Return on Investment (ROI) is the term used to measure the efficiency of the investment and to compare with other investments. It measures the returns obtained on our investment with relative to the cost of the investment. In layman terms, it is the returns of the investment divided by the cost of the investment.
Return on Investment (ROI) = (Gain from the investment – Cost of the investment) / Cost of the investment
The amount obtained after the sale is done is called Gain from Investment.
Though the process of calculating Return on Investment (ROI) is same for all the businesses, there are slight changes in considering the cost of investment and they vary from sector to sector.
In particular with FMCG sector, it is imperative for a salesperson to get equipped with this concept as it is beneficial in negotiating with the distributor who always tries to get the most of you as he is a fink in using all permutations and combinations to extract more from you.
Hence the first question we get from him is “Sir! I am investing this much amount of money but I am not getting anything from it, so what is the use of my investment?” it is because he is precarious to ensure that he is getting any benefit of that investment else that would go waste. When this is done in a perfect way, it always develops a healthy relationship with the distributor as he becomes sure that this is a ‘win-win’ business for him and the company too.
Getting into the calculations of Return on Investment (ROI), we first need to know a few formulae.
- Return on Investment (ROI) = Returns/ Net Investment
- Returns = Earnings – Expenses
- Earnings = Gross Margin that the dealer gets
- Expenses = Direct Expenses + Indirect Expenses
- The main trick lies in calculation of the
Because the distributor is dealing with a number of companies rather than a single company, he has to share his resources. He may have a single dedicated salesman for a single company or salesmen dealing with other companies also. Hence, he may share his resources like godown space, accountant, and supply system. However, in some cases, there would be a single person acting as manager-accountant-salesman etc. This is where the concept of direct and indirect expenses comes into the picture.
For the expenses incurred exclusively for a single company they are direct expenses and if the expenses are incurred in total for all the companies where the resources are shared, they are called indirect expenses.
In the calculation of the expenses, we need to consider the direct expenses and a portion of the indirect expenses.
- The second trick lies in the calculation of NET INVESTMENT.
The distributor’s investment mainly lies in 3 parts.
- a. Avg. Closing Stock
- b. Avg. Market Credit
- c. Avg. Claims Outstanding
Hence, Investment = Avg. Closing Stock + Avg. Market Credit + Avg. Claims Outstanding
The usual mistake a layman does is taking the closing stock of the month end as the avg. closing stock. He may also ask the distributor himself to tell the closing stock which is actually a grave mistake that should be obviated. This should be avoided because in sales, in particular, FMCG we have a trend of pushing (primary) in the closing week and pulling (secondary) in the upcoming weeks. Therefore, the last week’s closing should not be taken as the avg. closing stock for the month. (To clarify, primary is what your company bills to the distributor and secondary are what your distributor bills to the retailer)
To illustrate with an example, consider a trend of primary and secondary distribution of a distributor for a month.
|WEEK||OPENING STOCK||PRIMARY||SECONDARY||CLOSING STOCK|
The closing stock is the average of (4,50,000+3,50,000+3,50,000+5,00,000) which equals to 4,12,500 but not 5,00,000. The former one is lesser than the latter and hence his investment goes down and ROI goes up.
In the next post, we will learn the calculation of ROI with an empirical illustration.