By: Ed Cote, President on May 14th, 2020
How To Calculate An ROI For Your Packaging Equipment
When calculating the ROI of your packaging equipment, there are various items of importance to look at and understand during the process of generating this information. Here at Industrial Packaging, we have helped thousands of businesses calculate and understand their return on investment. In this article, we will take a look at each element of utilizing an ROI calculation for your packaging equipment.
Why Make a Capital Expenditure On Packaging Equipment?
There are many reasons a business may choose to invest in the purchase of capital equipment. Are you looking to increase productivity? Could this new packaging line make you more successful in the marketplace?
Will this purchase help with being superior to your competition in quality? Might this capital purchase improve the morale in your plant? The answers to these questions should come before taking the time and effort to calculate a return on investment (ROI).
Calculating An ROI For A Packaging Equipment Purchase
When considering investing in an equipment line, a useful starting point is to be able to determine what the return on investment is of a purchase like this.
A simple ROI calculation formula would look like the following: (Return - Investment) / Investment X 100%. This formula will give you a simple bottom-line ROI on any capital purchase. The limitation of this equation is that it does not account for time. Here is an example to help illustrate the value of calculating an ROI for your packaging equipment purchase:
Let's say that you are contemplating making a $250,000 investment in a high-speed over-wrap packaging line. You have determined that this investment will return $600,000. The math is calculated in the following way: ($600,000 - $250,000) / $250,000 X 100% = 140%. What we do not know from this formula is in what time frame was the $600,000 return achieved. For this example, we will assume that the $600,000 came in over ten years. On an annual basis, the return is 14.0% (140% / 10).
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What To Do With This Analysis?
We will assume that a business owner is evaluating the result. What would a 14% annual return mean to him or her? If the owner were contemplating investing $250,000 into the stock market, their money spent on the equipment purchase looks to be a better use of that capital. Historically, stock index funds have generated an 8% long-term return; the 14% is significantly better.
What would a 14% rate look like to a bank for funding? It may or may not matter to a lender. In some cases, a bank may be more interested in how many years it would take to get your money back. Our analysis shows that it would take just over four years to recover the $250,000 paid for the equipment. This amount of time assumes an even $60,000 per year return over ten years ($600,000 / 10).
Even if a bank is comfortable with the 14% return on investment, are you? What is your risk tolerance of spending $250,000 on equipment? What type of questions might you ask yourself? What is your confidence level that you need the machine for ten years? Could you dispose of the equipment quickly, or is it used for a unique application? Depending on how you feel about the answers, 14% may or may not be high enough. The higher the risk, the higher the return expected.
Unsure Of How To Proceed?
We opened with the question, "Why make a capital expenditure on equipment?" We also indicated that the ROI formula featured in this article was a simple one. If you feel that there is not enough information at this point to make a decision, then some additional action may be prudent. Below are some options to consider.
Talk with another business owner. Discuss your reasoning for buying a piece of capital equipment to determine if their situation is similar to yours. Get a thorough understanding of what factors led to the purchase. Is your risk tolerance about the same as this person? How does this business owner feel about the decision they made now?
Consult with a certified public accountant. The CPA will have the necessary technical knowledge to perform more sophisticated ROI calculations. He or she would be in a position to provide you with a professional opinion as to whether purchasing the equipment is a sound business decision. This type of feedback could be just what you need to feel good about your decision.
Talk with a banker. Lending institutions will have a conservative approach to capital spending. They will ask numerous questions to make sure that you have considered all the aspects of an equipment purchase. The bank will want to make sure that your decision results in being able to pay back a loan should you need one. Being able to make all payments on a note is in your best interest.
Taking The Next Step
Utilizing an ROI is an excellent fundamental business practice. Use the information in this article as a starting point for your possible capital equipment purchase.
Ask plenty of questions to yourself and any third party from which you seek advice. By doing your homework, the higher the likelihood of making the right decision. If you are not sure where to start, feel free to reach out to one of our packaging professionals to see if we are the right company to help you calculate an ROI for your packaging line and equipment.