Understanding Return on Investment (ROI)

[ATeam]

According to some, Return on Investment or ROI is an important indicator in running an expedite business and an important concept to grasp. Personally, I am not so sure of that, but there are others who are very sure.

Perhaps some helpful people who understand ROI better than I can use this space to explain not only what it is, but exactly how to use it as business people in the expedite industry. So as to not discourage responses, this is my last post in this thread. (Phil sits back to listen and learn).

 

[Doggie Daddy]

Well my take on it is that ROI or Regularly Organized Instigation is when a person or persons continually start topics on the forum that they know will create a big bruhaha.DD.

 

[LDB]

A fairly good discussion is available here:

Rate of return - Wikipedia, the free encyclopedia

 

[Doggie Daddy]

But that's ROR,were trying to understand ROI here. DD.

 

[Turtle]

Phil, you have stated that you believe that "ROI is not a significant indicator in a one-truck expedite business." Yet, ironically, ROI is the only indicator in a one-truck expedite business. Look at your bottom line at the end of the year, there ya go. I think it's just a matter of definitional semantics.

Return on Investment is simply a measure of how effectively a business uses its capital to generate profit. For a given use of money (an investment) in an enterprise, the ROI is how much profit, or cost saving (i.e., sleeper versus motel, nitrogen versus air, Airtabs versus not), is realized from that investment. The overall ROI for an enterprise is sometimes used as a way to grade how well a company is managed. In a one-truck, single-asset based, service-oriented expedite business, all capital investments, be they for hard assets like a truck sleeper or operational expenses like fuel, all fall into the category of how a business uses its capital to generate profit.

If an enterprise has immediate objectives of getting market revenue share, building infrastructure, positioning itself for sale, or other objectives, a return on investment might be measured in terms of meeting one or more of these objectives rather than in immediate profit or cost saving. One example might be someone in a Sprinter trying to determine the value of having a permanent bunk and the ability to get needed rest while loaded, versus the possible revenue potential of being able to haul three skids instead of two. It's more abstract and less quantifiable in terms of a dollar amount ROI, but hardly less significant.

In it's simplest terms, ROI is Annual Profit divided by all Investment Capital operations. (annual profit)/(expenses).

In an asset-based enterprise, it is also a profitability measure that evaluates the performance of a business by dividing net profit by net worth (annual profit)/(net assets).

The concept of return on investment is a very general business concept that is used in all manner of commerce and other activities involving finances, from project management to real estate, home improvement, cash and stock investments, human resource training, home remodeling or, yes, expediting. It's an abstract concept only in the sense that it can be applied many ways to gets many different results. It is an abstract concept that yields concrete results.

Calculations are normally based on capital invested, or expenses, and profit, but they can also be made using gross revenue and cash flow.

Whether you are a investing in the stock market, or a plumber investing in tools, or an expediter investing in a truck and tie-downs, the amount of profit realized from the use of those capital investments (be they asset investments or cost-of-operations investments, like fuel) is the Return on Investment. Take the net profit and divide it by the total amount of money you spent, there ya go. That's the best ROI indicator for an enterprise not based on acquiring assets, like expediting.

If you want to figure out the ROI of an individual investment within the enterprise, say, a truck, you must first figure out the percentage of total investment in the asset for the given time frame you wish to figure, and then figure out what percentage of the net profit is generated by that particular asset. In the case of expediting, where the truck in-total is generally the sole enterprise asset, it makes little sense to try and separate out the truck from things like cargo securements, sleepers, and other accouterments. All that matters is whether or not the capital expenditures resulted in an acceptable net profit figure.

Using your example of someone who generates $200,000 of gross revenue for a fleet owner, and then using that to determine how much truck they can afford to buy on their own, they have to incorporate the cost of the truck into an closely estimated CPM (Cost Per Mile) in order to obtain the actual ROI of the truck. The CPM times all miles is the Total Cost of Operations (TCO). You divide the TCO figure by whatever net profit you wish, and that's your ROI percentage. To determine the cost of a truck that you can afford, simply alter the annual fixed truck cost in the TCO figure.

If you plan on paying a truck off over a 5 year period, take the total amount paid for the truck, including interest payments, and divide it by 5 to get the annual cost of the truck over 5 years, and plug that figure into the annual TCO. If the ROI result isn't what you want, look at a different priced truck.

 

[davekc]

Leo....your too funny. That is the same link I used.
But somewhere I read that definition is inaccurate.


DD........it covers that as well.

 

[davekc]

This would be good to add or follow up on Turtle's post.
At the time, I was using these figures, but one could plug their desired amount in.


$85,000 truck on original purchase

residual value at 5 years or 500,000 miles is 25% of $85K or $21,250.00
add this figure to the present depreciated value...

