The Return on Investment ROI – Definition, Uses, and More
Investment ROI – The return on investment is a quotient that aims to calculate the percentage of gain expected from an investment compared to the initial bet. The general formula for return on investment is: (earnings – investment costs) / investment costs. Break-even time is when it takes for the initial bet to recover (return on investment equal to zero).
Calculating the ROI allows conversions and an understanding of the different strategies: Marketing Strategy, Customer Satisfaction and KPIs. We then speak of marketing ROI.
But more often, the ROI is used to see the capital invested and the real return on investment and not just the gross margin. For a quick investment such as rental, the ROI is a calculation method that you must perform.
Return on Investment: Definition
The return on investment (RSI), also known as ROI in English (Return on Investment), is a financial indicator that makes it possible to measure and compare investment returns. In general, the return on investment base on the following calculation: ratio of the benefits of the investment/cost of the investment.
In other words, the return on investment is an essential indicator for comparing different investments made. It measures the return on investment when considering the sums invested and the money that has been gained or lost. While the time parameter does not appear in an obvious way in the formula, the sums gained or lost consider over an annual period. We then speak of yearly returns.
Also, the return on investment is an essential indicator for choosing between several projects and determining which one will bring in the most money compared to the initial sums invested. The independent ROI is to know if an investment is capable and profitable. In the additional or less short term, an investment must be a source of gain to be beneficial. However, we will explain its other features and who they are for.
Return on Investment – What is it for and for Whom?
Return on investment can calculate in two different frameworks:
- On the side of investors, they choose to make between different financial products or investments. The investor will consider the return on investment and other indicators such as risk.
- Within a company, in the case of a choice between different projects. The company will determine the most profitable products or projects from returns on investment.
Calculating the return on investment has the main objectives of analyzing performance and aiding in decision-making. Indeed, when you know the return on investment of action, it will be easier to guide your investment choices to select the one or those who will be the most profitable later. Thus, you can redirect your strategy by strengthening certain investments or, conversely, by removing them. The aim here is to maximize the return rate and guarantee profitability for the company with good ratios.
This indicator relates to human capital because its purpose is to promote its projects. The media can be a valuable help for the more efficient progress of this digital strategy. The communication of the ROI can be done through contact on social networks using the branch of marketing communication so that there is a rapid return on investment.
Please note that this indicator may, however, have certain limitations. For a good reason, it turns out that the ROI does not take into account the other benefits (in particular, the improvement of customer satisfaction) and is based solely on purely financial and economic data.
When to use ROI?
Investors use the return on investment to select one project among several. Having a return on investment makes it possible to offer a basis for comparison, and it also makes it possible to measure a posteriori the profitability of the sums invested.
It can therefore consider as a KPI. This KPI finds all its importance in measuring the performance of marketing actions, especially for digital marketing:
- However ROI of an Adwords campaign, inbound marketing.
- ROI marketing of a lead operation (taking into account intermediate KPIs such as acquisition costs, conversion rate or conversion rate to calculate the return on investment).
- And more ROI of an email campaign
- ROI of a communication campaign (advertising expenses compared to profits made).
The objective is to determine if the campaign was profitable and study the points to improve a more robust performance.
Thanks to these examples, we clearly distinguish the two main functions of the indicator:
- Decision support (based on forecasts)
- Performance analysis
Return on Real Estate Investment
It is common to ask:
- And more is it worth buying to rent?
- Is it worth buying to resell a few years later?
- Therefore is it interesting to buy to resell, renovate and then resell?
Real estate speculation is the subject of return on investment. In our case, the asset corresponds to the purchase of the property. Future gains will be either the future rents or the amount collected on the apartment’s resale (or both).
In the case of real estate specifically, it will be necessary (and this is where the task is difficult) to value the increase in value of the property in the future. If I buy today at €150,000, how much could I expect to sell my property in 10 years? By then, how much will my loan have cost me in interest? There is no mathematical answer to this subject, and it is about market behaviour and trends. Real estate specialists have an idea of its evolution even if surprises exist.
The installation of a TGV line between Bordeaux and Paris in 2017 could significantly increase the attractiveness of Bordeaux (and therefore increase the demand for housing), which could lead to a “shortage” effect and therefore increase the value of the real estate. The calculation of the return on investment here is a measuring tool; the very essence of the operation is a bet on the market. It is precisely what finance is about: attaching a performance measurement tool to operations in the business’s life.
How to Calculate Return on Investment?
The following formula sorts it very easy to calculate the return on investment in percentage:
Return on investment ROI (%) = (investment gain – investment cost) / investment cost.
Please note that the return on investment calculation method does not consider the risk of each project. An expressively higher ROI on a project can also hide a much higher risk rate. Therefore, it will be up to the investor to arbitrate between potential profitability and risk incurred.
In the case of long-term investments, we are using a cash flow discount coefficient (€1 in 2010 will not have the same value as in 2100). There is a further precise (and complex) method in finance called: present net worth.
Be careful, and if the ROI is positive, you can arrange that you have made a profitable investment.
Similarly, your accountant is your best supporter to manage your daily activity. We, therefore, advise you to call on its expertise to assist you in monitoring your financial indicators. It has the performance keys you need.
Calculating its return on investment is very important to define its essential objectives. The time spent calculating your investment budget and measuring the investment is crucial.
Return on Investment ROI – Examples
Let’s take a concrete example of calculating return on investment:
- A project requires an investment of 10,000 euros (let’s say buy a vehicle to work as a taxi). The gain brought by this project is 11,200 euros (the turnover generated by the races carried out over a period).
- For this period, this project’s real return on investment will therefore be: (11200 – 10000) / 10000 = 12%.
- Finally, let’s take a second example to understand it better:
- For an investment whose cost is 10,000 euros and yields a gain of 15,000 euros, the return on investment is equal to (15000-10000) / 10,000 or equal to 50%.