Return On Investment Explained: How to Calculate ROI

A return on investment (ROI) is a financial ratio showing gains or losses from an initial investment in relation to the investment cost. The metric calculates the attractiveness, profitability, or rate of return of an investment decision. ROI is a universal metric for determining the profitability of different investments, such as a house, a stock, or a car. In general, a high ROI percentage indicates a high return on investment.

The ROI calculation is flexible and can apply to investments such as a home renovation or stocks, but there are a few disadvantages to the metric:

1. 1. Non-financial gains: ROI only measures finances, and a good ROI varies from investment to investment. The ROI calculation doesn’t consider other non-financial gains from an investment, such as the social impact or personal growth attached to the investment.
2. 2. Miscalculations: It’s easy to miscalculate ROI. For instance, an ROI of a house might not include the closing costs, repairs, and the other expenditures that come with homeownership.
3. 3. Time value of money: The ROI calculation does not factor in the time value of money—the idea that money is worth more now than it will be in the future. This can make it a less useful metric for evaluating long-term investments.

You can calculate the ROI by dividing the net profit (net present value minus cost) by the investment costs, then multipyling the number by 100 to get the ROI percentage. It is possible to have a negative ROI, as objects depreciate over time.

ROI = (Net Income / Cost of Investment) x 100

The standard ROI formula does not consider the timeline of the investment, so a short-term investment has the same ROI as a long-term investment. However, if you want to take into account the value of an asset over time, then use an annualized ROI calculation to find the annual return:

[(Net Income / Cost of Investment) ^ (1 / # of Years) – 1] x 100

These three profitability metrics you can use to calculate return on investment, assets, and equity.

1. 1. Return on investment: Return on investment (ROI) measures the gains or losses from an initial investment in relation to the investment cost and calculates the profitability of a potential investment.
2. 2. Return on assets: Return on assets, ROA for short, measures how profitable a company is relative to its total assets. ROA is used to gauge whether or not a company is using its assets efficiently. A higher ROA means a company is earning more money on less investment.
3. 3. Return on equity: ROE, return on equity, is used by shareholders to calculate how well a company generates profits for its shareholders. It also considers potential liabilities, so an ROE calculation is essentially a return on assets minus liabilities.

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