1 year or 100,000 miles deduct one 40% of the original price and add the residual value

or 85k-21,500 = $63,500 x 60% = $38,100.00 + residual = $59,600.00

2 years or 200,000 miles

$63,500 x 40% = $25,400.00 + residual = $46,400.00

3 years or 300,000

$63,500 x 20% = $12,700.00 + residual = $34,200.00

4 years or 400,000

$63,500 x 10% = $ 6,350.00 + residual = $27,850.00



5 years or 500,00 $21,250.00

The above is using a rapid depreciation schedule. If you look at the classifieds, you seldon see many trucks over the 5 year mark. Including class eights,even though they will go longer.
You usually lose you depreciation value at that point.
I would also use 5 percent off as a margin because the industry is starting to flood with trucks. That may go to 10?

 

[Moot]

Go to www.williamjeffersonclintondefinitions.gov and enter R.O.I. That should clear up any semantics related issues. Bill isthe final word.

 

[davelees1]

Return on my investment? You mean there is a return? Seems like:
The truck stops get 33%
The truck payment and maintenance get 33%
Walmart gets about 33%
Sometimes I get what's left!
Isn't that about right?

 

[greg334]

What this again?

No No No…

You all have it all wrong…..

I really think someone is trying to find a way to justify a trip to Geneva.

Here is how it goes

I have a Rolex.

It is up for it’s annual inspection and cleaning.

I take my G550 to Geneva to drop it off at the artist who created my work of art to do the work the right way, can’t trust those American jeweler hacks.

While I wait for a group of artist to fall all over themselves to service my beautiful work of art time piece, the emotion of the pain that the time piece may go through has me stressed out and due to all the stress of driving my quarter million dollar sub-compact RV/super expediting truck, I have to get emotionally recharged. I have a complete day of it to relax, I go and have skin treatments, some spa treatments, get some chocolate, some of that great Cognac and after all that, I have my time piece delivered to me at the airport as my G550 is warming up to fly me back to my quarter million dollar sub-compact RV/super expediting truck.

So I can’t say there is a return on investment in monetary terms because there is none, but on an emotional plain, the ROI is really great.

How else would have your time piece inspected and cleaned but by the artists who created that work of art in the first place?

And beside all that, we can’t worry about any stinkn’ ROI when we are part of the RVing expediting club, can we…. It’s only money…. oh yes have some Camembert and here is some Lafite, it is ’45 vintage … I picked it up while I was slumming in Paris.

I think that Moot has it right, but wrong name......

 

[Dreamer]

Dang. I had a pretty good answer working, and then I read Turtle's post!

He had everything I had and then some.. so therefore..

WHAT HE SAID! (Great post Ken!)

Dale

 

[are12]

Hey Greg,

That was too funny!! Thanks for the laugh!

 

[ATeam]

OK. I have been reading more about ROI in the other thread, private messages and e-mails received, and on a handful of online resources. For the purposes of discussion, I will, for the moment, set my opinion aside that ROI is a meaningless indicator in a one-truck expediting business. Instead, I will sincerely try to understand why, as others here argue, it is meaningful.

The best way to do that is apply the concept to my own circumstances. It doesn't get any more real than that. My problem is, that there really are a wide variety of explainations about what ROI is and is not (grant me that at least, in fact, explainations from credible sources differ.). So I remain at a loss. With various explainations, how does one know which one is right? More to the point, which explaination is most appropriate for a one-truck, owner-operator expedite business?

Perhaps we can make things very, very specific. An ROI formula appropriate to one-truck expediting can be agreed on, can it not? Since ROI is itself a result of a calculation, we need only agree on what the calculation should be, correct?

So, my question is, what is the formula? How, specifically, should should an one-truck expedite owner-operator calculate his or her ROI. Even more specifically, how should I calculate mine?

What inputs should be used? What assumptions? What time periods? and What mathematical operations?

Can we come up with a hypothetical situation that resembles mine and use it to come up with the appropriate ROI formula to use.

Truck model year:
2006

Purchase date:
1/1/06 (date selected to make math easy for calander year periods, new truck bought off the lot, no trade in).

Purchase price:
$224,000 ($200,000 +24,000 FET).

Truck equipment:
$5,000 (over and above major components already included in the purchase price, things like computer, freight handling equipment, etc.)

Truck useful life:
1,000,000 miles (class 8 truck, high quality brand)

Miles driven per year:
140,000 (estimate based on the owner-operator's history)

Owner's Intent:
This husband/wife team intends to drive the truck through its entire useful life. Get 1,000,000 out of it, then trade, sell, or junk it as is then appropriate to its salvage value, or lack thereof.

With the above as a start, what else do we need to know and what assumptions must be made to do a valid and expedite-appropriate ROI calculation, and how is the calculation made? Feel free to plug in values and assumptions you believe are appropriate and reasonable to the calculation.

 

[LDB]

Dave, I didn't see your link but didn't read all the other thread.

DD, part of the first sentence of the link:

In finance, rate of return (ROR) or return on investment (ROI), or sometimes just return,...

 

[ATeam]

Doh!!!

I said above I would not post in this thread, and then I did. Embarrassed here. I meant to put this not in this thread but in the General Economic Conditions thread, so as to honor my promise not to post in this one. The reason the link to "the other thread" points to this one is I thought I was in the General Economic Conditions thread when I created the link. My mistake. My bad.

