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Analyzing Your Return on Investment (ROI)

return on investmentReturn on Investment is a useful tool to understand, analyze, and compare different investment opportunities. ROI measures the efficiency of a specific investment by revealing how net earnings recover the cost of the original investment. Have you ever wondered if the result of your investment was really worth the cost? Well, a return on investment model looks at the inputs and assumptions of the ROI equation to determine if the benefits of the investment are worth the costs. Following are the ROI model tools you need to analyze ROI and improve ROI. Then you can determine the value of your investment:

Analyzing Your Return on Investment (ROI)

The first step is to identify and analyze overall benefits from the investment. For different financial situations, the percentage of returns may vary according to what the decision-makers consider to be gains or losses from the investment. As long as you are consistent with how you classify benefits of the investment, you should be able to effectively use your calculations for analysis and comparisons. Focus on benefits which are measurable and attainable. Measure and evaluate tangible benefits to improve ROI percentages.

If the benefits appear significant, then the next step is to identify and analyze associated costs of the investment. Costs are simpler to identify than benefits. Make a list of costs and then breakdown the costs into groups to better categorize the origination of costs. This will enable you to understand where the majority of costs are coming from. Are there any costs that appear inflated? Can you easily reduce some costs? Are there costs that could be eliminated completely? These questions will help you analyze expenses of the investment. Keep in mind that the cost of an investment includes not only the start-up cost, but also the maintenance and improvement of the investment over time.

Improve Return on Investment

To improve the return on your investment, business managers and directors should develop comprehensive and realistic projections for both revenues and expenses. Effective planning will account for unexpected expenses and underperforming sales revenue. By analyzing projections, you should be able to develop strategies to reduce costs and increase sales.

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Return on Investment (ROI)

See Also:
Return on Invested Capital (ROIC)
Return on Common Equity
Internal Rate of Return Method

Return on Investment (ROI) Definition

Return on investment (ROI) is the ratio of profit made in a financial year as a percentage of an investment. In other words, ROI reveals the overall benefit (return) of an investment using the gain or loss from the investment along with the cost of the investment.

Return on Investment (ROI) Explanation

Return on investment is a useful and simple measure of how effective a company generates profits from an investment. Many firms use ROI as a convenient tool to compare the benefit of an investment with the cost of the investment. For example, if a company effectively utilizes an investment and produces gains, ROI will both be high. Whereas if a company ineffectively utilizes an investment and produces losses, ROI will be low. For investors, choosing a company with a good return on investment is important because a high ROI means that the firm is successful at using the investment to generate high returns. Investors will typically avoid an investment with a negative ROI, or if there are other investment opportunities with a positive ROI. Return on investment models are used often because the ROI ratio and inputs can be modified to fit different companies and financial situations.

Similar formulas to calculate profitability include return on equity, return on assets, and return on capital.

How to Find Return on Investment (ROI)

The return on investment ratio calculates the percentage return (profitability) on an investment. Check out the following ROI formula:

Simple Return on Investment Ratio = (Earnings from Investment – Cost of Investment) ÷ Cost of Investment

One issue with the simple return on investment formula is that it is often used for short-term investments, so it does not account for the time value of money. Thus, it is less accurate for calculating ROI for long-term investments over one year. To measure the long term return on investment for future years, use the discounted ROI formula.

Discounted Return on Investment Ratio = Net present value of benefits ÷ Total present value of costs

= (PV Earnings from Investment – PV Cost of Investment ) ÷ PV Cost of Investment

Return on Investment Example

For example, this year, ABC company has produced earnings of $50,000 from an investment. The cost of the investment was $30,000.

Simple Return on Investment Ratio = ($50,000 – $30,000) ÷ $30,000 = 67%

Based on the result, we assume that ABC company has an annual percentage return on investment of 67%. The benefit (gain) was $50,000 and the investment cost was $30,000.

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Return on Investment (ROI)

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