In this article, you will learn how to calculate the Return of Investment ROI as part of the lean manufacturing improvements and sig sigma implementation activities.
Return of Investment Definition (ROI)
Return on Investment (ROI) is a metric to demonstrate when or how long you shall recover and receive back a particular money investment dedicated to improving a particular business, process, machine, or area.
The return of investment is a performance measure used to evaluate the efficiency of an investment or to compare the efficiencies of several different investments done as part of implementing lean manufacturing improvements.
In other words, Return of Investment estimates the actual revenue or profit returned based on a particular investment (investment’s cost) during a specific period of time.
4 Factors to Consider Prior to Calculate the Return of Investment ROI
The best way to calculate the return of investment is by considering the following 4 factors:
How to Calculate the Return of Investment ROI
To calculate ROI, the benefit (or return) of an investment is divided by the cost of the investment.
The result is expressed as a percentage or a ratio.
The return on investment (ROI) formula is as follows:
( Money produced after the process improvement – Money produced prior process improvement ) x 100
Money invested in the process improvement
The difference between the money produced after the process improvement versus the money produced prior process improvement is the “Current Value of Investment” with means the revenue or profit obtained from the investment or improvement.
ROI is measured as a percentage, it can be easily compared with returns from other investments, allowing you to measure a variety of types of investments against one another.
Understanding Return on Investment (ROI)
The ROI is a popular metric since its versatility and simplicity.
Essentially, ROI can be used in an easy manner to measure an investment’s profitability.
This could be the ROI on a machine or facility investment, the ROI a company expects on expanding a manufacturing operation, or the ROI generated in a new product start-up transaction.
ROI can bring positive or negative values and results during its calculation.
A positive ROI means it is probably worthwhile.
But if other opportunities with higher ROIs are available, these signals can help investors eliminate or select the best options.
Likewise, investors should avoid negative ROIs, which imply a net loss.
Return of Investment Calculation Example:
For example, suppose you have a manufacturing process ABC which generates $300,000 dollars per month.
If you invest $500,000 to improve it and now it can generate $400,000 dollars per month.
To calculate the return on this investment, divide the net profits ($400,000 – $300,000 = $100,000 / month) by the investment cost ($500,000), for a ROI of ($100,000/$500,000) x 100, or 20% monthly.
In other words, you shall recover your whole investment ($500,000 Dollars) in 5 months.
And, suppose you have a manufacturing process XYZ which generates the same $300,000 dollars per month.
If you invest the same $500,000 to improve it, but now it can generate $500,000 dollars per month.
To calculate this return on this investment, divide the net profits ($500,000 – $300,000 = $200,000 / month) by the investment cost ($500,000), for a ROI of ($200,000/$500,000) x 100, or 40% monthly.
In this case, you shall recover your whole investment ($500,000 Dollars) in 2.5 months.
With this information, you can compare the investment in the manufacturing process ABC with the XYZ and with any other process improvement projects.
As you may notice, you shall recover your whole investment with the improvement in the manufacturing process XYZ ($500,000 Dollars) in 2.5 months instead of 5 months with the manufacturing process ABC.
Based on this ROI analysis, you can observe that the manufacturing improvement in the process XYZ can bring a better return of investment since you can recover your money in less time and obtain more profit and benefits for your money than the process ABC.
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REFERENCES: Return of Investment.