Still, can we proceed with the discussion?

 

[davekc]

Leo, as you found, that is a pretty accurate description.

In Phil's case, a lot more information is needed. Fill out the CPM form that say OOIDA provides, and I will give you a realistic number. Also need a number for actual loaded miles and DH miles.
With that, then you can view the specific details. One would then take those numbers and develop a margin to value against other trucks in the industry whether reefer or anything else.
Milage and what was paid for the truck isn't enough. Based on that info, you don't even have the interest calculated.
If it is a cash only deal, then interest for that period has to be applied against the truck value. In otherwords, what do those dollars do invested in a plain jane money market?
Generally for business purposes, I would calculate on five years.
Anything after that pretty much equals a payment or repairs minus the deduction. Any decent accountant in trucking can formulate that for you. Class 8, class 7 it doesn't matter much after 5 years.

Phil
I think most will forgive the posting.

 

[ATeam]

The case presented is not my case, it is a hypothetical case of a one-truck owner-operator team. It is a formula I seek. I want to know how to calculate ROI. I am asking about a formula so we can avoid slipping into a debate about truck cost, sleeper size and lifestyle choices.

I want to know, simply, given the information presented in the hypothetical case above, what FORMULA should the hypothetical team above use to calculate their ROI?

The formula to caclulate the square footage of a rectangular room is, length times width or, Square Footage = L x W. We do not need to know anything about the room. The room does not even need to exist in the real world. But we can know the FORMULA to calculate any rectangular room's square footage is L x W.

Since ROI is the result of a calculation, only the formula is needed to calculate one's ROI. Whatever one's gross revenue, depreiation rate, cost per mile and other stats may be, those numbers can be plugged into the formula and one's ROI can then be calculated and known.

So, please, what is the formula?

I have all the numbers I need to plug into an ROI calculation for our business. I can literally account for every personal and business penny we have spent since we bought our truck, including depreciation and finance costs. I can even tell you the date I found $0.20 on the street and added that to our income; and about the one time in 2007 we paid a $0.75 currency conversion fee to our credit card company. I can tell you about office supplies purchased for business use and office supplies purchased for personal use (Scotch tape for wrapping Christmas presents). Cash tips given to truck wash guys are documented as a business expense, as is every quarter we ever put in a coin laundry machine on the road. Our business and personal financial records are categorized as such and detailed to the penny. Nothing is hidden or missed. No business costs would be omitted from any ROI calculation I would do. Our total miles for any time period can be quickly pulled up, and our actual loaded and deadhead miles are known to the single digit.

I know my numbers. What I don't know is how you ROI advocates would have me calculate my ROI.

I have learned from my reading that one of the reasons ROI has so many explainations is it is applied to so many different things. An ROI calculation done to determine the return of say an office building that someone builds and leases out is significantly different than an ROI calculation done to determine the return of a purchased income stream (annuity). Explained in a vacuum, ROI can become a quickly muddled concept.

That's why I now seek not a textbook, dictionary or classroom definition of ROI, but a specific FORMULA that is appropriate to a one-truck, owner-operator expedite business.

Again, please, what is the formula?

DaveKC, I would think this would be an easy question for you to answer, since you are a strong ROI advocate and use the indicator in your business. In your business history you have been both a multiple truck fleet owner and a one-truck owner-operator (you drove your own expedite truck for a time). Certainly, there is a formula you can share that reveals nothing about your specific business operations but is appropriate for a one-truck owner-operator team to use. Am I right?

And if not DaveKC, how about someone else? Certainly someone involved in this ROI discussion has an ROI formula that is accurate and appropriate for the hypothetical one-truck expedite business described above. Yes?

E=mc2 is a formula. SF = L x W is a formula. The formula to calculate CPM is CPM = Costs / Miles.

In the case above, what is the formula best used by this hypothetical team to calculate ROI? And thus, what is the formula I can use to calculate my own ROI?

 

[OntarioVanMan]

I can understand the concept of ROI, but it seems to such a fluid formula based on a specific personal need.
I kind of break mine down to the phrase "did the vehicle pay for itself over it's lifetime?"

If my van costs $50,000 with interest, team operated and makes 80,000/ year x say 5 yrs. $400,000 accounting for fixed costs and fuel and maintenance projections the I'd say it did pay for itself.

 

[davekc]

I think everyone pretty much gets it by now. Again....this link/definition provides the formulas at the bottom.
Rate of return - Wikipedia, the free encyclopedia

If you need to apply it into to a one truck operation, I thought Turtle had a good post. No point in constantly repeating the same information.

http://www.expeditersonline.com/for...tanding-return-investment-roi.html#post238777

If that doesn't work, I would advise seeking an accountant to explain it to you.
No point in complicating the simple

 

[greg334]

If that doesn't work, I would advise seeking an accountant to explain it to you.

No point in complicating the simple

THANK YOU Dave.

It seems that for some reason with, I think, three or may four threads on the same subject, we should get the picture by now.

It is not like we are talking about important items, say like Goats or Wal-mart, chinchillas or the important EO bobble heads.