Return on Investment or ROI is a performance measurement for a company. It is evaluated in order to compare the efficiency of different investments or to determine the efficiency of a single investment done by a company.
In order to know how to calculate return on investment, you must know what it calculates. ROI calculates the amount of return that a company gets on its investment in relation to the cost of its investment.
In order to evaluate the return on investment, you need to divide the benefit from an investment by the investment’s cost. As a result, the figure that you get is expressed as a ratio or percentage. The formula for ROI is:
ROI = (Profit from Investment – Cost of Investment) ÷ Cost of Investment
In this, the profit that you get from your investment includes the proceeds that you obtain from your investment’s sale. You can easily compare this with the returns that you obtain from your other investments. This is because ROI is expressed in a percentage form. This allows you to measure various different investment types against each other.
Now, you know how to calculate return on investment. ROI can be easily as well as quickly calculated, which makes it even simpler for you. Return on investment is a very important measurement for your company because of its simplicity and versatility.
Advantages of calculating Return on Investment
You can use your ROI to measure the profitability of your investment. Moreover, you can also use it to find about the profitability from different types of investments. This means that if one of your investments gives a negative ROI or if you get other investment opportunities that generate higher ROI, then you can determine the investments that will be more favorable for you.
For instance, if you invested $1,000 in Store A in the year 2010 and sold your shares for $1,200 in 2011, you will need to divide your profits, that is $200, by the cost of your investment, that is $1,000, in order to calculate your return on investment.
As a result, your ROI will be 20%. Now, you can also compare your investment’s profitability with your other investments. Suppose you invested $2,000 in Store B in the year 2011 and you sold your shares in the year 2014 for a total amount of $2,800. Now, you will ask the question how to calculate return on investment.
Your ROI will be 40%, which can be calculated by dividing $800 by $2,000. This way, you can simply compare the profitability of your two investments. This means the ROI of 40% from your investment in Store B is twice as big as your 20% ROI from your investment in Store A. This will tell you that your investment in Store B is a wise move as compared to your earlier investment.
Limitations of Return on Investment
However, there are also some limitations on return on investment. This is particularly when you compare your different investments through ROI. One of the major drawbacks is that ROI does not include the time of sale.
For instance, although the ROI of your investment in Store B was twice as much that of your first investment, the time between the buying and sale was 1 year in your first investment and 3 years in your investment in Store B. This means that your ROI from your first investment was 20% in only 1 year and your ROI was 40% from your second investment for 3 years. This way you can question that your first investment was more profitable than the second one.
Nevertheless, ROI forms an important part of your investments. As an investor, you cannot evaluate your investment without calculating your ROI, no matter if it’s a stock, rental property, bond, collectible, or any other alternative.
By knowing your ROI, you can make wise investment decisions for yourself, which will help you in future. And although you may find that you get constant calculation, different kinds of investments bring forward unique variables that are very handy.
And now that you know how to calculate return on investment and the benefits that you get by calculating your ROI, you must get started with it.