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What Is The Return On Investment?
The return on investment can be defined as the amount or percentage of profit that has been obtained from an investment. It is the ratio that highlighted the amount of return on any investment relative to the investment cost. The ROI can be calculated on a monthly, quarterly, and yearly basis. The higher the amount that has been obtained as investment return, the greater the profit it is considered. At the same time, it is to be noted that the return on investment is not necessarily the same as profit.
How To Calculate Return On Investment?
The concept of ROI is straightforward to understand. It is the benefit which you have received on your investment. However, ROI can be calculated when you subtract the initial value of investment from the final value of an asset, and as a result, your Net income will be extracted. Then you’ll divide that net income with the actual cost of investment and then finally multiply it by 100.
For instance, you are the restaurant owner, and you have invested 500$ to buy a point Sale software for restaurants. The revenues of the restaurants were 1000$ before. After an investment of 500$, the gains that were generated were 1500$.
Hence the Return on investment would be
Gain from the investment - the cost of investment/ cost of investment x 100
1500$-500$/ 500$ x 100
1000$/500$ x 100
ROI = 200%
Hence, after installing the point of sale software, the restaurant revenues increase to 200% of the total sales. So they have gained a 200% return on their investment.
Whereas, Gain from the investment - the cost of investment= Net income.
Therefore, the return on investment can be calculated with the very most straightforward formula, which is highlighted below:
(Net Income/ Capital Cost) 100 = Return on Investment
(Investment Gain/ Investment Base) 100 = Return on Investment
Benefits Of Return On Investment
There are different benefits of return on investment, but the most prominent ones are:
The Return on investment is very beneficial for the businesses because it keeps a business person informed about their loss of profits.
It is very easy to calculate and understand.
ROI is a universal measure of calculating the returns.
Disadvantages Of Return On Investment
Some of the drawbacks of return on investment are mentioned below:
There is sometimes room for error in calculator ROI that creates misperceptions.
ROI lacks room for a holding period. Hence it disregards the factor of time.
The return of investment formula is sometimes susceptible to manipulation, and it involves the risk of managerial fraud.