RETURN ON INVESTMENT

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What Does ROI Mean?

ROI (or return on investment) measures the gain/loss generated by an investment in relation to lớn its initial cost. ROI allows the reader lớn gauge the efficiency & profitability of an investment và is often used to lớn influence financial decisions, compare a company’s profitability, & analyze investments.

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How khổng lồ Calculate ROI

Return on investment is a key financial ratio that measures the gain from an investment relative khổng lồ the amount invested. You can calculate ROI by dividing net profit (current value of investment - cost of investment) by the cost of investment.

What Is the ROI Formula? 

The simplest ROI equation is as follows: 

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ROI Calculator 

For the most straightforward way to tabulate ROI, there are plenty of online return on investment calculators available. 


How Can ROI Be Used? 

There are many scenartiện ích ios where ROI is useful:

ROI Example #1

An investor buys $1,000 worth of stocks and sells them 1 year later when their value reaches $1,500.  In this case, the net profit of the investment ( current value - cost ) would be $500 ($1,500 - $1,000), and the return on investment would be:

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ROI Example #2

A company spends $5,000 on a marketing chiến dịch & discovers that it increased revenue by $10,000. 

In this case, the return on investment would be:

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ROI Example #3

A homeowner is considering a trang chủ renovation to add an extension and pool. The home page is currently appraised at $500,000 and the renovations will cost $100,000 – but they"re also expected to increase the value of the trang chính by $250,000. In this case, the return on investment would be:

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Return on Investment Interpretation

Due to lớn its flexibility và simplicity, ROI is one of the most frequently used profitability metrics. It"s extremely useful for measuring the efficiency & success of investments và helps investors, analysts, & companies make future business decisions. 

With a key performance indicator, users can determine whether an investment is worth making – và then traông chồng its performance.


Pros & Cons of Using Return on Investment 

Like any other profitability metric, there are advantages và disadvantages of using ROI. Consider the following benefits & drawbacks:

Pros of using Return on Investment 

Simple. The ROI formula only requires a few inputs & provides a single output value, making it a very straightforward way khổng lồ traông xã efficiency and profitability.

Clear. A positive sầu number indicates a positive return, whereas a negative sầu number indicates a loss.

Flexible. ROI works for a variety of investments such as sale campaigns, stoông chồng purchases, vehicles, trang chính renovations, and beyond.

Versatile. ROI can be used for a number of applications lượt thích tracking efficiency, measuring profitability, analyzing business decisions, & more.

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Divisional. Since ROI measures the return of a single investment, companies can traông chồng the profitability of each business unit khổng lồ optimize their operation & increase earnings.

Cons of Using Return on Investment 

Room for error. One of the most comtháng ROI mistakes is confusing cash flow và profit, resulting in a much higher expected return. Additionally, to calculate a useful ROI, you need lớn first determine your baseline in order khổng lồ calculate any incremental profit. 

Variance. The standard formula for ROI is profit/cost, but the definition of those inputs can vary, depending on a company’s accounting policies. Factors lượt thích interest, tax, and net profit vs. gross profit can influence the outcome, making it hard khổng lồ accurately compare companies.

Potential bias. ROI is a great indicator of profit, but it doesn’t always consider the full picture. Investments that have sầu a lower ROI (but improve the business as a whole) could be disregarded if the company only focuses on increasing their ROI.

Manipulation. Business unit managers can manipulate ROI by changing accounting policies & calculations, reducing spending on inputs, or even discarding old yet functional equipment. This practice can decrease cost or increase return khổng lồ give the illusion of svào performance even if the actions are detrimental khổng lồ the company as a whole.

Disregards time. A 10% gain over one year is better than a 10% gain over two years, but when measuring the profitability of an investment, ROI doesn’t consider the holding period. This can lead khổng lồ investors or managers avoiding new investments due to lớn the uncertainty of returns or prioritizing short-term gain over long-term profitability.


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