Unsure about ROI? Let us lead the way
Back to school: calculate your return on investment with this helpful guide
However experienced you are, or whether you are a production engineer, purchasing manager or something else, we know that calculating return on investment is key to making decision about capital equipment.
How long will it take to recoup your investment? How do you compare the ROI of one machine to another? What factors do you need to include?
We break it all down for you here.
Spotted a mistake? Let us know.
Why is ROI for automation important?
Why is calculating return on investment for a potential packaging machine purchase so important. It boils down to this: You need to be sure that any investment in capital equipment will be profitable for your company.
Though it sounds like common sense, you might be surprised at how few companies actually run the numbers before purchasing a packing machine. It takes some time and effort, but the results can be invaluable to your decision-making.
Here’s our step-by-step explanation of how to calculate the return on investment for your next equipment purchase.
How to calculate return on investment for equipment purchases
To calculate the ROI of new packaging equipment or industrial automation, you need two important numbers:
Total cost of the new packaging equipment
Estimated annual net benefit/loss of the new packaging equipment
ROI formulas help you compare these two numbers in a meaningful way that shows whether it makes sense to invest in that new system.
1. CALCULATE THE TOTAL COST OF NEW PACKAGING EQUIPMENT
When purchasing automated packaging machinery, you should take into consideration more than just the price of the machine. Your ROI calculations will be most accurate if your equipment cost represents the total cost of ownership including factors like:
Equipment purchase price
Shipping costs
Commissioning and installation costs
Training costs
Annual maintenance and parts expenses
These costs are hard to estimate, so we recommend contacting a packaging equipment supplier to request more information about costs specific to your application and business needs.
2. CALCULATE THE NET BENEFIT/LOSS OF INVESTING IN NEW EQUIPMENT
A major piece of ROI calculations is the total GBP amount you expect to gain or lose if you purchase the new equipment. There are three main categories to consider when making these comparisons:
Annual workforce costs
A. First, write down the current wage per hour for your packaging staff including the rate of pay, pension contributions, national insurance, paid time off, and other employee perks. Then work out your total workforce cost per year for all employees that work on your packaging line.
B. Then consider how your workforce costs would change with a new automated packaging system. Your wages per hour may not differ, but the number of employees required after implementing automation will probably change. Often this means the number of employees required to run a packaging line will decrease, sometimes by half or more.
Once you’ve calculated both numbers, subtract B from A to arrive at your estimated workforce gain/loss.
Annual gross profit
A. Begin with calculating how many packages are currently produced annually and what your profit per package is in GBP (or your local currency). Multiply those together to get your annual gross profit.
B. Then estimate how your gross profit will change with packaging automation. Using the specifications provided by packaging equipment manufacturers (we provide this on all our machines), you can work out how many packages you could expect to produce after implementing automation. Multiplying this number by the hours spent packaging per day, the number of days per week, and operational weeks per year will give you an annual estimation. Then multiply your estimated packages produced per year by your usual profit per package.
Now subtract B from A to arrive at your estimated gross profit gain/loss.
Annual expenses unique to your business
A. Current packaging-related expenses could include things like scrap and rework and the value of the plant space currently occupied by your packaging line.
B. Potential costs with a new packaging system could include things like engineering or R&D of a custom packaging system. This could also include the value of plant square footage gained when consolidating multiple manual packaging areas into the smaller footprint of a machine.
Now subtract B from A to arrive at your net gain/loss.
3. PERFORM RETURN ON INVESTMENT CALCULATIONS
Keep going - we’re nearly there!
Now add up the net gain/loss from all three categories in step two to arrive at your total net gain/loss generated by the new equipment. You will plug this number, along with the total cost of ownership for the new equipment, into the ROI formula below.
Simple Return on Investment (ROI) formula
A standard definition of ROI is the ratio of a benefit or loss made in a fiscal year expressed in terms of an investment and shown as a percentage. The ROI formula for equipment purchases looks like this:
(Net benefit or loss generated by new equipment / Total new equipment cost) x 100
As an example, if you are considering purchasing a packaging system for £200,000 and predict a net annual benefit of £150,000, your return on investment will be:
(£150,000 / £200,000) x 100 = 75%
Payback period formula
The payback period calculates how much time it will take to recoup the initial investment. In packaging equipment terms, the payback period formula is:
Total new equipment cost / Total periodic benefit from new equipment
Using the same example above of £200,000 equipment cost and £150,000 net annual benefit, the payback period will be:
£200,000 / £150,000 = 1.3 years
How to interpret your ROI results
Return on investment is useful for answering the following questions:
Will the new equipment bring a net gain or loss?
Should we buy this equipment right now?
How profitable will this investment be?
Which equipment should we choose to maximize profits?
In general, a positive ROI result indicates a favourable outcome. When comparing multiple packaging equipment solutions, a higher ROI on one can highlight the better choice.
So what if your ROI result is a negative number? Generally, this indicates a net loss within that time period and to move forward with caution or not at all. One thing to consider about negative ROI - many investments result in a net loss in year one but improve over time (hence the payback formula).
Remember that return on investment calculations are only as accurate as your data. If your numbers are fuzzy, your ROI will be too. You don't want to make big decisions based on faulty or incomplete numbers. Additionally, ROI does not take into consideration the inherent risk or uncertainty of a potential capital equipment investment.
We hope this post has helped to answer some questions about ROI but please note we are packaging equipment suppliers and not financial advisors, so run your ROI calculations past an expert before making a final decision.
And for help working out the relative costs and performance of different machines, just give us a call, we’re here to help.
