ROI formula: ROI = (Total Returns – Total Cost) / Total Cost * 100. Subtract the total cost of the loan from the total returns generated, and then divide by the total cost. Multiply the result by 100 to express the ROI as a percentage.

For example, if the return you expect on a loan is $115,000, and the total cost of the loan is $100,000, then your equation would be: ($115,000 – $100,000)/$100,000 * 100, which equals 15% ROI.

Interpret the ROI calculation by comparing it to industry benchmarks or internal goals. A positive ROI indicates that the returns exceed the costs, making the loan investment financially beneficial. Assess the ROI in conjunction with other financial metrics and considerations to make informed decisions about the loan’s impact on business growth and financial sustainability.

Strategies to Maximize the Benefits and Mitigate Risks of a Small Business Loan

While calculating the ROI of a small business loan provides valuable insights, it’s equally important for business owners to implement strategies that maximize the benefits and mitigate potential risks associated with the loan. By adopting these strategies, you can optimize your loan utilization and enhance the overall financial health of your business.

1. Be Strategic: What is your overall business strategy? How does a loan fit into it? At its core, a strategy is just a set of limiting decisions that focuses where you spend your time, energy, and money. Your strategy should define success, and tell you where to play, how to win, and what capabilities you need in order to achieve that success. Only seek financing if it fits into your strategy and you can forecast positive returns (if you’re forecasting negative ROI, what’s the point?).
2. Develop a Detailed Business Plan: A well-defined business plan serves as a roadmap for executing your strategy, which includes utilizing the loan funds effectively. Outline specific objectives and growth targets, along with tactics to achieve them. A comprehensive plan provides clarity on how the loan will be invested, ensuring that the funds are allocated towards revenue-generating activities and essential business needs.
3. Evaluate Loan Options Carefully: Before securing a small business loan, conduct thorough research and evaluate different loan options available. Compare interest rates, repayment terms, fees, and conditions offered by various lenders so that you understand the initial cost and the investment amount. Choose a loan that aligns with your business needs and offers the most favorable terms to optimize the return on investment.
4. Monitor Cash Flow: Efficient cash flow management is crucial to ensure the smooth repayment of the loan. Regularly monitor your cash flow statements, track income and expenses, and make necessary adjustments to maintain a healthy cash flow. Timely payments reduce the impact of interest and penalties, improving the overall ROI of the loan.
5. Invest in Productivity and Efficiency: Allocate a portion of the loan towards investments that enhance productivity and operational efficiency. Upgrade equipment, implement technology solutions, or automate processes to streamline operations and reduce costs. These investments can result in long-term savings and increased profitability, positively impacting the ROI of the loan.
6. Seek Professional Advice: Consult with financial advisors or business consultants who specialize in small business financing. They can provide valuable guidance on loan utilization, financial planning, and growth strategies. Their expertise can help you make informed decisions, minimize risks, and maximize the benefits of the loan investment.
7. Continuously Monitor and Review Performance: Regularly track the financial performance of your business and monitor the impact of the loan investment. Compare actual results with projected figures and assess whether the loan is delivering the anticipated returns. Make adjustments as necessary to optimize the utilization of the loan and maximize its overall impact on business growth. For example, you may need to adjust your pricing in order to increase sales (or profits) in order to maintain or achieve positive ROI. Or you may need to launch a marketing campaign to attract more sales, even if this isn’t something you had considered when you were creating your initial investment plan.

Following these guidelines will help you make the most of your loan investment, creating the greatest likelihood of achieving good ROI.

What is the Difference Between ROI and APR?

The difference between ROI (Return on Investment) and APR (Annual Percentage Rate) lies in their respective purposes and calculations. ROI measures the profitability or return generated from an investment, indicating how effectively an investment has performed. It is calculated by dividing the net profit or gain from an investment by the initial investment cost and expressing it as a percentage. On the other hand, APR is a measure of the cost of borrowing, typically associated with loans or credit products. It represents the annualized interest rate, fees, and other costs incurred by the borrower. While ROI focuses on the returns gained from an investment, APR focuses on the costs associated with borrowing funds. They serve different purposes in evaluating financial outcomes and should be considered in their respective contexts when assessing investment performance or loan affordability.

Takeaways

In sum:

1. The formula for calculating ROI is: (Total Returns – Total Cost) / Total Cost * 100.
2. To get a meaningful result from this formula, you need to use meaningful and accurate numbers in your forecasts.
3. You should only seek financing if you have a clear strategy and a solid business plan for executing that strategy that requires financing in order to be successful. If you don’t have these yet, take some time and develop them.
4. Never be ashamed to ask for input or advice from people with more experience.
5. Don’t be afraid to pivot your strategy or tactics if they aren’t working.

How Biz2Credit Can Help

When it comes to navigating the complexities of small business loans and calculating the ROI, Biz2Credit is here to assist you. As a leading online marketplace helping small business owners get funding, Biz2Credit offers a range of resources and services that can support your loan ROI analysis and decision-making process. Here’s how Biz2Credit can help:

1. Personalized service: Biz2Credit provides a user-friendly platform where you can input your business information and loan requirements, and receive personalized loan offers tailored to your needs. This enables you to evaluate different loan terms, interest rates, and repayment options to make an informed decision.
2. Loan Application Assistance: Applying for a small business loan can be a time-consuming process. Biz2Credit simplifies this process by offering a streamlined online application. Through their platform, you can complete your loan application efficiently, ensuring accuracy and completeness. Their team of experts is also available to provide guidance and answer any questions you may have.
3. Business Loan Calculators and Tools: Biz2Credit offers a suite of loan calculators and financial tools that can help you estimate loan ROI and assess the financial impact of different loan scenarios. These tools enable you to input relevant loan details and generate projections, helping you make data-driven decisions about loan affordability and potential returns.
4. Financial Advisory Services: If you require personalized guidance and expert advice, Biz2Credit’s financial advisory services can be a valuable resource. Their team of financial professionals specializes in small business finance and can provide in-depth analysis, strategic insights, and customized recommendations to optimize your loan ROI.
5. Educational Resources: Biz2Credit understands the importance of knowledge and education in the loan ROI calculation process. They offer a wealth of educational resources, including articles, guides, and webinars, covering various aspects of small business financing and loan ROI analysis. These resources can enhance your understanding and empower you to make informed decisions.

Biz2Credit’s commitment to small businesses and their expertise in loan financing make them a trusted partner in your loan ROI journey. Whether you’re just starting to explore loan options or seeking support in the application process, Biz2Credit offers the tools, guidance, and resources to help you make the most informed decisions for your small business.

Joyal and Sarvinder know this from experience. These two entrepreneurs had a vision to open a restaurant that would connect their community with nostalgic food from their culture. Following the above steps convinced them that financing was a smart move, so they took the plunge and began working with Biz2Credit, who financed their dream and let them finally open the doors to their new restaurant, Taste of Mumbai.

With Biz2Credit’s assistance, you too can navigate the loan landscape with confidence, calculate loan ROI accurately, and position your small business for success.