What is Return on Investment (ROI)? [Formula and Example]

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Perhaps on more than one occasion you have heard about ROI, or return on investment; It is a financial term that has a very important role in the proper functioning of a business.

Generally speaking, return on investment (ROI) is a performance measure used to evaluate the efficiency or profitability of an investment. Additionally, the return on investment has the objective of calculating the return obtained from a specific investment, relative to the cost of the investment.

There are different reasons why return on investment is a widely used measure, but mainly this is because it is a versatile and easy-to-use formula.

The return on investment calculation is usually easy to perform, in addition to helping to determine whether it is advisable to proceed with an investment or not.

The goal of this formula will be to avoid negative ROI at all costs.

How to calculate return on investment

As mentioned, calculating the return on investment requires a formula that involves several concepts; These must be analyzed in depth to ensure that the result is optimal. The formula to calculate the return on investment is:

ROI = (profit obtained-investment) / investment

The current value of the investment refers to the profits obtained through the sale of the investment interest.

The result of the return on investment is presented as a percentage, so it is easier to make a comparison with the returns of other investments.

It is important to take into account that each process to calculate the return on investment takes up specific elements that will help to measure the performance of the investment. investment and calculate its degree of efficiency, both before and after carrying out the operation.

The formula is based on the investment made and the benefit that has been obtained or that which is pursued as ideal. Once the benefit obtained or planned is known, the result will be divided by the investment cost, resulting in the return on investment.

How ROI Works

In practice, the ideal is to measure each of the operations carried out by a company in terms of conversion, as well as the results obtained through an investment; This is why the return on investment is positioned as a fundamental operation for the optimal performance of a company.

The return on investment works by being the economic value that is generated as a result of decision-making and the performance of specific movements, which will allow the return generated from an investment to be objectively measured.

The results of the formula to obtain the return on investment can be both positive and negative; In the first case, the first good news will be to notice that the project is profitable and that the income will exceed or have exceeded the investment made.

In the case of negative investment returns, two scenarios can be considered; The first would be that the project, in short, is not profitable, or, well, that its profitability is given in the long term.

ROI and time

In addition to the data to take into account to proceed with the return on investment formula, it is essential to take into account the time plan on which the comparisons of two different investments will be carried out.

For example, according to the portal investopedia.com, if a certain investment (A) has a return on investment of 20% over a period of 3 years, while another investment (B) has a return on investment of 10% in one year, and a comparison of both is made, it will be necessary to contemplate both in the same time plane.

Concept-ROI --- Konfio
Photo: Konfio

Why is ROI important in business?

The formula for determining ROI is very important, especially in business.

This is because, from its calculation, it will be possible to determine which will be the most profitable stocks, make the right decisions and decide which projects need more monitoring to continue the upward trend in their growth.

The main benefit of knowing the profitability of the shares is based on the fact that they have the task of generating a return of money and, thus, knowing if this goal is being achieved will help to make decisions in the short and long term.

Among the main benefits of return on investment are:

  1. Its formula brings investors and managers closer to knowing more closely the viability of an investment or project being successful or not.
  2. Helps set concrete goals based on realistic scenarios
  3. Helps to identify the time required for an investment to generate a return on investment
  4. It serves as a basis for adjusting the investments to be made in the future

Understanding the concept

There are certain fundamental aspects to take into account when analyzing the importance of return on investment, such as:

What is considered a good ROI?

Much is said about how important it is to determine ROI, but how do you know if it is really “good”? Qualifying a return on investment as good will depend on issues such as the time in which the investment will generate results, for example.

In general, higher risks are associated with higher returns, and vice versa, so that some investors will decide to accept lower investment returns, these being “good” for their interests.

ROI limitations

The return on investment, while useful, also has some limitations. The businessnewsdaily portal proposes three limitations of ROI:

  1. The flow of capital is not directly reflected by the return on investment, so the first limitation of this formula is that of guaranteeing the financial health of a company.
  2. To calculate an exact or close to reality return on investment, the company needs to have specific knowledge of all future expenses that the company will have to absorb.
  3. Return on investment only measures the financial success of a project; This means that although an investment is useful and improves employee productivity, it will not always be seen as positive prior to its implementation, therefore, it could be discarded due to its poor financial performance.
ROI --- ExpokNews
Photo: ExpokNews

ROI benefits

On the other hand, the return on investment promises benefits such as:

  1. A more accurate measure of profitability: ROI is used to evaluate the financial performance of a company.
  2. A comparative analysis: From the ROI, companies will have a more general understanding about the short and long term results of their projects.

FAQs

How to calculate the return on investment in real estate?

ROI =

cost

Profit − Cost

.Profit = Profit on investment

Cost = Cost of investment

Although the formula is fully established, there are variables that are not considered in it, such as maintenance costs, loans and their interest, etc., that can affect the ROI results.

.What is ROI in simple terms?

In simple terms, it can be said that the return on investment is a financial ratio in which the profit that is obtained or obtained is compared with respect to an investment.

What does 30% ROI mean?

Although the numbers will be positive depending on the project or the company, experts assure that a 30% return on investment will be the minimum figure to look for when carrying out a financial operation.

What is the ROI formula?

Generally speaking, return on investment (ROI) is a formula used to measure the performance and efficiency of the profitability of an investment. Along with this task, the return on investment has the objective of directly measuring the amount of return obtained from a specific investment, relative to the investment cost.

TO From its calculation, it will be possible to determine which will be the most profitable stocks, make the right decisions and decide which projects need more monitoring to continue the upward trend in their growth.

ROI-Concept---TuTasa.com.uy
Photo: TuTasa.com.uy

conclusion

In simple terms, it can be said that the return on investment is a financial ratio in which the profit that is obtained or obtained is compared with respect to an investment.

Return on investment is a simple formula that serves as a guideline for companies to make decisions that will strictly benefit them financially; Although it has some limitations, the calculation of the return on investment continues to be a determining factor for the implementation of projects that will benefit a company in the short, medium and long term.

 

Source: Investopedia.com / economipedia.com

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