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Return on Investment

Definition

Return on investment is the ratio between the net profit and cost of investment resulting from an investment of some resource. A high ROI means the investment's gains compare favorably to its cost. As a performance measure, ROI is used to evaluate the efficiency of an investment or to compare the efficiencies of several different investments. In purely economic terms, it is one way of relating profits to capital invested.

What is Return on Investment (ROI)?

It is a performance measure used to evaluate proficiency of an investment or compare the competence of different investments. It measures the amount of return on an investment associated with the investment cost.

"Gain from Investment" in the above formula refers to profits that are obtained from sale of investment of interest. As ROI is measured as a percentage it can be compared with returns from other investments thereby allowing one to measure various types of investments against one another.

Breaking down ROI

ROI is a well-known metric due to its flexibility and effortlessness. Return on investment can be calculated and interpreted easily besides being applied to wide range of investments. In case the investment does not have positive ROI and other opportunities available with higher ROI, then ROI values could initiate the person to an investment that are preferable to other.

Limitations of ROI

ROI inherently accounts for an amount of time during which investment in question takes place. This metric is often used in conjunction with rate of return that essentially pertains to specified period of time unlike ROI. One can also incorporate Net Present Value that accounts for differences in the value of money over time due to inflation or sometimes due to precise ROI calculations. The application of Net Present Value while calculating rate of return is often called as the Real Rate of Return.

It is important that you keep in mind the meaning of calculating a return on investment and its definition which can be altered to suit the situation. Everything depends on what one includes as costs and returns. The definition of the term in simple words attempts to measure the profitability of investment and there is no one standard calculation.

While using ROI to assess investments in real estate, one uses initial purchase price of the property as the cost of investment and the ultimate sale price as the gain from investment, though it fails to account for all the intermediary costs like property tax, renovation and real estate agent fees. This flexibility puts forth another limitation of using ROI. These ROI calculations are easy to manipulate to suit the user’s purpose and the results can be expressed in different ways. While using the metric, the investor makes sure that he understands the inputs being used. Just the return on investment ratio cannot paint a picture that looks quite different from what one may call an accurate ROI calculation. Incorporation of relevant expenses goes into the maintenance and development of an investment over a period of time.

Developments in ROI

Many investors and businesses today have taken keen interest in the development of new forms of ROI metric known as "Social Return on Investment". This was initially developed in the early 00s and takes into account social impacts of projects and works towards including those affected by the decisions in planning the allocation of capital and other resources

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Further Reading


A systems approach to measuring return on investment for HRD interventions
onlinelibrary.wiley.com [PDF]
… Considering the characteristics of ROI in the HRD field, we redefine return on investment for an HRD program as any economic returns, monetary or non- monetary, that are accrued through investing in the HRD interventions …

Average internal rate of return and investment decisions: a new perspectiveAverage internal rate of return and investment decisions: a new perspective
www.tandfonline.com [PDF]
… Considering the characteristics of ROI in the HRD field, we redefine return on investment for an HRD program as any economic returns, monetary or non- monetary, that are accrued through investing in the HRD interventions …

Social return on investment (SROI) and performance measurement: The opportunities and barriers for social enterprises in health and social careSocial return on investment (SROI) and performance measurement: The opportunities and barriers for social enterprises in health and social care
www.tandfonline.com [PDF]
… Considering the characteristics of ROI in the HRD field, we redefine return on investment for an HRD program as any economic returns, monetary or non- monetary, that are accrued through investing in the HRD interventions …

Social enterprise and the measurement of social value: methodological issues with the calculation and application of the social return on investmentSocial enterprise and the measurement of social value: methodological issues with the calculation and application of the social return on investment
www.tandfonline.com [PDF]
… Considering the characteristics of ROI in the HRD field, we redefine return on investment for an HRD program as any economic returns, monetary or non- monetary, that are accrued through investing in the HRD interventions …

The decomposition of return on investment for forensic laboratoriesThe decomposition of return on investment for forensic laboratories
www.tandfonline.com [PDF]
… Considering the characteristics of ROI in the HRD field, we redefine return on investment for an HRD program as any economic returns, monetary or non- monetary, that are accrued through investing in the HRD interventions …

The rate of return on investment in wineThe rate of return on investment in wine
onlinelibrary.wiley.com [PDF]
… Considering the characteristics of ROI in the HRD field, we redefine return on investment for an HRD program as any economic returns, monetary or non- monetary, that are accrued through investing in the HRD interventions …

Do global firms measure expatriate return on investment? An empirical examination of measures, barriers and variables influencing global staffing practicesDo global firms measure expatriate return on investment? An empirical examination of measures, barriers and variables influencing global staffing practices
www.tandfonline.com [PDF]
… Considering the characteristics of ROI in the HRD field, we redefine return on investment for an HRD program as any economic returns, monetary or non- monetary, that are accrued through investing in the HRD interventions …

Aggregate return on investment and investment decisions: A cash-flow perspectiveAggregate return on investment and investment decisions: A cash-flow perspective
www.tandfonline.com [PDF]
… Considering the characteristics of ROI in the HRD field, we redefine return on investment for an HRD program as any economic returns, monetary or non- monetary, that are accrued through investing in the HRD interventions …

Empirical models of the effect of integrated manufacturing on manufacturing performance and return on investmentEmpirical models of the effect of integrated manufacturing on manufacturing performance and return on investment
www.tandfonline.com [PDF]
… Considering the characteristics of ROI in the HRD field, we redefine return on investment for an HRD program as any economic returns, monetary or non- monetary, that are accrued through investing in the HRD interventions …



Q&A About Return on Investment


Is there only one way to calculate ROI?

There are many ways to calculate ROI. It depends on what costs and returns you include in your calculation. You can also change how you define these costs and returns based on your situation.

What is included in the definition of return on investment?

Return on investment includes all profits gained from selling an investment, as well as any interest earned over time during which an investor holds onto their initial investment. This definition allows investors to consider both short-term gains and long-term gains when calculating their return on investments. Some investors may choose not to include interest earned over time, while others may choose to do so depending upon their personal preferences and financial situations.

What is the definition of return?

Return is the amount of profit on an investment.

What are some examples used to measure rates of returns over time periods?

Examples include years, months, quarters, and weeks.

What does a return include?

A return includes any change in value and cash flows from an investment such as interest payments, dividends, or the payoff from a derivative or structured product.

What is the formula for ROI?

The formula for ROI is "Gain from Investment" / "Investment Cost".

How can you compare returns over time periods of different lengths on an equal basis?

You can convert each return into a rate of return over a period of time using standard length. The result is called the rate of return.

What does ROI measure?

ROI measures the profitability of an investment.

How can you interpret a positive or negative value of ROI?

A positive value indicates that the investment was profitable, while a negative value means it wasn't.

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