Return On Investment Wikipédia

return investment definition formula video lesson

Return on Investment (ROI) is a widely used financial metric that quantifies the profitability or efficiency of an investment, relative to its cost. It essentially measures how much money you gain or lose compared to the initial investment amount. A higher ROI suggests a more profitable investment.

Formula: The basic formula for ROI is:
ROI = (Net Profit / Cost of Investment) * 100

Where:

Net Profit is the revenue generated by the investment minus the total costs incurred.
Cost of Investment is the total amount of money invested.

The ROI is often expressed as a percentage, making it easy to compare the profitability of different investments. For example, an ROI of 20% indicates that for every dollar invested, you earned $0.20 in profit.

Applications: ROI is a versatile metric applied across various sectors and contexts. It is used for:

Business Investments: Evaluating the profitability of projects, marketing campaigns, or new equipment purchases.
Personal Finance: Assessing the returns on stock investments, real estate, or education.
Capital Budgeting: Comparing the potential returns of different investment opportunities to make informed decisions about resource allocation.

Advantages of ROI:

Simplicity: The formula is straightforward and easy to understand, making it accessible to a wide audience.
Comparability: Allows for easy comparison of the profitability of different investments, regardless of their size or duration.
Universality: Applicable across various industries and investment types.

Limitations of ROI:

Ignores Time Value of Money: ROI does not account for the fact that money received today is worth more than money received in the future. Discounted cash flow methods like Net Present Value (NPV) are better suited for this purpose.
Oversimplification: It is a single-period measure and does not capture the entire life cycle of an investment or potential future returns.
Potential for Manipulation: Net profit can be influenced by accounting practices, potentially distorting the true ROI.
Difficult to Apply to Intangibles: Quantifying the “return” from investments in areas like employee training or brand building can be challenging, making ROI calculations less reliable.
Doesn’t Consider Risk: Two investments might have the same ROI, but one might be significantly riskier than the other. ROI alone doesn’t capture this difference.

Alternative Metrics: Due to the limitations of ROI, other financial metrics are often used in conjunction with it, such as:

Net Present Value (NPV): Accounts for the time value of money.
Internal Rate of Return (IRR): Calculates the discount rate at which the NPV of an investment equals zero.
Payback Period: Determines the amount of time required to recover the initial investment.

In conclusion, ROI is a valuable tool for evaluating the profitability of investments, but it’s important to understand its limitations and use it in conjunction with other financial metrics to make well-informed decisions.