For a small business, the return on investment represents the value a business gains when it invests money into an area of its own operations. Accounts payable, which includes all of the money a business owes for purchases already made, has a limited yet meaningful effect on ROI.
A business' return on investment is essentially a comparison of its income and its invested assets. Everything that the business owns or buys in order to operate forms part of its invested assets, including production facilities, payroll and other production costs. The value of accounts payable typically rises as costs rise, especially when rising costs force the small business to buy necessary items on credit. Unless income rises instantaneously, the result of more spending through accounts payable is a lower return on investment rate.
Profit margins, which are the percentages of sales that constitute profits as opposed to covering costs, figure prominently in calculating return on investment. For example, whenever a small business spends money on raw materials that it turns into finished goods, the price paid for those materials takes away from the profit margin at a given sale price for the finished product. A business with a rising accounts payable balance may choose to raise the prices it charges for its goods or services to maintain profit margins. In other cases, the business may keep prices fixed and allow its profit margins to fall.
Accounts payable has a more direct and significant effect on a small business' cash flow than it does on overall return on investment. This is because some spending is never part of accounts payable. Instead, accounts payable only represents past spending that has yet to be paid for. In other words, accounts payable creates a need for cash at some point in the future, when the accounts come due. Meanwhile the business can hold onto its cash, though the negative balance of accounts payable effectively gives the cash a neutral impact on return on investment and net worth.
Investing in Accounts Payable
Some of the money a small business invests into itself goes toward managing accounts payable. This money, like other forms of spending, can be measured in terms of ROI. For example, if a business spends $10,000 on training and recruiting to improve its accounts payable staff, it can compare this amount to any money that the department saves by avoiding errors and making on-time payments. If these savings only add up to $8,000 compared to accounts payable performance before the investment, the ROI is -$2,000. However, any savings above the $10,000 investment value represent a positive ROI.