According to Investopedia, ROI is “a performance measure used to evaluate the efficiency of an investment, or to compare the efficiency of a number of different investments. To calculate ROI, the benefit (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 formula is:
ROI = (Net Profit / Cost of Investment) x 100
In its simplest form, ROI is the percentage profit you make on your sales. Look at a very simple example. You buy an item for $10 and sell it on Amazon for 29.99. The Amazon and FBA fees come $7.05 so your gross profit is $22.94. Subtract your cost and you get a met profit of $12.94 on an item that costs you $10. To get your ROI you would divide the $12.94 profit by your cost of $10 (and times 100) and it gives you an ROI of 129.4%.
If you were investing in a stock that you bought for $100 and sold six months later for $120, your ROI would be 20% (less commissions). It’s the same with a product. The example above is somewhat uncommon, although I have seen higher ROIs.
I recently bought a book at a garage sale for $1 that I sold for $14. That is a 1400% ROI before fees. But in the normal world, you have selling fees and storage fees. When you are selling on Amazon you always want to calculate your fees The fees on that book were $4.12 – so that gives me a net profit of $9.88 and true ROI of 988%
I have over 200 products that I buy wholesale. Due to competition, I can only double the price, or sometimes not even that. Let’s look at just one.
I have a product where my product cost is $60 and the most I can sell it for is $113.00, if I want to win the buy box. The Amazon and FBA fees on that product are $29, so my net after fees is $84; less my product cost that gives me a profit of $24.00. When we do the math on that one, my ROI is 48%. That is a more normal experience for most sellers.
So far we have looked at ROI as an individual transaction, but ROI is normally measured over a year. So looking at that last example, if I ignore things like inventory carrying costs and storage fees, and I sell one of those products a month, then my annualized ROI is 12 x 48 = 576%. Not bad!
But there is a real world to consider. Its fine to look at the ROI of a single product to compare it to other products –that helps you determine what your winners are. If you focus selling your higher ROI products and eliminate the lower ones, the theory is you will make more money.
But there is another factor you need to consider. How often do you sell that item? If you have to purchase those by the case of 12 –and you sell one per month, it will take an entire year to get your investment back.
Now let’s look at your ROI in this context. Your landed cost on the case is $720. In the real world you do have interest carrying costs. Let’s say these are 8% for the whole year. Add that to your cost and you are at 777.60. Now let’s look at ROI over the whole year. Your profit on the whole case is $288.00. Dividing your cost and you get an actual ROI of 37% for the whole year. That is still not a bad ROI. There are not that many investments where you can make 23% a year.
But we are still looking at only one product. Let’s look at our whole business. To keep it simple we will assume this is our first year in business and we had no starting inventory. Starting in January we purchase $10,000 per month in product and send it into FBA. (I am going to ignore the interest carrying cost in this example as it would just get too complex, but remember in the real world, money tied up in inventory has a real cost).
So over the course of the year we purchased $120,000 worth of inventory. We will assume our sales are pretty good and as of December 31st we only have $20,000 worth of inventory left. So what is our ROI?
If our total sales on the $100,000 worth of inventory that sold for a total of $212,000, and the Amazon and FBA fees (and returns) came to $59,360, that means our net was $152,640.
Even though we sold $100,000 worth of the inventory, remember we still have $20,000 left at the end of the year, so we have to account for that also. Let’s do the math. Our profit was $152,640 minus our cost of 120,000. That gives us a net margin of $32,640. Divide that by our cost of $120,000 and our ROI for the year was 127% which is quite good. Most brick and mortar retail stores are thrilled to earn a 20% profit at the end of the year.
As you can see, even though you are making insanely high ROIs on a few products, you have to look at your overall business.