How to Calculate a Return on Investment (ROI)
So, what is a return on investment? The return on investment is a financial performance measure that is used to evaluate the efficiency of an investment. Return on investment is also referred to as the rate of return or rate of profit. This key performance indicator helps answer the question: how well are we generating sustainable profits?
Why Is the Return on Investment Indicator Important?
Remember, ROI is a financial performance measure used to evaluate the efficiency of an investment. It also helps to compare the efficiency of several different investments before capital is allocated. ROI calculates the most tangible financial gains or benefits that can be expected from a project versus the costs of implementing the suggested programme or solution. In short, it is the ratio of money gained or lost to the amount of money invested.
Return on Investment Is a Popular Metric
ROI is a very popular metric within organisations because its versatility and simplicity are powerful aids in the decision-making process. By running an ROI projection, an organisation can determine the likely return on investment. If there are other opportunities with a higher ROI, it is possible that the lower ROI-yielding investment will not be started or will not be a priority.
Micro ROI
The Micro return on investment focuses on elements of any company project or programme. Most such initiatives would have a shorter time frame (maybe up to a year). These may include:
- A direct mail programme
- A print advertising programme
- A sales promotion
Micro ROI includes anything a company would expect a positive financial result from in less than a year.
Macro ROI
Macro ROI is concerned with the overall performance of major company initiatives. These may include:
- Adding a new assembly line
- Creating the company’s own truck delivery system
- Building a new production facility
The payout for these types of initiatives is probably more than a year and could extend for several years.
Formula
Return on investment is calculated in several ways. For example:
ROI = (Gain from investment – Cost of Investment)/Cost of Investment
In this formula, ‘Gains from Investment’ refers to the proceeds obtained from selling the interest investment. Return on investment can also be calculated as net benefits/net costs or as profit/cost x year days/period.
Frequency
ROI is measured at the end of a programme such as a marketing effort. Here, it is straightforward to calculate the ROI based on known and complete costs and benefits. However, ROI is also measured as a percentage of return over a year, which is most useful for longer-term projects.
Target Benchmarks
Organisations will set their ROI targets, and where possible, will base these on industry benchmarks. The higher the investment risk, the greater the potential return or potential loss.
Your Challenge
Choose an investment you have made or are considering making. Calculate the ROI using the fundamental guidelines mentioned above. Once you have calculated the ROI, compare the efficiency of this investment with other investments you have made or are considering making. Reflect on your findings and refine your investment strategy accordingly.
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