Return on Investment, ROI, is the money an investor in a business earns for the injection of financial capital. Any return is from the net profit the business makes and is a mark of the efficiency of investing capital in the venture.
How to calculate ROI
The easiest way to calculate ROI is to express it as a percentage, gain or loss, of the initial capital sum.
To figure the ROI the investor will subtract the "cost of the investment" from the "total gain on the investment" and divide that by the "cost of investment." For example if an investor puts $5,000 into a clothing store and at the end of the year they receive $6,000 in return, the ROI will come out as:
($6,000 – $5,000) / $5,000
ROI = 20%
The uses of return on investment
ROI,once calculated, has many uses—to the investor and to the store owner. For the investor, it will tell them the potentialreturn when looking at places to put their money. By comparing the ROI of a clothing store with that, say, of a shoe retailer, they'll see where their money will earn more.
Astore may use ROI going to the market looking for investors. By showing that an investor may get 20% over the term of the money being in the store, the storeowner is making the business an attractive one in which to invest.
The opposite is also true. If the ROI is very low or, in some cases, even zero or negative, the store will not look very attractive to an investor. In those instances, the owner may need to look at the workings of the store. While not the same as profit, ROI is a clear indicator of how the store is performing over time.
ROI is not as simple as it may appear
A simple reading ofROI may be misleading. Time is also a factor and is important when considering investing in a business.
ROI of 30% from one store may lookbetter than one of 20% from another. But, for example,the 30% may be over three years as opposed to the 20% from just one. Thus, the one year investment with a 20% ROI is the better option.
Still, the one year investment may carry more risk than the three-year one, and the investor mayprefer to invest for the longer term.
What Is Return on Investment? FAQ
What is an ROI example?
ROI (return on investment) is a measure of the profitability of an investment. An example of ROI would be if you invested $1,000 in a business venture and after one year, you received $1,200 in profits, your ROI would be 20%. ($1,200 - $1,000 = $200/$1,000 = 20%)
What is ROI in simple terms?
ROI stands for Return on Investment and is a measure of how much money is earned relative to the amount of money spent on an investment. It is usually expressed as a percentage and calculated by dividing the net profit from an investment by the cost of the investment.
What is return on investment and why is it important?
Return on investment (ROI) is a measure of how much money an investor has earned or lost on an investment relative to the amount of money that was initially invested. It is a key performance indicator used to measure the efficiency and profitability of an investment. It is important because it allows investors to determine the profitability of their investments, compare different investments, and make informed decisions about where to allocate their capital. ROI is also used to evaluate the efficiency of a company's use of resources, such as labor and materials.
What is return on investment means?
Return on investment (ROI) is a measure of the profit earned from an investment relative to the amount of money invested. It is generally expressed as a percentage and is typically used to compare different investments or to compare the efficiency of an investment over time.
? Definition and Guide - Shopify (2024))
