How to Calculate the Return on Investment on the Purchase of a Business

by C. Taylor

When purchasing a business, it's important to analyze the company's balance sheets and calculate your anticipated return on investment (ROI). If you borrow money to make the purchase, then you are increasing your costs, due to interest on the loan. Although somewhat counter-intuitive, this increased cost may improve your ROI by leveraging the investment with other people's money. This requires less initial investment on your part, which frees up capital for other ventures.

1. Consult the current owner and acquire the most recent balance sheet. You need to look at the overall expenses and total revenue. If the current owner has a loan payment related to the purchase or start-up of the business, then disregard this amount, because it will be paid off when you buy the company. For example, if the total annual expenses were $120,000, but $36,000 of that was a loan payment from the current owner's start-up expenses, then the total expenses would be $84,000. You are probably still paying for these expenses, but they will be rolled into your purchase amount.

2. Add your loan payment to the total expenses. For example, if you are purchasing the business for $400,000, but plan to finance half that amount, you might incur a $2,000 monthly loan payment, which is $24,000 per year. Therefore, your expected annual expenses ($24,000 + $84,000) total $108,000.

3. Subtract the total expenses from the total revenue. In the example from the previous steps, if the total annual revenue was $180,000, then you can expect $72,000 in total profits ($180,000 - $108,000).

4. Divide this figure by your total investment to calculate the ROI. In the example, you invested $200,000 in the purchase of the business, so you would divide $72,000 by $200,000 for a return of 0.36, or 36 percent. In contrast, if you had not financed the purchase, then your total profits would be $96,000 with a $400,000 investment, which gives you a ROI of 24 percent.