Every business is challenged with making decisions and your art business is no different. Some of the decisions you make may be creative while others are more business related. More often than not these decisions will have financial implications that will affect your overall profitability.
In making most business decisions you will be faced with choosing among various alternatives. How do you choose the best? In this article I will take a look at a tool that will help you choose among various alternatives called Return on Investment (ROI). You don’t need a finance degree to understand Return on Investment, it’s just a matter of understanding a basic concept and applying some simple math.
One of the questions that successful business owners frequently ask themselves is, “Was it worth it to do …., or should I spend X dollars on…” Business is a lot of trial and error to find out what works and what doesn’t – not everything you do will be successful. Many successful entrepreneurs have said that success was the result of a hundreds (or even thousands) of failures. Your art business is no exception.
In business you are faced with many choices of how to spend your time and your money – even doing nothing is a choice! Yes, doing nothing is a choice. As you try different approaches or make different business expenditures it is important to measure their return on your investment. You may measure the return on investment of a past investment or you may estimate the return on investment for a proposed investment or change in your business.
How you can use Return on Investment in your art business
Not every financial business decision requires using a Return on Investment analysis but it should be carefully considered when making major investments or changes in your art business.
Some investments / activities where you should measure the return on investment include:
- Trying a new artistic approach or body of work that will require additional investment tools, supplies and possibly even new facilities
- Testing a new festival or art venue to determine which is most profitable
- Trying a new marketing campaign or approach
- Determining whether to produce prints in-house or have an outside supplier produce them (this is called a make or buy decision)
- Buying a new machine or tools of your art business
- Trying new processes or materials to reduce your costs or improve quality
- Opening a new retail location, studio or other facility
- Finding out which alternatives will give you the best return on your money
- Deciding to invest spare cash in your art business or putting it in a bank
- Measuring social media (yes it can be done, sort of…)
- Just about any major activity or proposed change where you spend your time and/or money!
How is Return on Investment stated?
- Return on investment is stated in terms of a percentage. Here are some examples:
- The festival in Santa Fe returned 200%.
- The festival in my downtown area returned 50%.
- Our investment to produce limited prints returned 5000%.
- Our old direct mail campaign returned 10% on funds and time invested.
- Our new direct mail campaign with a different list and message returned 15%.
- The new machine we bought has returned 40% in time savings and rejected pieces.
- Our social media efforts returned 1000% in new business.
- I invested our cash in a money market fund and it returned 2%.
- Adding two more assistants had a negative return of 20% (-20%) because of additional training time and broken pieces.
Calculating Return on Investment
The general formula for calculating Return on Investment (ROI) is:
An example of using ROI in an art business decision
Suppose you participated in two art festivals and you want to decide which one performed better. Here is how you do it!
From the above example you can see that each dollar invested in Festival 1 yielded a return of $.67 and Festival 2 yielded a return of $.33 for each dollar invested. From an ROI standpoint, Festival 1 is clearly the place to put your money.
Determining the cost and gains of an investment
The cost of investment should be fairly easy to determine if you keep good records and have a good accounting system. It is important to include all of the costs associated with an investment like direct costs such as labor and materials as well as indirect costs such as overhead.
In the world of accounting, calculating the gain from investment is usually a savings in labor and material costs, reduced operating expenses and increases in sales/profit. These types of savings are tangible in that they can easily be measured. Some benefits from an investment may not be so easily measured in dollar terms but none the less still have a value that you may want to consider. Some examples of benefits that have value now and in the future include:
- The new machine didn’t really save me any time but I don’t lay awake at nights wondering if the old machine will finally give up tomorrow.
- The new décor of our gallery hasn’t had an immediate effect on our sales but we notice our customers really like it and they are telling their friends.
- Social media efforts that have increased the visits to my website and exposed my art to a worldwide audience.
- The public relations program that resulted in a cover article about my gallery in a major art publication.
As you can see, putting a dollar figure on sleeping well at night or determining the value of a cover story in a major magazine probably won’t come from your accounting system, but these things do have value! If you can quantify these type of intangible values then put them into your ROI calculations. In many cases these intangible benefits may not be realized until well into the future at which point they can probably be quantified.
The bottom line(s)…
Use the return on investment (ROI) analysis to help you choose among various investment alternatives. You will constantly be faced with choices of how and what to spend your money on in your art business. If an investment isn’t working then you should take corrective action. If an investment is working then you should consider similar investments until they become less effective. One way to benchmark your investments is to compare your ROI with taking the same funds and putting them in the bank. If your investment doesn’t return more than a riskless return like a bank then you should give this choice some serious consideration.
Here are a few links if you would like to explore ROI further and see how others are using this powerful tool.
Understanding and applying the ROI concept is key to building a profitable art business. If you need help with calculating ROI your accountant should be able to help you out. Good Luck!