As an investor, you will want to know that the company you are placing your bets on will bring a high return. Regardless of you are a bondholder or a shareholder, a high return on investment will ensure that you are actually profiting from this business. This is particularly why you might want to make some calculations before chipping in with your cash.
What Is ROI?
The return on investment (ROI) is a ratio that expresses the profitability of a company – the result being a percentage from the original costs. To put it as plainly as possible, this ratio tells you exactly how much you made in cash from the investment – as a percentage resulted from the purchase price.
The ROI formula will tell every investor how efficient every dollar is in creating a profit for the company. Technically speaking, investors don’t apply this formula just to see how well a company performs; they do it for comparing their performance with other investments – regardless of their sizes and types.
For instance, a stock investment may be easily be put in comparison with an equipment investment. The type of investment matters too little, mainly because the measurement only looks at their costs and profits that have been associated with the said investment.
Having said that, the ROI calculation is very useful mainly because if its simplicity and versatility. A manager can use it to compare the capital performance rate of the equipment while an investor can see precisely what stocks are likely to perform better.
The Formula
One can get the return on investment by subtracting the investment cost from the investment revenue – and then dividing everything by the total investment cost. As a result, the formula looks exactly like this:
As you may have noticed, the formula is very simple to apply – as long as you have the data available. Granted, depending on the individual, total revenues and total costs can mean two entirely different things. For example, an accountant of the company may add the costs of goods sold and net sales as total revenue and expenses. On the other hand, an investor may take a more global look at the formula, using the gross sales and all the other expenses that were involved in creating or selling a certain product. This will include both operating and non-operating costs.
This is why the ROI formula is such a versatile tool – but can also be fairly manipulative, depending on the results that you are looking for. There is no particular equation for providing the return on investment. However, it does provide a basic idea on the income profits.
To get a true understanding of your return on an investment, you ought to know precisely what costs and revenues should be used in the equation. This can differ from purpose to purpose – so you need to know your target. This may also depend on whether you are the company manager or just someone planning to invest in a particular firm.