The business of owning and operating a McDonald’s restaurant franchise is without a doubt, capital intensive. From the hefty initial investment to the steady stream of re-investments to keep your restaurant operating at peak performance, the amount of capital poured into your business is substantial.
And as with any investment decision, it is a critical part of the evaluation process that one analyzes and understands what the expected and potential return on the invested capital may be prior to moving forward. Before we get into some of the important questions one may have when considering whether or not to invest their hard-earned capital, let’s first review the concept of “return on investment” or ROI for short.
Put quite simply, ROI is a performance measure used to evaluate the efficiency of an investment or to compare the efficiency of a number of different investments. ROI measures the amount of return on an investment relative to the investment’s cost. Return on investment is a very popular metric because of its versatility and simplicity. Essentially, ROI can be used as a rudimentary gauge of an investment’s profitability.
To calculate ROI, the benefit (or return) of an investment is divided by the cost of the investment, and the result is expressed as a percentage or a ratio.
The return on investment formula is as follow:
In the above formula, "Gain from Investment” refers to the proceeds obtained from the sale or future cash flows of the investment. Because ROI is measured as a percentage, it can be easily compared with returns from other investments, allowing one to measure a variety of types of investments against one another. Keep in mind that the means of calculating a return on investment and, therefore, its definition can be modified to suit the situation. It all depends on what one includes as returns and costs.
Now, when considering whether or not to make a major investment such as a restaurant acquisition, major remodel, or a smaller equipment purchase, there are some important questions to consider:
Of course, the answer to this first question is highly subjective. At a minimum, one should expect to realize a return on any investment that equals or exceeds the amount of interest that would be earned by parking your cash in a secure, interest bearing savings account. Add to that a risk premium to compensate one for the added risk of an investment not guaranteed by any government or institution. If a potential investment’s ROI falls short of this criterion, one should seriously consider the merits of such an investment.
How does depreciation law come into play?
A component of this calculation is always how much and how quickly one can depreciate the assets in which they are planning to invest. Depreciation deductions can increase the “gain” portion of the above formula for ROI by increasing the net, after tax, future cash flows from an investment. While major re-investments can often times greatly decrease potential tax liabilities in any given year, it’s important not to let the tax tail wag the dog and keep in clear focus the longer term financial impact. Of course, a sharp-minded CPA can help you do just that.
Meeting your long-term financial goals depends on a number of factors. When considering any potential investment in a vacuum, the projected ROI can be a very informative and formidable analytical tool. However, your business and your world do not exist in a vacuum and so what may seem like a sound investment decision, based on a calculation of ROI, may not actually be the best long term decision for your business, and vice versa.
Some (but not all) of the other things that should always have serious weigh in any investment decision – aside from your investment capital and rate of return – are inflation, taxes and your time horizon. Your trusted CPA can help you sort through these factors and determine whether any investment you are considering is right for you.