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Grow Your Business Finances

What is ROI?

What is ROI? ROI, or return on investment, is a common business term used to identify past and potential financial returns / Credit: Return on Investment Image via Shutterstock

ROI, or return on investment, is a common business term used to identify past and potential financial returns. Managers and executives look to the ROI of a project or endeavor because this indicates how successful a venture will be. Often expressed as a percentage or a ratio, this value describes anything from a financial return to increased efficiencies.

Defining ROI

Any expense a company has can be calculated into terms of ROI. While some expenses or activities — such as buying staples or repairing an employee bathroom — may not have a direct or financial ROI, each expense contributes to an overarching investment. For example, hiring a graphic designer to create ads, paying a photographer for taking pictures of the company, overhauling the company’s website and so on can be considered a return on investment.

In many instances, ROI is used to calculate how much of a value an investment is. For example, an angel investor would want to know the potential ROI of an investment prior to committing any funds to a company. Calculating a company’s potential or actual financial ROI typically involves dividing the company’s annual income or profit by the amount of the original or current investment.

ROI is also used to describe “opportunity cost,” or a return the investor gave up to invest in the company. If a business owner were to invest their money in the stock market, they could expect to receive an annual return of at least 5 percent. By investing that same money in a company, an owner would expect to see a similar, if not higher ROI for their money.

Companies even use ROI to measure the success of a specific project. If a business were to invest money toward an advertising campaign, they’d look at the sales generated by the ad and use that information to determine the ROI. If the money generated exceeded the amount spent, then a business could consider it an acceptable ROI.

ROI formula

One way to calculate ROI is to divide the net profit (return) by the amount that was invested:

ROI (%) = Net profit / Investment x 100

Another way of calculating ROI is to take the gains of an investment, subtract the cost of the investment and divide the result by the cost of the investment. The ROI formula is:

ROI = (Gains – Costs) / Costs

Learning from the past

Calculating return on investment isn’t meant to act as a precise method of measurement, instead only yielding approximate figures. More accurate projections always help, but some error is generally expected with ROI. Understanding the return on investment of any project or marketing campaign helps in identifying what is a successful business practice versus what isn’t.

Many companies use ROI to identify methods of marketing and advertising that will yield the highest return based on previous successes. This way ROI becomes not only an indicator of how much ROI was found over the last year, but also how much a company could expect in the following months.

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