Return on investment (roi) definition


Return on investment, or ROI, is a mathematical formula that investors can use khổng lồ evaluate their investments và judge how well a particular investment has performed compared to lớn others. An ROI calculation is sometimes used along with other approaches khổng lồ develop a business case for a given proposal. The overall ROI for an enterprise is sometimes used as a way khổng lồ grade how well a company is managed.

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If an enterprise has immediate objectives of getting market revenue share, building infrastructure, positioning itself for sale, or other objectives, a return on investment might be measured in terms of meeting one or more of these objectives rather than in immediate profit or cost saving.

Calculating ROI

The most commonly used ROI formula is net profits divided by the total cost of the investment.

For example, take a person who invested $90 inkhổng lồ a business venture and spent an additional $10 researching the venture. The investor"s total cost would be $100. If that venture generated $300 in revenue but had $100 in personnel and regulatory costs, then the net profits would be $200.

Using the formula, ROI would be $200 divided by $100, for a quotient, or answer, of 2.

Because ROI is most often expressed as a percentage, the quotient should be converted to lớn a percentage by multiplying it by 100. So this particular investment"s ROI is 2 multiplied by 100, or 200%.

Compare that to lớn another fictitious example: An investor put $10,000 inlớn a venture without incurring any fees or associated costs. The company"s net profits were $15,000. The investor made $5,000. It"s significantly more than the $200 in net profits generated in the first example. However, the ROI offers a different view: $15,000 divided by $10,000 equals 1.5. Multiplied by 100 yields an ROI of 150%.

Although the first investment produced fewer dollars, the higher ROI indicates a more productive sầu investment.


What is ROI used for?

ROI measures can be used to evaluate various types of investments. Businesses also use ROI calculations when evaluating potential investments or the success of prior investments.

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Individuals can calculate ROIs to lớn judge their own personal investments and compare one investment -- whether it"s a stoông chồng holding or a financial stake in a small company -- against another in their own investment portfolquả táo.

However, calculating the figures for each piece of the equation can be complicated for businesses who frequently have sầu khổng lồ determine various elements of each part of the equation.

Example of ROI calculations: Investing in new computers

Calculating the investment figures for each piece of the ROI equation can be complicated for businesses.

For example, if a company wants to lớn invest in deploying new computers, they must consider a variety of deployment costs. The business would have sầu lớn consider the actual price of the computers, plus tax và shipping costs, plus consulting fees or support costs paid to purchase, plus thiết lập costs & maintenance costs.

Then, the business would have to calculate net profits over a set period of time. These net profits could include hard dollar amounts coming from increased productivity và a reduction in maintenance costs compared to the previous computer system.

That business could calculate that ROI when evaluating two different types of computers using anticipated costs và projected gains khổng lồ determine which ROI is higher. Therefore which computer represents the better investment: Investment A or Investment B?

The business could also calculate the ROI at the kết thúc of the phối time period using actual figures khổng lồ then compare the actual ROI lớn the projected ROI lớn evaluate whether the computer implementation met expectations.

ROI"s cons

ROI is one of the most common investment & profitability ratios used today. However, it does have some limitations.

One potential drawback khổng lồ this formula is its inability khổng lồ consider time in the equation. Take the first two examples cited above: The 200% ROI is higher than the 150% ROI. On the surface, the higher ROI seems like the more productive investment. But, what if the investment took 10 years lớn produce that 200% ROI, while the second investment took just one year lớn produce the 150% ROI?

Investors can sometimes tài khoản for time by paying extra attention lớn the figures they"re using as inputs inlớn the formula. In the case of the new computer example above, investors could use the net profits produced in the first year for Investment A và compare them with the net profits produced for Investment B in the first year, thus ensuring a more apples-to-apples comparison, if the time holding the investment is important lớn the investor. Other metrics, such as rate of return, have sầu such time elements actually incorporated inlớn the formula.

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Another drawbaông xã of using the ROI formula is that it does not have sầu a way to lớn trương mục for non-financial benefits. Take the ROI for the new computers example: The business can use specific dollar amounts khổng lồ calculate the net profit & total costs to lớn come up with an ROI. However, calculating the value of improved worker morale as a result of getting new computers is difficult khổng lồ do. Businesses often calculate ROIs for such nontangible benefits, frequently labeling these calculations as soft ROIs while the calculations made with actual, tangible dollar amounts are called hard ROIs.

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