I am sure you would have heard of the term Return of Investment.
You put in money into the business and you want to earn money out of that. Hopefully more than you would get from a Fixed deposit in a bank.
You have this expectation for a higher return because of the risk you are taking. Fair enough.
How to reduce the risk while you are building or renovating your property to give you returns as per your expectation.
It boils down to one simple strategy.
Work the numbers Top down.
Most of us make a bottom up ROI calculation. It means that we first find out how much the renovation or equipment cost and then put a number in excel on what it will take to get a Return on that investment.
We tweak the excel format to squeeze out the lemon. We imagine and think up numbers
But business is not done on excel sheet and if it were life would be so easy.
So what is a better approach.
Top down obliviously:
How does that work?
Start with the revenue that you are making. Identify if the renovation or capital investment will improve revenue or save cost. (Frankly there are only 2 reasons to undertake any capital investment)
Be realistic as to how much improvement you seek to get out of the investment based on the historical or industry standards if any.
Factor that into the Profit and loss calculation
Now calculate the cost of the investment and figure out how much time will it take to break even on that investment.
This is another area where many hotels falter. They find a project does not break even in one year and they push the investment or discard the proposal.
However breakeven calculation is not ROI. You need to look beyond the break even and calculate the ROI as you meant to when you started the journey to see if the project was viable.
There is another metrics called IRR or Internal rate of Return
That gives you the rate return over the period of the life of the investment since a capital investment will last more than a couple of years.
Why don’t many people use it? It is confusing and slightly difficult to understand.
But with the advent of computers and excel file, it is very easy to calculate what the true return of any investment would be.
Plan for all projects to have a return of investment before you begin