360° Coverage : Analyze The ROI Of Your Innovation Idea, Step By Step

2 Updates
Analyze The ROI Of Your Innovation Idea, Step By Step
Photo Credit: Forbes Business

Analyze The ROI Of Your Innovation Idea, Step By Step

Dec 27 2013, 9:07am CST | by

Do you have a great idea for improving your industry? For most people, inventing a new product is foreign territory. There are multiple steps (and costs!) involved in bringing an idea to life—like...

Filed under: news

 
 
 

39 weeks ago

Analyze The ROI Of Your Innovation Idea, Step By Step

Dec 27 2013, 9:07am CST | by

Do you have a great idea for improving your industry? For most people, inventing a new product is foreign territory. There are multiple steps (and costs!) involved in bringing an idea to life—like market research, product design and prototyping, patent and legal fees, and marketing, just to name a few.

At Edison Nation Medical, we have worked with thousands of inventors and entrepreneurs over the past decade, and we’ve learned a lot about which ideas are viable — and which are not, particularly from a financial point of view. We do know that innovation requires expertise and money.

The question is, how do you know if your idea is worth investing in? And, if it is worthy of investment, how much?

Calculating ROI

ROI is a performance measure used to evaluate the efficiency of an investment. To calculate ROI, the return or net profit derived from the investment is divided by the total resources that were invested (the initial investment plus any subsequent costs), with the result expressed as a percentage:

ROI = (Net Profit)/(Invested Resources) X 100

The primary advantage of an ROI calculation is its ability to quantify the benefits of investments and returns of varying size. For instance, if Jack and Cindy invest in two different products and Jack makes $50,000 in profits and Cindy makes $100,000 in profits, you might think that Cindy made a better investment.

But if Cindy’s costs were $80,000 and Jack’s were only $10,000, Cindy’s ROI is 25% and Jack’s is 400%, making Jack’s investment the better one. The absolute dollar value of profits generated is meaningless without considering the investment that was required to generate those profits.

Even Better Than ROI: Net Present Value (NPV) and Internal Rate of Return (IRR)

As informative as ROI may be, its greatest shortcoming is that it ignores the importance of “time value of money.” Consider two projects – “A” and “B” – that may require the same investment and eventually earn the same return; if the return for “A” occurs in just one year while the return for “B” is not realized until year five, the better investment is “A.”  Calculating the time value of money is especially important for new product introductions that typically entail a long developmental lead time and generate returns that vary year by year.

To do this, create an Excel spreadsheet and follow these steps:

  1. In the first year, show the total investment needed to launch your invention idea.  Enter this as a negative number to reflect your anticipated investment costs.
  2. In years 1 through 5, you need to calculate your projected free cash flow (in other words, your anticipated profits after all expenses have been paid that year). If you have an income statement this will end at Net Income.
  3. From this Net Income add back your Depreciation & Amortization and subtract Capital Expenditures, and increases in Net Working Capital (e.g. increases in year-over-year Current Assets minus Current Liabilities).

Net income
+ Depreciation/Amortization
- Change in Working Capital
- Capital Expenditure
—————————-
= Free Cash Flow/>/>/>/>/>

Then calculate the following important ratios:

  1. Net Present Value (NPV): The present value of a series of cash flows generated by an investment, minus the initial investment. NPV is calculated because of the important concept that money today is worth more than the same money tomorrow. The basic rule of thumb is that if a project is NPV positive, it should be accepted.

  2. Internal Rate of Return (IRR): IRR calculations are commonly used to evaluate the desirability of investments or projects. The higher a project’s IRR, the more desirable it is to undertake.  The easiest way to calculate IRR is to use the formula built into Excel. Simply type “=IRR” in an empty cell and follow the prompts to complete the formula. A simple way to think of IRR is that, over the next X years, your invention may have some years with losses (in particular, year 1 when you are making major investments), some years with profits (if all goes as planned), and some years that break even. IRR is a bit like calculating the average profitability over all X years, with extra credit being given if the investment gets paid back sooner rather than later.

  3. Payback: This measures the amount of time it takes a firm to recoup the initial costs of a project without taking into account the time value of money.

Going back to our earlier example, Cindy’s IRR on her $80k investment in the first 5 years turns out to be 13% with a payback in 2 years. This is not a bad outcome for a personal investment, and it beats the returns she might get on a money market fund, but it is not a “25% return” as the ROI suggests.

Likewise, Jack’s product idea is still a very attractive investment, assuming he can keep costs to $10K and generate the anticipated profits as quickly as expected. But for him to represent his invention idea as having a potential “400% return” would also be incorrect since his true rate of return is 209%. The NPVs for both investments in this case are positive, and thus should be pursued.

Innovation Is a Business Opportunity

Why is any of this important to an inventor? Adjusting the forecast model may give insight into how best to proceed in bringing a new product to market. If the initial investment can be minimized through a shared developmental program, a project’s IRR can actually improve – depending on changes to the project’s return and the timing of those returns.

In our experience, those who view their invention as a business opportunity (and keep their emotional attachment to their idea out of the equation) are the most successful. Calculating the fundamental financial metrics outlined here is a critical first step to ensuring that you are making smart business decisions grounded in real data. If your idea still looks financially viable, it may well warrant the investment of significant time and money. If not, you may want to start brainstorming your next big idea instead./>/>

Bobby Grajewski is President of Edison Nation Medical, a healthcare product and medical device incubator and online community for people that are passionate about healthcare innovation. Prior to joining Edison Nation Medical, Grajewski, a serial entrepreneur, co-founded two online companies (Heritage Handcrafted and eCollectors) and spent 5 years in venture capital and private equity both in the middle market and at larger LBO firms.
/>

The Young Entrepreneur Council (YEC) is an invite-only organization comprised of the world’s most promising young entrepreneurs. In partnership with Citi, YEC recently launched StartupCollective, a free virtual mentorship program that helps millions of entrepreneurs start and grow businesses.

