As the word implies, “Return on investment” or “ROI” refers to the gain or loss generated on an investment or simply the return you get from your investments. It helps investment planners analyse and choose the best investment option. If you are an investor, the ROI shows you the profitability of your investments.
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.
Generally, ROI is measured as net profit 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 most common way to calculate it is given below:
ROI = net profit on investment/cost of investment x 100
Where:
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.
Net Profit = Total Returns – Initial Investment
For example, if you invest $1,000 in a project and after a year the investment is worth $1,200, the ROI would be:
Net Profit = Total Returns – Initial Investment
$1200-$1000= $200
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 the Cost of Investment is $1000.
The final step in calculating the percentage return on investment by dividing your net profit by the cost of investment. You just have to take the numbers from two previous steps.
ROI = (1200−1000) / 1000 × 100 = 20%
A 20% ROI means that the investment has yielded a 20% return on the original investment amount.
ROI is a useful metric for comparing the efficiency and profitability of different investments.
ROI can be used for various types of investments, including stocks, real estate, projects, and business ventures.
ROI is a versatile metric but doesn’t account for the time value of money, risk, or other factors that might be important in a more comprehensive investment analysis.
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:
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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