Page 3: Return on investment
When an organisation makes an investment, it is taking a business risk. When a company spends money on opening or moving to a new location, it will hope to see a return on this investment through increased profits. For example, by opening a new branch close to a buoyant or developing market, the business would hope to increase its sales. This in turn should lead to higher profits.
Setting up a new Enterprise branch generates costs. These relate to:
- set-up costs, such as for obtaining planning permission decorating and fitting out the buildings and installing fire alarms and security
- fixed costs, including rent and other overheads such as heating and lighting
- variable costs, which will depend on the volume of business. These include staff salaries – as the business grows, a company will hire more staff – and, for Enterprise, the cost of owning and maintaining vehicles.
There are several ways in which Enterprise assesses whether a new branch or relocation will generate sufficient return on the required investment. The starting point for any method of investment appraisal is to forecast how much additional revenue the new operation will generate.
However, this also needs to be considered against how much that business may take away from other Enterprise locations nearby. This revenue forecast can then be used to obtain a profit forecast.
Projected revenues and profits
Projected revenues and profits can be linked back to costs in several ways:
- Payback measures the length of time it will take to generate sufficient profit to cover the costs of the initial investment. When assessing different project options, companies sometimes choose the project that has the shortest payback period.
- Return on capital employed expresses the amount of profit generated in a given period (usually a year) as a percentage of the costs of the project. Investors would usually only back projects where this percentage is greater than prevailing bank interest rates. It would make little sense to back a business project if investors could get a greater return by simply keeping their money in a bank account.
- Break-even analysis is a way of assessing how long it will take (or how many customers are required) for a new business venture to generate a profit. This analysis relates sales revenue to total costs. The break-even point is achieved when the revenue equals the costs incurred to date.
A large multi-national company like Enterprise may sometimes take a location because it offers a strategic advantage. For example, it may stop a competitor obtaining the location or may be situated in a developing area where the longer term projections are very good.