How to Calculate Return on Investment: Calculations, Formulas, & Analysis

As the word implies, “Return on investment” or “ROI” refers to the gains, profits, or simply the return you get from your investments. It helps investment planners analyse and choose the best investment option.

Generally, the return on investment is expressed or indicated as a percentage. In simple terms, ROI gives you a financial ratio that helps you study the benefit of your investment against the costs. ROIs can be positive or negative. If the return on investment is negative, you can lose money on the investment. You should always pick an investment that offers the maximum return over a given time period.

There are standard ways you or investment planners can calculate an ROI. This article will try to break down the answer to the question “How to calculate return on investment?” using calculations, formulas, and analysis.

, How to Calculate Return on Investment: Calculations, Formulas, & Analysis

Generally, ROI is measured as net income divided by the original capital cost of the investment made. The higher the ratio, the greater the return.

There are several versions you can use to calculate return on investment. The two most commonly used by investment planners are shown below:

Method A

ROI = net return on investment/cost of investment x 100%

Or

Method B

ROI = ROI = (final value of investment – initial value of investment) / cost of investment x 100%

Here is how you can calculate the return on investment using method A.

1. Identify the Net Return On Investment

The first step to successfully calculating the percentage return on investment using this formula is identifying the net return on investment. Net ROI refers to the net amount you have received from your investment project.

For example, assume you have purchased an apartment for $500,000 and are planning to renovate it and sell it one year later for a price of $550,000. Assume you hired a real estate agent, where you pay up to 5% of the property sale value to each party’s agent, which comes down to $27,500.

When you do the calculation, it will result in this: Net Return on Investment = ($550,000 – $500,000) – $27,500 = $22,500

2. Determine the Cost of Investment

This refers to the amount you paid to make an investment possible. The cost of investment often varies depending on the type of transaction and whether you are investing in something tangible or not. Following the example from our previous step, you can determine that if you purchase the apartment for $550,000 through a loan that requires you to pay 20% upfront, your cost of investment will be:$550,000 x 20% = $110,000

3. Divide the Net ROI by the Total Cost and Multiply by 100%

The final step in calculating the percentage return on investment by using method A is to divide your net ROI by the cost of investment. You just have to take the numbers from two previous steps. After dividing the numbers, it’s important to multiply it by 100%, like this: Net ROI / cost of investment = $22,500 / $110,000 = 0.20

ROI = 0.20 x 100% = 20%

Here is how you can calculate the return on investment using method B.

Another effective method of calculating the percentage return on investment is using a formula that breaks down the value of investment into an initial and final value. To figure out ROI through this method, you need to consider using the formula = (final value of investment – initial value of investment) / cost of investment x 100%. Here’s how to use it.

1. Identify and Subtract the Final and Initial Value of the Investment

When calculating the initial value of the investment, you can use method A to calculate ROI using the same numbers. At the time of the purchase, the purchase value was $500,000
for which you paid 20% upfront and a loan covered the remaining 80%.

The initial value of this investment is still $500,000. After identifying this, you can focus on calculating the final value of the investment, which is essentially your sale price minus any costs you incurred, including 5%, or $27,500, that you paid to each party’s agent. Next, you subtract the final value from the initial value. These calculations would look like this:

Final value of investment = $550,000 – $27,500 = $522,500

Final value of investment – initial value of investment = $522,500 – $500,000 = $22,500

2. Divide the Number by the Cost of Investment

The next step is to divide the $22,500 by the cost of the investment. Based on the information from method A, you know that it was the 20% that you paid upfront when buying the flat. The amount turned out to be $110,000. As a result of this step, you get a decimal of 0.20.

3. Multiply the Number by 100%

The final step in calculating the percentage return on investment using method B is to multiply the decimal by 100% and get 20%. By this stage, you will be able to notice that it’s the same number as our result from the previous method, which is correct. This is because you didn’t add any more numbers or figures to the equation. Instead, you just used two slightly different formulas to calculate the same thing.

As evident, return on investment is a simple calculation that goes a long way in helping potential investment planners decide the best options available. However, as with any investment, thoroughly mastering the art of how to calculate return on investment, alongside influencing market factors, requires experience.

It is also important to emphasise that ROI calculations come with their own set of limitations:

  • Inability to consider time
  • Calculations differ between businesses
  • No way to account for nonfinancial benefits

This is where reliable financial advisory firms and consultants can be your guide. They can help you analyse the investment market dynamics and lead you towards making ideal choices that align with your financial goals and risk tolerance while assuring the best return on investment.

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  • The ROI Formula
  • Method A
  • Method B
  • How to Calculate ROI
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  • The ROI Formula
  • Method A
  • Method B
  • How to Calculate ROI