ROI is the acronym for Return On Investment. The indicator allows us to measure investment performance.
For this calculation, we have to divide the profits between the investment. The result is shown as percentages or rates -
If you’ve invested $100 and you get $150, your ROI is 50%, or 1.5:1.
There are several versions of the ROI formula. The two most commonly used are shown below:
The first ROI formula (net income divided by the cost of an investment) is the most commonly used ratio.
The ROI formula is calculating the “benefit” and dividing it by the “original cost”. When someone says it has a positive or negative ROI, it’s important to ask them to clarify exactly how they measured it.
An investor purchases property A, which is valued at $600,000. Two years later, the investor sells the property for $2,000,000.
ROI = (2,000,000 – 600,000) / (600,000) = 2.33 or 233.33%
ROI calculations are easy and assist investors to choose whether to accept or skip investment opportunities. The calculations can also be an indication of how an investment has performed.
When an investment presents a positive or negative ROI, it can be an important sign to the investor about the benefit of their investment.
Using this ROI formula, the investor can group low-performing investments and high-performing investments. With this method, investors and managers can strive to optimize their investments.
The ROI metric is commonly used because it’s simply easy to calculate. Only two figures are required – the profit and the cost. Because a “return” can mean different things to different people, the ROI formula is easy to use, as there is no compulsory definition of “return”.
Return on investment is a globally understood concept so it’s almost assured that if you use the metric in a conversation, then people will know what you’re talking about.
While the ratio is often quite beneficial, there are likewise some limitations to the ROI formula that are significant. Below are two key points to note.
A higher ROI number does not always mean a more suitable investment option.
For example, two investments have the same ROI i.e. 50%. However, the first investment is achieved within three years, while the second investment needs five years to deliver the same yield. The same ROI for both investments clouded the bigger picture, but when the factor of time was added, the investor easily understands the better option.
The investor needs to link two instruments at the same time and under the same circumstances.
An ROI calculation will change between two people depending on what ROI formula is used in the calculation. A marketing manager can use the property calculation without accounting for additional costs such as maintenance costs, property taxes, sales fees, stamp duties, and legal costs.
An investor needs to look at the correct ROI, which accounts for all probable costs incurred when each investment increases in value.
The calculator uses the examples described above and is designed so that you can easily input your numbers and see what the output is under different scenarios.
The calculator includes four different ROI formula methods -
- The Net Income
- The Capital Gain
- The Total Return
- The Annualized Return
The best way to learn the difference between each of the four approaches is to include different numbers and scenarios and check the results.
An acceptable ROI level for a marketing campaign may sometimes vary from 4:1 to 6:1. Any value below this tells us of an urgent need for improvement. Some successful campaigns might reach a 10:1 ROI, though it’s exceptional.
For a marketing strategy to work correctly, you have to be able to measure its effectiveness very accurately, as the final purpose is to have that investment indicate an actual profit increase for your company.
Here is where ROI comes into play. It’s a tool that will provide objective information about the investment made/obtained profits. For example:
Investment X had higher profit in absolute terms, so we might be inclined to prefer this type of investment; but taking into account that both investments were different, our result might be different as well.
Using the formula to calculate the ROI of the example above, we get the following:
Now it’s pretty clear that investment Y is much more profitable than X, and we can see precisely in what proportions.
This way, you can make the right decision concerning your future marketing strategies, and thus, making the best of your investment.
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