In the world of business and investment we have several ways to measure the return on investment. One of the most popular and simplest method is ROI.
How to calculate ROI (Return on Investment)
First of all we need to find the net profit.
Net Profit = Revenue – Cost
ROI = (Net Profit/Cost) X 100
ROI is usually expressed as a number in percentage format
If ROI > 0 means you profit from your investment
If ROI = 0 means the investment has been made at par
If ROI < 0 means you loss from your investment
Example 1
Mr. A sells clothes online with a total income of $100,000, he spent the money for the cost of producing the product at $60,000 and advertising costs $20,000 which can be calculated as ROI as follows:
Net profit = $20,000 (100,000 – 60,000 – 20,000)
The ROI = 25% (20,000/80,000) x 100.
In this case, Mr. A make the profit 25% of his invested money. (That is, invest $80,000, get a profit of $20,000), which is considered a very worthwhile investment.
Example 2
Mr. B invested in the shares of a start-up company at the beginning of 2020, spent a total of $10,000 and sold all of his shares at the end of the same year for a price of $9,000, representing ROI as follows:
Net profit = – $1,000 (9,000 – 10,000)
ROI = -10% (-1000/10,000) x 100
In this case, Mr. B loss 10% of money from his total investment so it’s better for him to avoid this kind of investment.
ROI can be used to compare the return profit from each investment whether the rate of return is worth it or not. It can be used in deciding to continue investing in a profitable project or product or stop investing in things that offer lower returns or negative return.
ROI has the advantage of being simple and easy to use. However, the use of ROI is limited in some cases. For example, if we are measuring the results of sales or compare the success of each investment method which need to consider about investment time frames as well, using the ROI alone may not be able to provide the accurate answer for all of them and it may need to find other indicators for analysis and consider about various factor such as interest rates as well.
