Return on Investment (ROI) - Explained
What is a ROI?
If you still have questions or prefer to get help directly from an agent, please submit a request.
We’ll get back to you as soon as possible.
- Marketing,
Return on Investment (ROI) - Explained
What is a ROI?
If you still have questions or prefer to get help directly from an agent, please submit a request.
We’ll get back to you as soon as possible.
- Marketing, Advertising, Sales & PR
- Accounting, Taxation, and Reporting
- Professionalism & Career Development
Law, Transactions, & Risk Management
Government, Legal System, Administrative Law, & Constitutional Law Legal Disputes - Civil & Criminal Law Agency Law HR, Employment, Labor, & Discrimination Business Entities, Corporate Governance & Ownership Business Transactions, Antitrust, & Securities Law Real Estate, Personal, & Intellectual Property Commercial Law: Contract, Payments, Security Interests, & Bankruptcy Consumer Protection Insurance & Risk Management Immigration Law Environmental Protection Law Inheritance, Estates, and Trusts
- Business Management & Operations
- Economics, Finance, & Analytics
Table of ContentsWhat is Return on Investment?Example of Return on InvestmentHow is Return on Investment Used?Academic Research on Return on Investment
What is Return on Investment?
Return on investment (ROI) is a profitability ratio used for measuring the amount of profit generated by an investment relative to its cost. It evaluates the cost efficiency of an investment and is expressed as a percentage or ratio.
How to Calculate ROI?
It is calculated as the return of an investment divided by the cost of the investment. The formula for computing the ROI is,
ROI = Profit Margin / Cost of Investment
ROI = (Gain from Investment - Cost of Investment) / Cost of Investment
The gain on investment is the increase in value of an asset. The gain on investment minus the cost of investment is known as the profit margin.
If the investment is in products to be sold (rather than a single asset), then you will need to know the total quantity of goods purchased for sale and the total sales volume. This is important, as the cost of investment will include all products purchased. Your profit margin will be determined based upon how many items you sell.
Back to:INVESTMENTS & TRADING
Using ROI to Evaluate Performance of an Investment Center
If you are using ROI to evaluate the performance of an investment center in a company, you may see the equation as:
Return on investment = Operating income / Average operating assets
This measure provides an assessment of how effectively each division is using operating assets to produce operating income.
ROI can also be broken into two separate ratios, operating profit margin and asset turnover, which are multiplied together to get ROI as follows:
Return on Investment = Operating income / Average operating assets
Operating profit margin = Operating Income / Sales
Asset turnover = Sales Average / Operating Assets
Many variations of the ROI calculation are used in practice depending on the nature of the organization.
Operating income is the income produced by the division from its daily activities.
It excludes items used in the calculation of net income, such as income tax expense, interest income, interest expense, and any unusual gains or losses.
The focus is on how well the division performed relative to its core business operations, which does not include one-time gains or losses from the sale of property, plant, and equipment for example.
Average operating assets are the assets that the division has in place to run the daily operations of the business, and this value is calculated by adding beginning period balances and ending period balances and dividing by two.
Examples of operating assets include cash, accounts receivable, prepaid assets, buildings, and equipment.
As long as the division uses the assets to produce operating income, they are included in the operating assets category.
Examples of non-operating assets—assets not included in this calculation—include land held for investment purposes and office buildings leased to other companies.
An average of operating assets is taken over the period being evaluated for two reasons.
First, operating assets are often purchased and sold during an accounting period, and simply taking the ending balance might produce distorted, if not inaccurate, results.
Second, operating income represents information for a period of time (income statements always present information for a period of time), while operating assets are presented at a point in time (balance sheets always present information for a point in time).
If both of these items are to be included in one ratio (ROI), it is best to use average balance information for balance sheet items.
In fact, if the information is readil