Return on Investment (ROI)

Posted in Finance, Accounting and Economics Terms, Total Reads: 765

Definition: Return on Investment (ROI)

Return on Investment (ROI) helps to measure the amount of profit made in terms of capital invested. It is calculated by dividing net profit by total assets.

Return on Investment is given by the formula:

ROI = (Gain From Investment - Cost of Investment)/Cost of Investment

Example: - Of direct mails sent in B2B marketing


It is a measurement of profit earned from the investments made. It evaluates the earning power of the investment done in assets, which is measured as the ratio of profit less depreciation (net income) to the equity capital (average capital employed) in a project or company. It directly compares the timing and the magnitude of investment gains with the timing and magnitude of costs. Higher the Return of Investment, higher would be favorability of gains to cost.

Example: When the Long- Term Return on Investment is lesser than the Cost of Capital. This puts the company in a situation where liquidating its assets and depositing the amount in the bank will put the company in a better off place. Such a situation indicates that the returns from the asset purchased is lower than the amount spend on attaining and maintenance of the asset.

It’s a very important metric for calculating the financial consequences. There are many metrics available, but the best known metric is the Return on Investment. It is becoming increasingly popular as it helps in evaluating projects, capital acquisitions, initiatives and programs. It also helps in evaluating the traditional financial investments in stocks.

Different ways in which ROI can be calculated:

• To measure Rate of Earnings on the Total Capital Employed: Divide net income, taxes and interest by total liabilities

• To measure Rate of Earnings of the Invested Capital: Divide income taxes and net income by fixed liability and proprietary equity.

• To measure Rate of Earnings on stock and proprietary equity: Divide net income by total capital and reserves.

It is expressed in percentages; therefore the answer must be multiplied by 100.

The Return on Investment formulae is used in investing and financing. There are other similar formulas also that measure the profitability of the organization- Return on Capital, Return on Equity, Return on assets and many others.



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