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Calculating ROI

Help determine whether you will benefit from an investment.

DAVID MILLS, O. D., M. B. A.

When calculating the financial implications of an equipment purchase that requires a large capital expenditure, analyzing break-even point is often the first step (See “Break-Even Point Analysis,” April OM, page 62).

If the proposed expenditure passes the break-even analysis, use a simple measurement to calculate the benefit of the investment: the return on investment (ROI).

Here, I explain how to calculate ROI, and I discuss its value.

Calculating rate of return

In finance, “return” describes any profit made on an investment. A positive return implies that the investment created excess revenues after accounting for the cost of the investment. The rate of return is defined as the profit derived from the investment through a period of time.

The more accurate you calculate the gain from the investment and true cost of the equipment, which includes variable costs associated with the purchase of the equipment, the more accurate the ROI calculation. (See “ROI Calculation,” below.)

ROI Calculation

For example, if you are considering purchasing a retinal imaging instrument, you must also calculate the variable expenses your practice would incur due to the instrument, such as staffing expenses and insurance. In this case, a $30,000 cost for the instrument plus $5,000 in variable expenses, brings the total cost of the investment to $35,000. If you estimate the revenue attributed to utilizing the equipment based on the predicted reimbursement from insurance carriers is $40,000 in the first year, the ROI calculation is (40,000-35,000)/35,000, or 14.3%.

Utilizing ROI

Evaluating potential purchases by using ROI is advantageous because it is a simple method to compare two different investment options. For example, if you are considering the purchase of a retinal imaging system vs. a refurbished in-office lens edger, the cost and potential gain of each investment is different. Although the increase in revenues may be greater for one instrument, rate of return may indicate that buying that device may not be the most financially sound decision.

However, you should keep in mind that ROI disregards the value of future changes in cash flow. Similar to the stock market, the amount of gain realized from any investment may vary from year to year, and any variation can cause the ROI to fluctuate.

For instance, an insurance reimbursement cut two years after the purchase could have a devastating effect on the ROI. Recalculating the example above, a 40% decrease in the expected reimbursement results in a change of revenue from $40,000 to $24,000, which would yield a negative ROI, or a loss. (Unfortunately, there is no way to safeguard against this, as we have no control of what insurance reimburses or whether patient demand decreases by changing demographics.)

Calculating the ROI should never be the final determinant. Other intangible factors, such as delivery of quality care and meeting standards of care, must be factored when making buying decisions. If an investment enhances the quality of care you deliver, that investment should be seriously considered.

Evaluate potential return

ROI is a valuable metric to measure the profitability of potential, as well as acquired investments. Determine your own desirable ROI comfort levels when making investment decisions. OM

DR. MILLS PRACTICES AT OCEAN STATE EYE CARE IN WARWICK, R.I., AND HOLDS A M.B.A. FROM PROVIDENCE COLLEGE. E-MAIL HIM AT MILLSD@NECO.EDU, OR SEND COMMENTS TO OPTOMETRICMANAGEMENT@GMAIL.COM.