Return on Investment (ROI): Definition, Formula, Example

The ROI of a corporation is not just an investment, it’s the return on that investment. Corporations are always looking for ways to grow their profits and this is done through different strategies. It helps businesses consider all of the different investment options that will help their company earn the most.

In business analysis, ROI plays a vital role for companies seeking to maximize their profits. Since it is the primary measure of profitability, ROI is used in comparisons with other potential investments and when forecasting possible future scenarios.

In this article, we will explore the basics of Return On Investment. We will also look at its formula and some examples. So let’s get started!

What is Return on Investment

The Return on Investment (also known as ROI) is a performance measure used to quantify the return achieved from an investment and is expressed as a percentage or ratio. In layman’s terms, it can be thought of as how much money one gets back from their initial investments.

In more simple words, to make more profit corporations invest in smaller companies and their products that have potential. Then they use ROI as a metric to determine whether the investment was well worth it.

In short, it is a performance measure used to assess how efficiently an investment brings about a benefit. ROI is expressed as a percentage or ratio reflecting the rate of return gained on an investment relative to its cost or value.

Importance of ROI

  1. Return on Investment is used to compare the efficiency of different investments. It is also useful in determining which projects are worth pursuing. ROI can be used to compare similar companies, look at trends over several years, and view how a company compares against its competitors.
  2. ROI is one of the most frequently referenced performance measures for private companies in venture capital. The VCs want to know if their investment will yield a sizable return.
  3. ROI is also used by analysts to determine if stock prices are too high or low and by the managers of companies who would like to acquire other firms.

How to calculate Return on Investment

There are two ways you can measure ROI

  1. ROI = (Net return on investment / cost of investment) x 100%
  2. ROI = {(Final value of investment – Initial value of an investment) / Cost of investment} x 100%

Examples

Let’s say you bought 1,000 shares of a company at $10 per share. After one year, you sold the shares for $12. You also earned dividends of $500 for holding the shares for a specific period. You also spent a total of $125 on commissions to buy all the 1000 shares of that company.

The calculation of ROI is as follows

ROI formula = (Net return on investment / cost of investment) x 100%

Net return on investment = ($12−$10)×1000+$500−$150 = $2400

Cost of investment = $10×1000 = $10,000

ROI = ($2400 / $10,000) x 100% = 24%

As you can see from the calculation, your ROI is 24%.

Conclusion

So there you have it. In this article, we talked about what ROI is and how it works. We also went over the formula for calculating your ROI and some examples to help you better understand the concept of return on investment in corporate finance.

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