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Wednesday
Sep232015

Best Practice: How Can We Calculate and Compare the Return on Investment?

The following post was written by Bryan O'Rourke and Dag W. Lee for our weekly Best Practices series.

Question: How can we calculate and compare the return on investment produced by expanding our current facility vs. opening a new one? 

Answer: Begin by calculating the cost of each investment. Make sure your figures are as accurate as possible, and don’t leave anything out. Miscalculating expenses could result in a poor decision.

Now that you have an idea of what each alternative will cost, determine what each will generate in terms of cash flow. Estimate the likely revenues and operating costs for each, and be meticulous with your calculations.

In the case of expanding an existing club, make sure you have a clear understanding of how you’re going to utilize the additional space, so you can create a reliable basis for estimating your net cash flow.

Evaluating the return on a new facility requires some additional analysis. If you’ve identified a geographic area, hire a professional to conduct a market analysis, projecting both demand and supply in that trade area.

For each alternative, you’ll want to create a best-case, worst-case, and average cash-flow forecast.

The next step is to use a net present value (NPV) calculation to determine which option is best for you; using an online NPV calculator will simplify the process. When doing so, it would probably be wise to use a higher discount rate for a completely new facility, as opposed to an expansion.

Finally, it’s important to think about your business strategy. Managing several clubs can be far more challenging than operating a single location. Take your time when weighing the options and deciding what you want to commit to. And good luck!

Bryan O'Rourke
Principal & Chief Executive
Integrus, LLC
Covington, Louisiana

 

Answer: You’re going to need to consider a number of factors—e.g., the market, local competition, growth prospects, cost of capital, and even macroeconomic factors—and then calculate costs, returns, and payback times for both.

With respect to adding space to your current facility: Do a return analysis on the cash flow differential based on two different scenarios: (1) running the club “as is” without any new space, but with the capital expenditures required for upkeep, and with the expected P&L; and (2) running the club, but accounting for the costs of the expansion, including expenses that might be generated by a larger space, e.g., higher rent, etc.

You also should account for construction downtime, and consider how you’d grow your membership with the extra space.

With respect to building a new club: I assume you’d close your old facility and move the business to the new location. Prepare budgets for investments and the P&L, as well as a balance sheet, for the new project, factoring in the costs of leaving the old site and moving to the new one. Calculate the returns on the 10-year cash flow, and then compare the returns.

Other factors to consider: Building a new facility will probably require significantly more cash; construction projects entail risks; and you may need to negotiate favorable contracts with a landlord.

In the final analysis, it’s crucial for you to understand your market and your position, and to have a good gut feeling about the path you choose.

Dag W. Lee
Chairman of the board
Intouch Technology
Vancouver, British Columbia, CANADA

 

 

Best Practices features answers from experts from both inside and outside the health club industry to thought-provoking questions on a wide range of topics. If you have a question you'd like answered, submit your question today

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