Source: Forbes Business

 
Update
2

4 weeks ago

Khazanah throws MAS RM6b lifeline

Aug 29 2014 5:01pm CDT | Source: Business Times Singapore

August 30, 2014 1:15 AMKHAZANAH Nasional will inject RM6 billion (SS$2.4 billion) over three years to resuscitate loss-making Malaysia Airlines (MAS) under a recovery plan that includes even an Act of Parliament. Other key moves are migrating its operations, assets and liabilities to a new company (NewCo) and s ...
Source: Business Times Singapore   Full article at: Business Times Singapore
 

 
Update
1

4 weeks ago

MAS posts loss of RM307m for Q2

Aug 28 2014 5:00pm CDT | Source: Business Times Singapore

August 29, 2014 1:13 AMMALAYSIA Airlines (MAS) registered a loss of RM307 million (S$122 million) for the second quarter to end-June, but warned of worse to come in the second half when the "full financial impact of the dou ...
Source: Business Times Singapore   Full article at: Business Times Singapore
 

 

Don't miss ...

 

<a href="/latest_stories/all/all/30" rel="author">Forbes</a>
Forbes is among the most trusted resources for the world's business and investment leaders, providing them the uncompromising commentary, concise analysis, relevant tools and real-time reporting they need to succeed at work, profit from investing and have fun with the rewards of winning.

 

blog comments powered by Disqus

Latest stories

Underwater robot to help spot concealed contraband
New York, Sep 27 (IANS) Spotting concealed contraband at ports can now be a lot easier as researchers at the Massachusetts Institute of Technology (MIT), including an Indian-origin scientist, have developed an oval-shaped submersible robot that can perform ultrasound scans.
 
 
Kids with autism more sedentary than normal peers
New York, Sep 27 (IANS) Children with autism are more sedentary than their typically-developing peers, averaging 50 minutes less a day of moderate physical activity and 70 minutes more each day sitting, a study says.
 
 
Consumers show improvements on sustainable behaviour
Washington, Sep 27 (IANS) Although more people now expect global warming will negatively affect them during their lifetime than in 2012, environmental-friendly behaviour has shown an improvement among people in nine countries, including India, a new global analysis suggests.
 
 
Russia, Ukraine agree on interim gas deal
Berlin, Sep 27 (IANS) European Union (EU) Energy Commissioner Guenther Oettinger has said that Russia and Ukraine have agreed on an interim deal over gas supplies and would meet next week to decide on final details.
 
 
 

Latest from the Network

UN chief calls for end to hostilities in South Sudan
United Nations, Sep 27 (IANS) UN Secretary-General Ban Ki-moon Friday called for an immediate end to hostilities in South Sudan, saying "there cannot be a military solution to the conflict" in the world's youngest...
Read more on Politics Balla
 
'Modi as head of government is ring-fenced against summons'
New York, Sep 27 (IANS) Prime Minister Narendra Modi is "ring-fenced" as a sovereign representative of India and cannot be served summons in a case filed against him in a federal court here by an organisation claiming...
Read more on Politics Balla
 
Modi mingles with crowds, throwing security officials in a tizzy
New York, Sep 27 (IANS) As Narendra Modi plunged into the crowd of fans Friday to respond to their warm welcome of "Modi" "Modi" chants and placards greeting him with different messages outside his hotel, the Indian...
Read more on Politics Balla
 
Indian women's compound archery team claims Asiad bronze
Incheon, Sep 27 (IANS) The Indian women's team won the bronze medal in the compound archery event of the 17th Asian Games at the Gyeyang Asiad Archery Field here Saturday. The Indian team comprising Trisha Deb,...
Read more on Sport Balla
 
Three Nepalese athletes missing from Incheon Asian Games
Incheon, Sep 27 (IANS) Three athletes from Nepal have gone missing from the 17th Asian Games being held here. The missing athletes are a sepaktakraw player who went missing Wednesday and two wushu participants who...
Read more on Sport Balla
 
Carrie Underwood still can't believe she's pregnant
Los Angeles, Sep 27 (IANS) Country star Carrie Underwood, who is expecting first child with husband and NHL player Mike Fisher, says she still can not believe the good news. The singer shared her excitement regarding...
Read more on Celebrity Balla
 
Jordin Sparks isn't upset about split
Jordin Sparks isn't crying over her split from Jason Derulo. The 'No Air' singer, who recently ended her relationship with the 25-year-old R&B star after three years of dating, broke her silence on Twitter on Friday...
Read more on Celebrity Balla
 
Sarah Hyland says ex-boyfriend's mother refused to help
Sarah Hyland claims Matthew Prokop's mother refused to help her before she secured a restraining order against him. The 'Modern Family' star, who was recently granted a temporary protection order against her ex-...
Read more on Celebrity Balla
 
George Clooney hosts rehearsal dinner
George Clooney and Amal Alamuddin reportedly hosted a rehearsal dinner on Friday night (09.26.14). The couple, who are set get married on Monday (09.29.14), kicked off their wedding celebrations in Venice, Italy, in...
Read more on Celebrity Balla
 
El Salvador seeks global action for unaccompanied migrant kids
United Nations, Sep 27 (IANS) El Salvador Friday called on the international community to support Central American countries to act on the the crisis generated by the increased flow of unaccompanied migrant children...
Read more on Politics Balla