No, this isn’t a post about a loving couple I know. It’s about two ways of thinking about profitability – two among many that investors may look at before investing in your company.

ROI – or Return on Investment – is by far the best known calculation and one of the simplest and most versatile. The formula to calculate ROI is:

(Current Value of Investment – Original Cost of Investment)

Original Cost of Investment


Essentially, if you bought a house yesterday and sold it tomorrow, your ROI would be the difference between the two amounts divided by the original amount you paid. For an investor, it means that if investing in your company doesn’t have a positive ROI, or if another opportunity has a higher ROI, s/he’ll likely put the money elsewhere.

The catch with ROI is that there is no correct calculation, no uniformly accepted way to define the gains and what to include in the costs. You and an investor may not see eye to eye on these figures and that means you might lose out if you can’t persuade him.

But there’s a bigger flaw with ROI according to blogger Jay Cross. It assumes that funds are free and it doesn’t take into account what return an investor might see by investing her/his money elsewhere. EVA tries to factor that in.

For example, if you promised an investor a $32,000 return for her/his $200,000 investment in the first year, the ROI for investing in your company based on the formula above would be $32,000/$200,000 or 16%.

EVA, however, includes what an investor might have made on her/his $200,000 if, say, s/he put the money into a bond earning a 10% return, or $20,000. In other words the difference between investing in your company and earning $32,000 and investing in the bond and earning $20,000 is only $12,000 and the EVA return calculation becomes $12,000/$200,000 or 6% – a far cry from the 16% the ROI calculation presented.

Obviously, you’d prefer to persuade an investor s/he’ll make a 16% return by investing in your company but 6% is a truer number from her/his point of view – and one that may still be worth her/his while.

For more on ROI, EVA and a whole world of investment calculations and information, Investopedia is a great place to start.

By Adam

November 29, 2010