ROI - Definitions, Formulas with Examples

Return On Investment (ROI)

For a person working for a job is a source of his income. When you earn income then you will decided to bear expenses and try to keep some saving. That saving will become a part of your investment. Now a days, saving is not only the source of an investment. There are multiple sources which helps you to do investment and earn return. Investors always try to do such investments of high return with low risk. But it is a fact investment products that give high return with low risk do not exit. In reality, risk and returns are directly related, i.e., higher the returns, higher is the risk, and vice versa.

Top 10 Investment options :

Direct Equity
Equity Mutual Funds
Debt Mutual Funds
National Pension System (NPS)
Pubic Provident Fund (PPF)
Bank Fixed Deposits (FD)
Senior Citizen Saving Scheme (SCSS)
RBI Taxable Bonds
Real Estate
Gold

Definition :

Return on Investment (ROI) is a concept of performance. It is an indicator that shows to which extent a specific business produce gain from the use of capital. It shows the extent to which the amount invested in a particular action returns as profit or loss. Thus, it enables efficiency assessment of an amount invested or, in other words, ROI allows measuring the result in relation to the means used to obtain it.

Two types of data are needed to calculate ROI :

a. the cost of the investment project.

b. the profit of the project.

Formula :

ROI = [{(Revenue after investment - Amount Investment) / Amount Investment }* 100]/n

ROI = [(Profit (After Investment) / Invested capital )* 100]/n

ROI = [(Profit / Turnover) * (Turnover / Invested Capital)]/n

Example :

With in a projet, the investment made was ₹50,000 lei. The gain realized after this investment was ₹60,000 lei.

ROI = [₹(60,000-50,000)/50,000]*100 = 20%

Suppose a man invested ₹1,00,000 in XYZ company. After 3 years, the gain realized was of ₹1,50,000.

ROI = [₹(50,000/1,000)*100]/3 = 50/3 = 16.67 %

Note :

ROI cannot be used to compare investment projects having different economic durations.

Regarding the measurement of the volume of invested capital considered in calculating ROI, various alternatives are possible :

- only the own funds are retained;

- own funds and borrowed funds are considered;

- the invested capital is defined based on fixed assets used by the profit centre, including the capital of the investment centre assigned to finance current operating activities (working capital).

When two investment projects have positive but different ROI, at equal risk, the project with higher ROI will be privileged. If two investment projects have positive and about the same value ROI, the project with lower risk will be privileged. The ROI is bigger the investment situation is better. The aim of the company’s manager is to ensure maximizing this indicator for a long period, thus increasing the enterprise and shareholder remuneration.